Risk Is Not a Four-Letter Word

(This originally ran at Empire Financial Research.)

I was talking to a friend earlier this week about all things Silicon Valley Bank ('SVB') and he said that 'people need to relearn what risk is'...

He was referring to the way SVB was handled, telling me...

The fact that guys who don't know how to run a bank just put us back into QE [quantitative easing] and thus subjecting us to a far greater problem down the road puts me somewhere between sad and infuriated.

Like quite a few folks I know, my friend thought the government missed a golden opportunity to teach everybody a lesson about risk by not letting SVB off the hook – even if it meant hurting depositors, who did nothing more than trust the bank rather than a mattress to keep their money safe.

After all, how often do banks fail... especially those seemingly as well capitalized as SVB? According to the chart below, until this year, not often – certainly not since the financial crisis, when new guardrails were put into place to avoid this very thing. Take a look...

Then again, those safeguards were meant for the?big?banks...

Nobody?had regional banks on their bingo card for the start of the next financial crisis, which thankfully (at least so far) was avoided.

And not just any regional bank, but one as concentrated as SVB was with so many payrolls. By this, I don't just mean the venture capitalists... but the cash used to pay all of the people – from the janitors on up – who work at companies that stashed their cash at SVB. By contrast, Silvergate (SI) – the crypto bank that failed a few days earlier – was considerably smaller, with a focus on crypto-related businesses. And it returned all of the money to its depositors.

By saving SVB depositors, my friend suggests rules requiring banks to value their assets based on current market pricing have become meaningless. As he puts it...

They just did away with mark-to-market on bank portfolios – one of the good things to come out of the GFC [Great Financial Crisis].

He's hardly the only one who thought the SVB rescue makes a mockery of banking rules, let alone the nature of insurance that supposedly covers up to $250,000 in losses.

As Ken Griffin, founder of the hedge fund Citadel, recently told the?Financial Times...

The U.S. is supposed to be a capitalist economy, and that's breaking down before our eyes...

There's been a loss of financial discipline with the government bailing out depositors in full.

And as short seller Carson Block of Muddy Waters said recently...

Forcing uninsured depositors to take haircuts, which will likely eventually be 10% to 20%, would reinforce the need for such risk management. Making them whole, rather, would send the message, once again, that mass failures of risk management don't matter because the government will backstop you.

Here's the thing, though...

While they may not be wrong in isolation, forcing depositors to take a hit wouldn't have played out so rationally in the real world... especially with social media, which can turn any molehill into a mountain.

There's no question the SVB situation exposes potentially broader underlying issues and concerns at regional banks. But there's also no question that had there been no intervention, by Monday the level of panic would've likely been extraordinary... not just by depositors freaking out about how they'll make future payrolls, but by?everybody?– wondering if they should start yanking money out of their banks.

That didn't happen, and we can now move on to the next crisis du jour... which very well could be bank related, as it was today in Europe with problems at Credit Suisse (CS).

In the meantime, moral hazard or no moral hazard, thanks to the SVB situation we know two things...

1. Bank deposits are starting to look like actual business transactions because they are. (The point is, depositors are not paid to take risk.?So, can you really force them to bear it?)
2. The U.S. Federal Reserve will likely wind up doing a better job of defining which funding vehicles are protected (deposits) and which aren't (everything else) because that was always the social contract.

But there's still the issue of risk... and not just risk associated with banks but investing in general.

If nothing else, this market is a lesson in and a reminder of risk, especially for investors who thought the market was a game or a joke or an easy path to riches. When money is free, it surely can be... but as so many newbie investors learned, danger lurks. As my friend went on to tell me...

The worst thing that can happen to a newish investor is to have early success. Good outcomes without process leads to bad habits and if unchecked becomes overconfidence – oftentimes with terminal results.

This can be a good thing, because making mistakes is how the best investing lessons are often learned. Just ask anybody who invested in the shares of SVB...

And while the market might be relieved, as this tweet from yesterday illustrates so well, beware...

If that isn't convincing enough, consider these comments from Guggenheim Partners CIO Anne Walsh, who earlier this week told her firm's clients...

The fallout from the SVB situation is still fluid, and we do not believe that this is a Lehman moment. It may, however, be a Bear Stearns moment.

The risks in the market that catalyzed the SVB collapse are still out there. Regulators have given financial market participants a break by backstopping the SVB depositors and creating the BTFP [Bank Term Funding Program].

Investors must remain alert to the disintermediation risks that have been brought on by the Fed's unrelenting and ongoing quantitative tightening.

Complacency is the investor's enemy.

So is forgetting the most basic of all investment rules, courtesy of my friend who is concerned about the lack of regard for risk...

Like the old expression... even the seemingly safest assets cease to be so when you pay the wrong price.

As it turns out, that might be the ultimate moral of the SVB story.

As usual, if you have any thoughts about anything you've read here – agree or disagree – send them along! You can comment below or e-mail me at [email protected].