SVB, USDC & Lifehacks
“Desire makes everything blossom, possession makes everything wither and fade,”?- Proust
“Do your own thinking independently. Be the chess player, not the chess piece.”?- Ralph Charell
Have a read of my thought piece "On Gratitude": https://mohamedaudomar.substack.com/p/on-gratitude
Macro / Finance
SVB Goes Up in Flames
We just had the biggest bank collapse in America since 2008. And it happened because of a bank run.
That bank: Silicon Valley Bank (SVB). SVB is imploding before our eyes; let me tell you how SVB threw 50 years of goodwill and $80 billion down the drain in just 30 hours…
Imagine SVB was named in Forbes’ Annual ranking of Americas Best Bank - 5, yes, 5 days ago!
To understand this situation is to understand SVB's place within the startup ecosystem SVB situated itself as the bank for founders. Just signed a fat Series A??Put the money in SVB. And lots of people we're signing fat Series A's back at the start of the pandemic. Deposits in SVB grew from $60 billion in 2019 to over $189 billion in 2022, with all that money rolling in, SVB wanted to put the money to work and they ended up buying $80 billion in Mortgage Backed Securities (MBS) with an average yield of 1.5%.
With interest rates at historic lows, that 1.5% yield didn't look half bad BUT the?interest rates started to rise:
With every rate hike, the $80 billion SVB had locked up looked worse and worse and then deposits also started to fall. Those absurd valuations and checks startups were getting? They came back down to earth which means SVB wasn't getting the inflows it once was.
Since it was in a more precarious position than before, SVB decided to sell some securities (at a loss) in order to give themselves a little breathing room, the idea was to free up more capital and improve their liquidity.
Turns out that was a HUGE mistake, even though SVB didn't have a liquidity problem, investors got spooked and reacted as if it did (ironically enough this is a few weeks after Cramer gave the GREEN light for SVB stock being an easy buy):
A hilariously bad and convoluted press release on Thursday (09/03/22) only served to make investors more nervous, over the past two trading days SVB is down over 70% and its still falling… As the stock continues to free fall, SVB has wisely decided to scrap its capital raise not because they realized it was a bad idea but because they are now considering a sale.
All of this has obviously spooked founders as well, lots of VCs have jumped in to advise founders to get their money out of SVB that's sparked a bank run (one thing you don’t want during a bank run is the perception of risk that the bank is likely to fail regardless of actual level of risk).
Making matter worse, only 2.7% of SVB deposits are FDIC insured, whilst 97.3% aren't:
It's truly wild, absolutely insane that SVB went from one of the most important banks in the startup world with 8,500 employees, to being sold for scraps in the span of 30 hours, 30 hours?! The impact this is having on the startup community in Silicon Valley is incredible.
To put into context how quickly the castle fell Google couldn’t even populate the daily stock chart for SVB right now, its falling so fast:
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My thoughts:
One deep look at their financial statement reveals how horrific they were at risk management, that being SVB. And in my opinion incompetence explains only part of it, moral hazard must have been at play. What SVB did with their portfolio is either a signal of enormous incompetence or of outright moral hazard at play – by gambling away billions one the assumption that?policymakers will rescue you.
As a result of regulation, banks have flushed their balance sheets with trillions of bonds. Such a large amount of bonds on the balance sheet also comes with risks though, right? From a governance point of view it’s their job to account for such material risks. One being interest rate risk: if you purchase Treasuries and yields rise, you lose money. It’s easy maths to be quite Frank.
That’s why banks hedge the lion share of the interest rate risk coming from their bond investments. The mechanism is simple. When you buy Treasuries, you lock in a fixed yield you receive and rising interest rates represent a risk.
To hedge that risk
You enter into an interest rate swap: this time, you pay away a fixed yield and receive variable payments in exchange. There you go: you received a fix rate when buying Treasuries and you pay a fixed rate in the swap – Voila! A hedge.
Now, where did SVB go wrong? SVB had a gigantic investment portfolio as a % of total assets at 57% (average US bank: 24%) and 78% was in Mortgage-Backed Securities (JPM: around 30%). But most importantly, they DID NOT hedge interest rate risk at all! The duration of their huge portfolio before and after interest rate hedges was…the same?! Yes, THE SAME. Effectively, there were NO hedges. So, SVB was not applying basic risk management practices, and exposing its investors and depositors to a gigantic amount of risk. Not good.
Bailout I hear you say? But the evidence that moral hazard was at play are too big to be ignored. And we should not reward moral hazard. Not now, not ever.?I am not against depositor bailouts; I am against bankers bailouts. The solution we arrived at seems to be different from the traditional bailouts we are used to; and a good one at that.
Unlike in 2008, SVB and Signature investors are taking a loss, and executives at the banks will be fired. “That’s how capitalism works,” President Biden said, referring to the fact that shareholders won’t get a free pass for their financial flops (sorry if you took Jim Cramer’s advice). The Treasury Department is also stressing that this time the recovery money is not from taxpayers but from an FDIC fund that banks pay into.
However, there’s no free lunch for taxpayers (ever)…banks may have to shell out extra cash to the FDIC to make SVB and Signature clients whole, which could ultimately come out of their customers’ pockets.
Tech / A.I. / Crypto
USDC lives to fight another day
Another financial panic played out this weekend, but this time crypto didn't take centre stage. Nevertheless, it was a riveting performance as actor in a supporting role.
Usd coin (USDC), the world's second-largest stablecoin, lost its peg this weekend, but has since recovered — as of this writing it trades at a?premium?to a dollar, at $1.01.
Essentially, stablecoins are where crypto investors retreat in times of uncertainty. Confidence in their parity with the dollar is central to attracting serious investors to the asset class, providing an off-ramp to volatility elsewhere in the sector. At issue was the fact that Circle had $3.3 billion (about 8%) of its reserves parked at Silicon Valley Bank (SVB), which the FDIC took over Friday.
? During the weekend, uncertainty over the fate of that cash drove USDC as low as $0.88?on CoinGecko, but mostly it hovered around the $0.95 range.
? But then the Biden administration and banking regulators announced that they were invoking emergency provisions to guarantee all deposits at SVB, even those above the $250,000 maximum guarantee.
It must have been a very long weekend at Circle, the main stewards of USDC. The world's No. 2 stablecoin has a market cap over $40 billion and has been waiting in the wings to seize the top spot from tether. Circle had bet that its regulator-friendly strategy would inevitably engender more trust than the dominant option, which operates more like a shadow bank. USDC is designed to maintain a peg of $1. Each token is backed by dollars or treasuries held at various banking institutions. SVB was just one. It's such a big deal if a stablecoin loses its peg. Why is that you may ask?
Firstly, let’s begin with this analogy: Imagine you're building a house of cards. You carefully stack each card on top of the other, making sure everything is perfectly balanced. Finally, you step back to admire your work, but suddenly the ground beneath you starts shaking. The cards start wobbling, and before you know it, the whole house comes crashing down.
In this analogy, the stable coin is like the base card of the house of cards. It provides stability and balance to the entire system. But if the stable coin de-pegs from its intended value, it's like the ground beneath the house of cards starting to shake. Suddenly, the entire system becomes unstable, and the value of the stable coin and other cryptocurrencies tied to it can come crashing down.
Just like how a house of cards needs a strong and stable base to remain standing, the cryptocurrency ecosystem relies on stable coins to provide a foundation for trust and stability. Without that foundation, the entire system can quickly become chaotic and unpredictable, with potentially disastrous consequences for investors and the wider economy.
Beyond the analogy, anyone who sold all their bitcoin for USDC in October was suddenly 5% poorer all weekend?(which doesn't feel great). It's very bad for lenders in DeFi. Imagine a borrower had taken out a $1 million loan in USDC. They don't actually owe $1 million. They owe a million USDC. So, all weekend long, they could repay that loan at an unexpected 5% discount. Only 8% of usd coin's reserves were in clear jeopardy this weekend, so, in a perfectly rational world, the token should have never fallen further than $0.92 until the SVB exposure got resolved. Investors who believed Circle could fix this got an easy 5% or more return this weekend by simply buying USDC and selling this morning when banks re-opened.
What I read
“All courses of action are risky, so prudence is not in avoiding danger (it's impossible), but calculating risk and acting decisively. Make mistakes of ambition and not mistakes of sloth. Develop the strength to do bold things, not the strength to suffer.”?- Niccolo Machiavelli
With that, have a creative week,
M