wknd notes: The Bigger the 'Big' in 'Go Big'

“The overuse of the term moral hazard is distracting at best,” said the Chairman, no stranger to leading the nation though financial crises. “And at worst, it will lead to bad policy,” he said. “Moral hazard is when you knowingly take a risk in the expectation that if it goes wrong, others will bear the consequences,” he explained. “In this case, depositors were unaware of the risks, and never expected that they would bear the consequences of a bank run or much yet shift those consequences to others.”

Overall: “Will the deposits in every community bank in Oklahoma, regardless of their size, be fully insured now? Will they get the same treatment that SVB just got, or Signature Bank just got?” asked Senator James Lankford in Thursday’s hearing. “A bank only gets that treatment if a majority of the FDIC board, a super majority of the Fed board and I, in consultation with the president, determine that the failure to protect uninsured depositors, would create systemic risk and significant economic and financial consequences,” replied Treasury Secretary Yellen, answering Senator Lankford’s question with the precision of a Yale economics PhD. “So, what is your plan to keep large depositors from moving their funds out of community banks into the big banks? We have seen the mergers of banks over the past decade, and I’m concerned you’re about to accelerate that by encouraging anyone who has a large deposit in a community bank to say, ‘We’re not gonna make you whole but if you go to one of our preferred banks, we will make you whole at that point,’” continued Lankford, his master’s degree in divinity more than adequate to deal with such an obvious economic issue. “Look, I mean that’s certainly not something that we’re encouraging,” answered Yellen earnestly, truthfully. “That is happening right now!” barked Lankford, interrupting the Treasury Secretary. And he is entirely correct. Our policymaker’s intent is irrelevant in times like these, because of course, bank runs are wild stampedes, avalanches, volcanoes, bursting dams. A crisis of confidence cares nothing of noble designs. “That is happening because depositors are concerned about the bank failures that have happened and whether or not other banks could also fail,” said Yellen. “No, it’s happening because you’re fully insured no matter what the amount is if you’re in a big bank, and you’re not fully insured if you’re in a community bank,” explained Lankford.

Week-in-Review: Mon: regulators scramble to find solution to SVB issues / all deposits guaranteed at SVB and Signature Bank / Fed and Treasury announce new BTFP program (longer term discount window effectively), US 2y yields fall 61bp – largest decline since 1982, Xi plans to meet with Zelenskiy, Israel 4Q GDP 5.6% (5.8%p), Turkey CA bal -9.85b (-10.1b exp), India CPI 6.44% (6.4%e), Mexico IP 2.8% (2.4%e) / mfg prod 4.8% (3%e), S&P -0.2%; Tue: US CPI 6% as exp / Core CPI 5.5% as exp, Japan 10y falls below 25bp amid global bond rally, concerns around Credit Suisse viability increase, Riksbank’s Thedeen reiterates inflation “is still far too high”, Putin alleges explosive devices used on NS pipelines, NZ House sales -31.1% (-27%p), Australia cons conf unch at 78.5, UK emp change 98k (65k exp) / unemp 3.7% (3.8%e), Italy IP 1.4% (2.9%e), S. Africa mining prod -1.9% (-2.8%e) / mfg prod -3.7% (-5.2%e), US NFIB 90.9 (90.3e), S&P +1.7%; Wed: PBOC keeps 1y MLF unch as exp but larger injection of liquidity than exp ($41b), Saudi National bank – largest shareholder – rules out more investment in Credit Suisse / asks SNB for public show of support / SNB says it will provide liquidity if necessary, IEA says oil market in surplus due to Russia supply, FRC cut to junk by S&P / weighing options including a sale, US demands TikTok owner to sell stake or face a ban, Argentina CPI 102.5% (101.2%e), S. Korea unemp 2.6% (3%e), China IP YTD 2.4% (2.6%e) / ret sales YTD 3.5% as exp, Sweden CPIF 9.4% (9.2%e), EU IP 0.9% (0.3%e), S. Africa ret sales -0.8% (-2%e), US PPI 4.6% (5.4%e) / Core PPI 4.4% (5.2%e), US ret sales -0.4% as exp / Control group 0.5% MoM (-0.3%e), US NAHB housing mkt index 44 (40e), Israel CPI 5.2% (5%e), S&P -0.7%; Thu: ECB hikes 50bp as exp / avoids committing to further hikes, SNB provides $54b of credit to CS, Indonesia CB unch as exp, large US banks to deposit $30b with FRC, Fed’s excess reserves grow as discount window borrowing increases / “only” ~$12b borrowed via the new BTFP facility (~153b via discount window), N. Zealand 4Q GDP 2.2% (3.3%e), Japan machine orders 4.5% (-3.9%e), Australia emp change 64.6k (50k exp) / unemp 3.5% (3.6%e), HK unemp 3.3% as exp, US init claims 192k (205k exp), US impt prices -1.1% as exp, US housing starts 1.45m (1.31m exp) / permits 1.524m (1.343m exp), US Philly Fed -23.2 (-15e), S&P +1.8%; Fri: PBOC cuts RRR 25bp, Japan Shunto wage negotiations settle at 3.8% (2.95% exp) – largest rise since 1993, Xi to visit Russia Mar 20-22, Russia CB unch as exp, Turkey to ratify Finland’s NATO membership, ECB’s Kazimir says financial mkt events haven’t altered his view that rates need to continue rising, Singapore non-oil expts -15.6% (-15.8%e), Sweden unemp rate 7.6% (7.3%e), EU final Feb CPI 8.5% as exp / Core CPI 5.6% as exp, Brazil unemp 8.4% (8.2%e), US leading index -0.3% as exp US UofM 63.4 (67e) / 1y infl exp 3.8% (4.1%e) / 5-10y infl exp 2.8% (2.9%e), S&P -1.1%; Sat: UBS in talks to acquire all or part of CS, Warren Buffett in contact with Biden team on banking crisis.

Weekly Close: S&P 500 +1.4% and VIX +0.71 at +25.51. Nikkei -2.9%, Shanghai +0.6%, Euro Stoxx -3.8%, Bovespa -1.6%, MSCI World +0.8%, and MSCI Emerging -1.5%. USD rose +4.1% vs Chile, +2.2% vs Mexico, +1.2% vs Brazil, +1.2% vs Russia, +0.9% vs South Africa, +0.6% vs India, and +0.2% vs Turkey. USD fell -24.6% vs Bitcoin, -18.1% vs Ethereum, -2.4% vs Yen, -2.1% vs Sweden, -1.7% vs Australia, -1.2% vs Sterling, -0.7% vs Canada, -0.7% vs Indonesia, -0.4% vs China, and -0.3% vs Euro. Gold +5.6%, Silver +9.5%, Oil -13.0%, Copper -3.4%, Iron Ore -2.5%, Corn +2.8%. 10yr Breakevens (EU -20bps at 2.20%, US -19bps at 2.10%, JP -2bps at 0.65%, and UK -14bps at 3.52%). 2yr Notes -75bps at 3.84% and 10yr Notes -27bps at 3.43%.

Year-to-Date Equities (high to low): Ireland +12.2% priced in US dollars (+12.6% priced in euros), NASDAQ +11.1% priced in dollars, Mexico +10.7% priced in dollars (+7.1% priced in pesos), Taiwan +9.9% (+9.3%), Czech Republic +9.8% (+9.6%), Greece +9.3% (+9.7%), Italy +7.2% (+7.5%), Euro Stoxx 50 +6.8% (+7.2%), France +6.6% (+7%), Germany +5.7% (+6.1%), Spain +5.6% (+6%), China +5.4% (+5.2%), Netherlands +4.5% (+4.9%), Japan +3.9% (+4.7%), Korea +3.6% (+7.1%), MSCI World +2.9% priced in dollars, Russia +2.4% (+7.8%), S&P 500 +2%, Denmark +1.6% (+2%), Sweden +1.5% (+2.2%), New Zealand +0.9% (+2.2%), Philippines +0.3% (-1.5%), Austria -0.4% (-0.1%), UK -0.9% (-1.6%), Chile -0.9% (-2.8%), Canada -1.4% (+0%), Indonesia -1.7% (-2.5%), Switzerland -1.7% (-1.1%), HK -1.9% (-1.3%), Portugal -2% (-1.6%), Russell -2%, Singapore -2.2% (-2.1%), Australia -2.2% (-0.6%), Poland -2.9% (-2.1%), Belgium -3% (-2.7%), Venezuela -3.5% (+37.6%), Finland -4% (-3.6%), Argentina -4.4% (+9.7%), Thailand -4.6% (-6.3%), Saudi Arabia -4.7% (-4.8%), India -5.4% (-5.6%), UAE -5.5% (-5.5%), Brazil -6.8% (-7.1%), Hungary -7% (-6.9%), South Africa -7.2% (+0.1%), Malaysia -7.3% (-5.6%), Turkey -8.2% (-6.8%), Israel -9.5% (-5.7%), Norway -11.6% (-3.7%), Colombia -13.5% (-13.7%).

Boring: “What is our total exposure?” I had asked our COO as the Silicon Valley Bank run was intensifying, two Thursdays ago. All our client money is held in our investment funds, and excess fund cash is in T-Bills for security, so I wasn’t asking about that. I was asking about cash that our firm had on deposit at a commercial bank. Like so many other small and medium sized businesses, that in aggregate make up the US economy, we turned to a local bank when we started the firm in Santa Barbara, California, 10 years ago this week.

Boring II: The next day (Fri morning) I faced an important decision. We had millions of dollars in cash on deposit at the bank. Two-thirds of it was scheduled to be swept out for payroll and other accounts payable on Monday. The remaining third was earmarked for payments a week later. If we immediately wired the money out of our bank, we would miss payroll and this would hurt our employees, at least some of whom would then miss their mortgage payments and other payables. But if we kept the money on deposit and the bank failed, it was a material problem.

Boring III: If our bank had been SVB, I would have wired it out immediately. But it was another regional name, and I figured that even if the government failed to agree on a weekend bailout, our bank would probably survive long enough on Monday for our payroll to go out. So, we sat tight with the payroll money and moved the remaining one-third into T-Bills. Our COO had already started the process of opening new accounts at a Tier-1 bank; one of the too-big-to-fail affairs that are now politely called SIBs (systemically important banks).

Boring IV: Our bank’s stock price collapsed on Monday and will almost certainly not survive this bank run in its present form. But our payroll went out on time. Had it not, I would’ve lent money to our firm to pay our employees, and then waited an indeterminate period to get money back from the bank, less a haircut. We got paid absolutely nothing to take all these risks. In fact, by moving our money to a SIB and then sweeping excess cash into T-Bills, we will get paid a lot of money on our cash. Rarely in life do you get paid more to take less risk. You do now.

Boring V: Business owners take a lot of risk, endure sleepless nights. Our commercial banks are central to business. We want banks to operate flawlessly and be as boring as possible. But now our banks scare us. So, we will move to SIBs unless the government provides immediate blanket guarantees to all depositors. But even so, most of us will still now move, because we get paid nothing to stay. And US banking will be forever changed. Power will concentrate further into SIBs. Credit creation will suffer profoundly, and economic dynamism with it.

Anecdote: “They went big last weekend, which was the right thing to do,” said the Chairman, a veteran of financial crises, the two of us discussing the ongoing bank run, how policy can end it. “But the market always tests statements of confidence, whether from companies or the government,” he continued. “This week, at the first real test, policymakers mumbled.” Treasury Secretary Yellen’s responses to Senator Lankford in Thursday’s Senate hearing gave a glimmer of light to the worst fears of small business owners and savers at America’s non systemically important banks. The administration’s failure to dash these fears for depositors of $2, $5, $10 million has created a two-tier banking system in which the big banks are safe and most others are not. “The American people should know that the banking system, which is at the core of our economy, is a safe place for them to keep their money. And this is particularly true for the middle class and small business owners, who generally do not have easy access to treasuries. The idea that their banks are unsafe for their day-to-day operations and needs is absurd.” How we got here and how to prevent a repeat is a matter for another day. The fear and potential damage must be stemmed immediately. “For regulators and policy makers in times of stress, silence is the reward for good work,” said the Chairman. “In 2020, we went big on everything. The times called for it. For example, can you imagine if we had allowed the entire airline industry to be liquidated?” The cost of restarting the world’s largest economy with a severely crippled airline industry would have been staggering. “So, despite last weekend’s actions, deposits are flowing from small banks to large ones, and deposits at big banks are shifting into treasuries. The decisions that drive these flows are binary and irreversible. These are not tactical portfolio shifts of a percent or two, these are not moves to slightly trim exposure to small banks. These are zero-to-one decisions, all-or-nothing shifts,” said the Chairman. “The market is testing whether they will go big again. And the longer it takes them, the deeper the damage, and the more aggressively they will need to go, the bigger the “big” in go big.”

Good luck out there,

Eric Peters

Chief Investment Officer

One River Asset Management

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