Now that the Big Bond Bust has happened, as promised here, everyone wants to know how it happened. I want to know how on earth so many of them didn’t know it was going to happen — especially those who were supposed to be watching for this … including the regulators who were actively causing it?
What follows are some of the reasons:
SVB had well over a year to prepare its portfolio to engage with the Fed’s decision to lift the yields on Treasuries, but it took no action to do so. At the time of its collapse 55% of its assets were still invested in bonds, mostly at low-interest rates available over the time when they acquired those bonds that are impossible to sell without a loss when interest rates rise. 47% of SVB’s assets were in long-term bonds (over 5 years to maturity) — the kind that fare worse when you have to trade them during a time when rates have risen!
Tim Gramatovich, chief investment officer at Gateway Capital, told Insider that even though the Fed has been raising interest rates for a year, it was as if a higher-interest-rate landscape came as a surprise for SVB.
“For a $200 billion bank to have no interest rate risk controls is staggering,” he said. “And of course the regulators and rating agencies are allegedly engaged here too. Doing what, we aren’t sure.”
And, yet, they took no risk measures at all. SVB could have started to sell off its longer-term bonds in January of 2022, when the Fed made it clear to the entire world it would begin raising interest rates, and then reinvested the money in short-term bonds of ninety days or less. Why didn’t it?
One explanation would be arrogance. In a word, like so many investors over the past year that took heavy losses in bonds and stocks, they believed in the “Fed Pivot” narrative. (OK, that’s two words, so “arrogance.”) They weren’t reading this blog obviously, so they didn’t get it pounded into their heads that the Fed would “not pivot.” And it did not occur to them they could be wrong about that and, so, should take some conservative measures just to be on the safe side. They had a higher percentage of the wrong stuff on their books than anyone. That’s one big reason SVB was first to fold under the Fed’s new tightening regime.
Surely these people, whose job it is to deal daily in the US bond market and to work daily with the Federal Reserve System, were not ignorant enough to not realize bond prices would crash as the Fed raised rates. So, they must have believed the Fed would chicken out. So overconfident were they, they would actually “fight the Fed” as bankers because they believed they could, through sheer testosterone, keep doing as everyone believed in this era they could do in stocks as well — force a different reality because they were indomitable, indestructible and investment geniuses.
Of course the “Fed has our backs” narrative was part of the moral hazard that led so many to ignorantly believe the Fed would chicken out as soon as stocks fell 20%. Then 25%. Then? It was the now infamous “Fed pivot” narrative that addled their brains.
I know I couldn’t convince anyone who wanted to believe otherwise because they all knew they were right, too. The only ones convinced as they read anything I wrote were those already open to consider the fact that the Fed, like a slug, has laid a long slime trail of economic failures through its hundred-plus-year history. The Fed pivot-heads, who have been the vast majority, ignored the obvious fact that the Fed has a legal mandate to fight inflation, which clearly made this time different from all the times when there was virtually no inflation in the Fed’s environs. Many argued with me on a variety of sites that it was always ridiculous at all times to say, “This time is different.”
Well, it was different.
Team SV was also arrogant in that some employees informed the higher-ups of the considerable (obvious) risk from non-diversification, but the highly successful, much-lauded higher-ups didn’t listen to their lessers. They failed because of their arrogance.
When I’m talking with friends about what to do, they would say to me, ‘well, would you just let these companies fail?’
That’s the wrong question. These companies have already failed.
It’s not for me or anybody else to interfere with that – they have failed.
—Joseph Calandro, Jr, November 7, 2009
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