Sunday, March 12, 2023


Latest update: March 12th, 10:00pm EDT

The Minsky Financial Instability Hypothesis:

"If an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values"

FDIC Q42022 Banking Profile:

What follows is a summary of the current crisis and my best guess as to what happens next.

This past week, the FDIC warned THIS exact scenario could happen as a result of the fact that U.S. banks are sitting on RECORD unrealized losses:

"On Monday, the chairman of the Federal Deposit Insurance Corporation (FDIC)—the agency that backstops depositors—addressed risks U.S. lenders faced three years after the outbreak of the pandemic. Chief among them was the potential for a bank run."

Gruenberg warned these unrealized losses “weaken a bank’s ability to meet unexpected liquidity needs,” and cautioned that mapping out a strategy to fund themselves profitably would prove a “complex and challenging task”.


See chart above of unrealized losses. Among the various causes of this crisis, chief among the immediate risks is that these banks are sitting on gargantuan unrealized losses while still passing regular FDIC-conducted audits. In other words, the FDIC itself is to blame for this fiasco. Clearly the magnitude of potential losses dwarfs any prior period INCLUDING 2008. 

All that was required to bring down Silicon Valley Bank was a small deposit flight which was taking place anyways as their base of bankrupt Tech firms was steadily going out of business. That left them forced to raise capital and sell bonds at a loss, thus revealing the chasmic hole in their balance sheet which had been there all along. It's the exact same thing that happened to Bernie Madoff in November 2008, he ran out of cash to pay redemptions. 

Which gets us to what happens next?

Clearly the lessons of 2008 have long since been forgotten. Back then companies having deposits larger than the FDIC limit were forced to move these large deposits to multiple different banks in order to maintain FDIC insurance which at the time was $100k limit. Now, it's a $250k limit. 

Therefore, any responsible and albeit amnesiac CFO this coming week will be scrambling to move their millions out of individual banks and diversifying their bank accounts. Compounding this crisis is the fact that average rates on money market funds are ~4% higher than bank deposit rates. Yes, you read that right. So moving money out of banks to broker accounts is a no-brainer from a Treasury standpoint. Personally, I recommend t-bill accounts over money market funds. DO NOT assume as Ackman says below that there is any such thing as a "Systematically Important Bank" that could prevent its own depositors with deposits > $250k from taking massive haircuts. That's asinine. 

Bill Ackman summarizes what I just said:

In other words, within the next 48 hours, the government must raise the FDIC insured deposit limit from $250k to infinity. Something that would require an act of Congress.

While that's not happening, the cries for bailout will get louder by the minute.

"Voices from tech and finance are increasingly calling for the federal government to push another bank to take over the failed Silicon Valley Bank to protect uninsured deposits. Their main concern is that a failure to protect deposits over $250,000 could cause a loss of faith in other mid-sized banks"

"Observers are calling out the irony as some VCs with notoriously libertarian free-market attitudes are are now calling for a bailout"

[Update: Sunday March 12th, 10:10pm]

Ok, so we now know they got their bailout which comes in the form of an asset exchange program. Banks can use their "illiquid" aka. underwater assets for a short-term loan from the Fed. This way they can ensure ample liquidity in the event of a bank run without having to sell down their assets and otherwise expose their true capital deficit. 

However, the Fed just promised to make ALL depositors at SVB/Signature whole even beyond the $250k FDIC insurance limit. To do this, they will tap the FDIC Deposit Insurance Fund which has ~1% of assets relative to the U.S. deposit base. Yes, you read that right. Which means sure they will bailout everyone this time, but can they bailout every regional bank and ALL of their depositors? Of course not. Ex-Congress, the FDIC just unilaterally raised the $250k limit for those depositors who are part of the very first banking dominoes to fall. I have no doubt that's not actually legal. Basically throwing everyone else under the bus to bailout companies with millions of deposits.  

"The DIF currently has over $100 billion in it, a sum the Treasury official said was “more than fully sufficient” to cover SVB and Signature depositors"

CFOs, get busy...