Calcanis About SVB Crisis

3 thoughts on “Calcanis About SVB Crisis”

1. News flash. Banks don’t lend based on “fractional reserves.” The federal government lends them the power to create money out of thin air. When you get a loan, the bank manufactures a deposit and then you get to spend it, paying back the loan with interest – *to the bank* and not the public who let you do it. National banks admit in public testimony that this is exactly what happens, albeit in obscure jargon. The “fractional reserve” system was imposed to limit lending portfolio risk. SVB came unwound because it purchased an unusual amount of long-dated bonds and the face value on those bonds dropped as interest rates rose. In about a year of rate hikes, their losses in bonds exceeded their equity. This caused the run.

   FTX is part of a larger fraud problem in digital coins. Because the blockchain parts of the coins are maintained by private entities, they can front run transactions and conduct sandwich trades. If you control a node and see a bunch of oil trades coming in, you can buy oil and then your newly purchase asset bumps up in price because of the demand coming in, which makes you that much richer. It’s like Richard Pryor stealing fractions of a penny until he’s rich in Superman III.

   This is felony skimming in public markets – not that it doesn’t happen with high frequency trading or selling of order flows (e.g., Robin Hood – which robs from its day traders and gives to its sugar daddy).

   Our economy is now rife with middleman skimming. In the ’90s when commodity futures were opened up to non-producers and non-consumers, investment banks moved in to horde oil, copper and other commodities they could park in warehouses (some of them floating tankers). This created artificial shortages and jacked up the value of their property – which they then went out and rehypothecated (i.e., borrowed against using it as collateral).

   I predicted this particular problem of agent loss (skimming) in my graduate school research – along with the blockchain itself – back in the 1990s (see attached bibliography; although, in this particular context with bitcoin miners, I confess I somehow overlooked the internet middleman skimming until an international association issued a report on the issue). I said digital property could be protected and traded using encryption. This could prevent piracy and counterfeiting – including deepfakes – if done properly, solving an authentication problem in the web that Ted Nelson pointed out in his work in the 1970s. Such a system could authenticate public recordings and assign ownership – and then supervise lending/trading of property – like a combination clerk of court, stock exchange and public library. But I said the only way this would work is if these internet services were provided through cheap, common carrier public domain utilities – an observation for which I was called variously a Nazi and a Communist. (Hello, internet. You haven’t changed a bit, have you?)

   Channeling old observations about the first networked economy, railroads, I said if you didn’t provide internet services like search and advertising through publicly regulated utilities that had to treat their customers all equally, then you’d get giant growth-choking cartels that cheated their customers and competed with them. (Which is only one reason NFT’s are failing.) I said if you didn’t follow these rules for market transparency, responsibility and accountability – all central to maintaining information quality control – you’d get money laundering, tax evasion, fraud and other problems. (This is why Musk will fail at making Twitter useful for news: no information quality control, a la Edwards Deming. He knows no one wants to buy an exploding car, so he inspects Teslas for defects, yet he won’t do that in the “information” economy of Twitter. “News” isn’t separated from everything else and no attempt to force respectful competition in “debates” by forcing people to engaged with different opinions. There is no capitalist freedom without competition – and there no competition is possible in the first place without government regulations creating a fair marketplace. This will also bite autocompleting A.I. in the butt because none of the information on which it’s trained was injected into the internet with any quality control in the first place. Hence hallucinations reminiscent of gaslit teenage angst fed rabid on Facebook alienation. But I digress.)

   Which brings me to my second point about “cryptocurrency” frauds. FTX was engaged in “lending” and “borrowing” of “tokens” at high rates of interest like the dodgy auction rate securities of the 2000’s that went south when the interest rate regime shifted and rates rose, catching them in a long/short mismatch dilemma. I admit this is the problem I saw first. But FTX was worse. The way FTX was set up, it became a Ponzi scheme that ate other Ponzi schemes, amplifying the problem.

   And, finally, cryptocurrency is private bank-issued scrip, which collapses all the time because it rests on the solvency of a private corporate entity. Truly useful currencies are backed by the *public* taxing authority of a nation state financially healthy enough to borrow in its own currency. The currency retains value because it’s always useful to pay off public tax debt owed to the state and thus trades at par among private entities like a bearer bond. This is why cash is the top tier of debt in a capital structure (though often the worst to hold because it pays no interest unless you’re in a deflationary environment).

   SVB held the wrong long bonds in the wrong environment and it ate through its equity cushion for solvency. They couldn’t convert their long bonds to short ones fast enough and their depositors were pulling out of low interest bearing accounts for better returns parking their cash in treasuries. They got burned at both ends in a classic bank run. Bank of American is the only other large scale bank with bond erosion approaching its equity. Other, mostly regional banks have these bond problems because they’re carrying commercial office loans on their books and occupancy hasn’t exactly bounced back after the pandemic (not that Covid’s really “over”).

   Bibliography:

   “From Copyrights to Telerights: A modest proposal for protecting copyrights in this digital society,” in BYTE Magazine, Feb. 1996, p248, Vol. 21, #2.

   “Open Letter to Chairman Tauzin Concerning the Current Digital Copyright Controversy,” in The Computer Underground Digest, #9.77, Sun, Oct 26, 1997. (http://venus.soci.niu.edu/~cudigest/CUDS9/cud977)

   “A Solution To the Digital Copyright Problem,” in The Computer Underground Digest, #7.36, Sun, May 7, 1995. (http://venus.soci.niu.edu/~cudigest/CUDS7/cud736); also available at http://www.hwg.org/archives/docs/telerite.html (The HTML Writer’s Guild).

   “Response to Teleright Critics” in The Computer Underground Digest, #7.39, Wed, May 17, 1995 (http://venus.soci.niu.edu/~cudigest/CUDS7/cud739).

   “Open Letter to Al Gore: Fixing the Flats on the Information Highway,” in the 1994 LBJ Journal of Public Affairs (7pp) and electronically in The Computer Underground Digest (CUD), #6.60 (http://venus.soci.niu.edu/~cudigest/CUDS6/cud6.60) with a response to critics #6.68 (http://venus.soci.niu.edu/~cudigest/CUDS6/cud6.68).

2. When Sam Bankman Fried gambled with his customers’ money they called it fraud. When banks gamble with customers’ money they call it fractional reserve banking. Historically every fractional reserve bank went bust unless they held 20% or more of the customers’ money in reserve. Modern banks hold 5%. All banks are insolvent.

   • Should we take your opinion ‘to the bank’, as the saying goes? Pretty bad pun, sorry.

     As a matter of history, banks have always had to lend out some fraction of their deposits in order to charge interest, which by definition must cover operations and salaries, and depositors’ interest in turn. For instance, the Savings and Loan world (somehow) powered its operations by charging about 3% over its aggregate saver’s interest rate for the home loans it issued with around 10% of deposits in reserve.

     Its worked for decades … until the unholy alliance of politicians, bankers, and venturers coerced Congress to relax, then relax again, then relax yet again, the reserve requirements. 7%, 5%, 3%. And tho’ only the oldest of us remember, there really was a nation-shattering S&L Crisis, way back in the 1980s. Massive. Millions of peoples monies lost.

     So yah: too-thin bank reserves really does undermine the fundamental operational credibility of banks and credit unions. These days though, banks are in an increasingly precarious position … because they now (like they always did) need to create that marginal profit on loans-and-investments-over-depositors’-rewards … in order to operate. As always.

     And again, politicians, bankers and venturers have conspired to allow all sorts of basically imprudent investment instruments as acceptable risks. In the case of SVB, it would take a remarkably dark cynic to think that somehow US Treasury Bonds are a risky investment.

     Apparently, well over 30% of SVB’s deposits were invested in billions of dollars of US Treasury bonds. I’ve heard over 50 billion. Its probably more. And THE PROBLEM is that they were invested when Bond rates were near zero. Where they had been stuck for years and years. (which in a separate chapter, was a jaw-droppingly remarkable thing unto itself).

     Bonds, as ‘safe’ as they are, are also incredibly sold at no particular value. The Market of bond buyers determines what they’re willing to pay for the US Treasury paper, every Tuesday, at an AUCTION. Yep… this is how the strength of The Dollar is crafted, by letting the banking-and-retirement-pension fiduciary mendicants pick up little paddles and bid on the piles of brand new Treasury Bonds the government is trying to sell. When the dollar is strong, when belief in the prudence of The Fed is strong, when things are mind-numbingly boring-and-stable, the auctioneers get ‘face value’ for their grand sheets of IOU’s. Might deliver 2% or 1.5% of interest, barely on par with inflation, but hey … its safe.

     However, when things like Pandemics come along, wars, and international rearrangements aplenty happen, well … those banking-and-retirement-pension mendicants get jittery, and demand HIGHER RETURNS for their investments. Thus (nominally, until newer paper is printed), the piles of bonds get lower bids at auction. Because a lower purchase price effectively raises the paid-out interest to the investor.

     Nothing wrong so far! But what about holders of great big piles of Treasuries that were bought last week, last month, last year, or 4 years back? Ah… THEY TOO DEVALUE.

     You can not sell a $1,000,000 Treasury with a face coupon of 1% for $1,000,000 if present market conditions and Fed policy are both angling for 5% interest. No, the bonds don’t depreciate to 1/5 their value. Because at maturity the government WILL be paying out the whole $1,000,000 face value. Still … (depending on how many years are left), you might only find a buyer willing to pay $900,000 or $850,000 (or less) for your paper in the private or commercial exchange market.

     Wow. Poor SVB. Billions in absolutely rock solid bonds … that just had their sale-price devalued what … 15%? More?

     That would shatter their ‘reserve banking reserve’ requirements mightily. They would become ‘radioactive’. They’d run out of money right quick, and wouldn’t have a way to raise more.

     Thus … the pickle jar they’re in now. They can’t cover depositors’ withdrawals in whole because of the timeless triple whammy: rightfully skittish depositors making a ‘run’ on their deposits, failure of their semi-liquid fractional reserve to make money available, and a Fed that itself is in a world of hurt due to the same pair of factors.

     Lehman Brothers moment.
     When the bottom falls out of the investment barrel.

     Anyway, overly long. But factually accurate.
     Sadly so.

     Politicians, Venturers and hungry Bankers.
     ALWAYS THE SAME in the end. Just like in the 1930s.

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