A short addendum to my SVB post of yesterday. The insolvency of SVB is at least partially the result of an arcane accounting practice applied to assets that are designated as “Held to Maturity.”
Addressing the three of you still reading on, “Held to Maturity” is crucial to understanding what happened. I’m going to quote some numbers that may surprise you. SVB’s 12/31/22 balance sheet shows a net worth of about $16 billion. It also shows a value of $91 billion for its Held to Maturity assets. But in a parenthetical note, right there on the balance sheet, SVB reveals that the market value of that $91 billion of assets was worth at market prices only $76 billion. That’s a difference of $15 billion, equivalent to almost the entirety of its net worth.
Why is this allowed?
In early 2009 during the worst of the great financial crisis, virtually every major bank in the country was insolvent based on their large holdings of very complex securities, many of which were mortgage- related. Market prices for these securities were depressed based not only on fundamentals but based on panic that the banks would have to dump them en masse.
So the authorities instituted an accounting change allowing the banks to disregard the market prices and come up with different and higher prices for these complex securities based on the concept that the banks were intending to hold the assets to maturity. All of a sudden, bank solvency looked much better. Many people believe this accounting change was the positive trigger that stabilized the entire banking system since it curtailed forced selling into a panicked market, selling that would have led to a pernicious downward spiral.
But the rationale for SVB using this Held to Maturity accounting was suspect. Their portfolio of $91 (or $76) billion dollars of assets was not at all hard to value. These assets were almost entirely straight forward government guaranteed mortgage securities. Their market value was down because interest rates went up.
SVB reported net income of about $1.5 billion for the 2022 calendar year. The $15 billion loss during the year from their Held to Maturity securities was excluded from calculating their net income.
The run on the bank occurred when SVB had to start selling these securities to meet depositor withdrawals and therefore “realized” the loss, shining a light on the gap between actual value and accounting value. But to my mind, the loss had already happened. It was just hidden from most people, especially depositors who typically would not read footnotes to the financial statements of their banks.
If this all seems crazy to you, it does to me as well.
I don't think it is uncommon that actions we take to avoid a short-term loss come back to haunt us and so it is in this case. Pretending, in 2009, the losses in value were not real because they had not been realized led us to this happening in 2023. Likewise, bailing out banks once before set a precedent for a bailout of some sort now, though gov may not want to call it that. Protecting deposits over $250k will come back to haunt us at some point, even if only when the gov refuses to do it in some future case and they loses a lawsuit brought on the basis of precedent.
Let's smooth things over as best we can and also prevent responsible individuals from taking responsibility. No banker went to jail as a result of the 2008 crisis, though lots of people lost their homes.
I can't think of a specific book. But I can recommend Matt Levine's almost daily writing at Bloomberg. His writing is a pleasure, he has a great sense of humor, and he does a great job of explaining complex financial phenomena.