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The Silvergate collapse heralded a weekend of financial panic reminiscent of the 2008 financial crisis. But as two other banks collapsed, bitcoin prices jumped 18% over the weekend, breaking the $24,000 threshold from $20,000 on Friday.
Is it time to rethink what it means to be a risk asset?
All Moral Hazard Roads Lead to the Fed
Last weekend, we saw the financial avalanche of the banking industry. To understand it, it’s best to look back to the 2008 financial crisis:
- Easy credit under the Federal Reserve’s low interest rate regime fueled the housing bubble. That has prompted banks to lend to borrowers with low credit scores, limited income and high levels of debt.
- Fed-regulated banks packaged these subprime home mortgages into derivatives, resulting in systemic exposure to the financial system.
- Many banks used high leverage on these complex financial instruments, and when the Fed raised interest rates and caused the housing bubble to burst, their losses magnified dramatically.
Afterwards, Lehman Brothers filed for a $639 billion bankruptcy, the largest bankruptcy in U.S. history. The Fed also had to merge Bear Stearns with JPMorgan, and the Fed bailed out the acquisition with a $30 billion loan.
Likewise, the Fed assisted Merrill Lynch in its $50 billion merger with Bank of America. Overall, the Fed is estimated to have poured $498 billion into the banking bailout. These historic bailouts prompted the pseudonymous Satoshi Nakamoto to launch Bitcoin in 2009 as a sound currency outside of the central banking system.
So much so that Satoshi Nakamoto embedded the British bailout title into Bitcoin’s genesis block. The sharp spike in bitcoin’s price over the weekend was the result of similar bank dynamics.
What happened to Silicon Valley Bank (SIVB) and Signature Bank (SBNY)?
On Friday, we explained why Silvergate Bank collapsed. As mentioned earlier, most of the bank’s holdings include bonds, Treasury bills, and mortgage-backed securities. All of these assets are considered fixed-income securities—financial instruments that provide a predictable stream of income over a period of time.
However, the Fed can destroy this predictability by raising interest rates.
As the provider of the world’s reserve currency, the Fed, via the federal funds rate, places the world economy between cycles of monetary easing (“money printing”) and tightening. Image credit: fred.stlouisfed.org
During the transition to this new regime, fixed-income securities typically fall from a near-zero interest rate environment. As interest rates rise, so do the yields on new securities, making existing securities less attractive to investors. As a result, the market value of existing fixed income securities falls.
In short, the Fed poked a hole in the bank’s balance sheet. In the case of Silvergate Bank, this was exacerbated by the bank run that followed the FTX exchange crash. Silicon Valley Bank (SIVB) announced a $1.75 billion funding round on March 8, sparking a bank run.
SIVB’s reasoning was to close the loophole created by realized losses following the sale of its bond portfolio. JPMorgan analyst Michael Cembalest noted that Signature Bank (SBNY) and Silicon Valley Bank (SIVB) stand out from the banking crowd as venture-oriented lenders.
SIVB and SBNY have a deadly combination: risky deposits from non-sticky clients and poor capital allocation.Image credit: JP Morgan
Of course, the least sticky deposits are the first to jump ship at the first sign of financial trouble. Catering to big VCs, the bank run was massive and fast, pushing the once $200 billion SIVB into the ground. It held $120 billion in securities, but did not hedge interest rate risk.
In the age of instant social media, bank runs are dramatically magnified. Along with SIVB, crypto-oriented Signature Bank (SBNY) was not far behind, falling from $110.4 billion in December to $4.4 billion on Friday. New York regulators closed Signature Bank on Sunday to prevent systemic contagion.
Likewise, the Federal Reserve, the Treasury Department and the Federal Deposit Insurance Corporation (FDIC) issued a joint statement on Sunday saying SIVB would also be closed. In both cases, client funds are safe.
“All depositors at the institution will be made whole. As with the SVB resolution, taxpayers will bear no loss,”
So the question is, how is it possible that the taxpayers are not paying for billions of dollars of bank support?
A bank bailout with a different name?
Within a week, the venture capital-oriented Silicon Valley bank was out of business. Combined with Silvergate and Signature Bank, this makes the number of crypto banks in the crypto industry zero. However, the fallout continues. Many regional US bank stocks posted double-digit losses, with Western Alliance (WAL) and First Republic (FRC) leading the way with losses of -75% and -78%, respectively.
Over the course of a month, Bitcoin was compared to two deceased banks (SBNY and SIVB), as well as US regional banks. Image source: TradingView
By protecting failing banks from more than $300 billion in losses, the Fed is opening a new Pandora’s box of moral hazard. Central banks create a Pandora’s box with easing-tightening cycles, one leads to inflation, and a correction in inflation leads to a rise, i.e. a recession.
But if the Fed now covers unrealized losses for its upcycle, it actually begins to reverse the upcycle itself. So if the Fed looks for more gains, it could lead to more breakouts in the banking sector. On the other hand, if a rate cut acts as a pressure valve, it will lead to higher spending and accelerated inflation, which will lead to a depreciation of the currency.
In both cases, Bitcoin’s self-custody, decentralization, zero counterparty risk, and forever finite supply seem to be fueling a potential Great Financial Crisis 2.0. It aims to resolve the same event. Having said that, Bitcoin is also under selling pressure as bad loans bought with Bitcoin will have to be sold.
Likewise, with the closure of Silvergate and Signature Banks, there are fewer and fewer fiat-to-crypto rails in the US. To complicate matters further, the Biden administration proposed a 30% tax on Bitcoin mining electricity in its 2024 budget proposal. Ultimately, public perception of the nature of money will have to interpret these signals.
Will they go to bigger banks, highly centralize the financial system as a product of the Federal Reserve, or leverage a specific long-term solution in the form of Bitcoin?
Do you think Bitcoin can become a mainstream alternative to banks? Let us know in the comments below.
about the author
Tim Fries is the co-founder of The tokenist. He holds a Bachelor of Science degree. BS in Mechanical Engineering from the University of Michigan and MBA from the University of Chicago Booth School of Business. Tim was a Senior Associate in the investment team in RW Baird’s US Private Equity division and co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.
Information source: compiled from THETOKENIST by 0x information.Copyright belongs to the author Tim Fries, without permission, may not be reproduced