SVB Crash and Bank Capitalisation

Silicon Valley Bank (SVB), yesterday saw its share price crash by 60%, as it was forced to raise additional capital, by issuing $1.75 billion of new shares to shore up its balance sheet, following a capital loss of $1.8 billion from having to sell bonds with a value of $21 billion. The bonds, mostly US Treasuries, were yielding 1.79%, compared to the current yield on US 10 Year Treasuries of 3.9%. The crash spread panic across the US banking sector, with US bank shares dropping by around 6%, wiping $80 of their share prices. So much for banks being well capitalised following the lessons of the 2008 crash.

SVB has not gone bust, as with Lehman's in 2008, but it has had to raise capital to stay in business, i.e. it has had to sell a load of new shares to draw in additional capital, to plug the capital loss. This illustrates many of the things I have discussed over the last 15 years since the 2008 crash. Firstly, it shows the difference, highlighted by Marx, between profits and losses (resulting from surplus value), as against capital gains and losses (resulting from changes in prices). For a company that produces commodities, its profits (assuming prices equal exchange value) is a function of the surplus value produced by the labour it employs. If that labour produces more new value than the value of the labour-power (wages), it produces surplus value/profit. If it produces less new value than the value of the labour-power/wages, it results in a loss.

But, a firm might also benefit from having paid, say, £1 a kilo for the cotton it uses to produce yarn, whilst the price of cotton rises to £1.20 a kilo, by the time it sells the yarn, and which is reflected in the price it charges for the yarn. That would not change the amount of surplus value the firm's labour produced, but would appear as additional profit, when, in fact, it is merely a capital gain of £0.20 per kilo resulting from the change in the price of cotton. If the reverse happened it would result in a capital loss.  (See: The Tie-Up and Release of Capital)

For banks, their raw material is not cotton, but money itself. Their profit is made from the difference between the interest they pay to borrow money, and the interest they receive from lending money. Consequently, its often been argued that in conditions of rising interest rates such as those we have now, it benefits banks profits, because it widens the gap between the two. However, the other effect of rising interest rates, as I have set out in numerous posts, is to cause asset prices to fall. Because banks and financial institutions hold capital on their balance sheets in the form of financial assets, when interest rates rise, and these asset prices fall, they make capital losses.

If we take a government bond, as with those that SVB had to sell, a 10 Year US Treasury might have a face value of $1,000. The coupon interest rate on it, may be 2%, i.e. it pays $20 in interest each year to the holder. If held to maturity, the holder also gets back the $1,000 face value of the bond. However, bonds, like shares, are bought and sold in secondary markets. If interest rates are rising, the buyer of a new $1,000 10 Year US Treasury might get $30 in interest on it. That means the value of existing US 10 Year Treasuries fall. No one would want to pay $1,000 for these existing bonds, and get only $20 of interest a year, when they could buy a newly issued bond for $1,000, and get $30 in interest a year.

So, the market price of bonds falls. However, if the holder of those bonds holds them to maturity, whilst they will be losing out on $10 of interest a year, compared to the current rate of interest, they will avoid making a capital loss on the sale of the bond. Bond prices would have fallen to $666, from $1,000, creating a capital loss of $333, if they sold it in the market. This is the problem that SVB faced, and it was also the problem that British pension funds faced last Autumn following the sharp rise in interest rates, and fall in long-dated bonds, as a result of Truss and Kwarteng's Voodoo Economics.

SVB is not the only bank to have crashed in recent weeks, as interest rates have continued to rise, and asset prices fall. As I have set out previously, last year saw the biggest ever fall in bond prices in history, and when I say in history, I don't mean in the way the media usually mean, of in the last ten or twenty years experience of young journalists, but, literally, the biggest drop ever. Am I surprised? No, because I have been pointing out for the last 15 years that this was inevitable, and that despite all the assurances from central banks and governments that 2008 would not happen again, because banks balance sheets had been recapitalised and so on, it inevitably would. It would not happen in exactly the same way as in 2008, but it would happen, because the underlying causes of 2008 of massively inflated asset prices, be it shares, bonds, property or anything else that people can speculate in, had not been resolved. On the contrary, a look at the rise in global stock markets of around 150%, even from the peak of the 2007/8 bubble, the $18 trillion of bonds, globally, that had negative yields, the inflation of property prices once more, and so on, showed that it had grown much worse. All of that huge inflation of asset prices has been caused by the printing of excess money tokens and creation of credit.

As I stated more than a decade ago, the supposed recapitalisation of banks, particularly in Europe, following the Eurozone Debt Crisis of 2010, was a mirage. The capitalisation took the form of the assets on the banks balance sheets, and those levels of capital were flattered, precisely by the inflation of the prices of those assets. Again, that is precisely what has been shown now in relation to SVB, and undoubtedly many more will follow. These assets on bank balance sheets are valued at the prices the bank paid for them. As seen, if bonds are held to maturity, the holder can get back the face value of the bond. However, as a result of the idiocy of negative interest rates, some bonds were sold at prices higher than their face value. So, if you had paid $1,100 for a 10 Year US Treasury with a face value of $1,000, even holding it to maturity would still leave you with a $100 capital loss.

So, the capital adequacy of many banks is a fiction, and so are the so called “Stress Tests” carried out on them by central banks. Banks do not hold sterile assets if they can avoid it. In other words, they hold government or corporate bonds that pay interest. The investment banking side of banks and finance houses, of course, also hold shares in companies, and as with all such speculators over the last 30 years, their attention turned away from the revenue they could obtain from these assets (interest, dividends, rent) to the capital gains that could be obtained as asset prices continually rose due to the implementation of QE, and other methods of creating excess liquidity. But, now, as liquidity has sloshed out into the real economy, and inflation has risen, central banks have had to try to curtail that excess liquidity.

Their preferred method is to try to reduce inflation, by, again, hitting workers. The interest rate rises they have introduced have been designed to try to slow the real economy, causing workers to be unemployed, so that they do not demand higher wages to cover rising prices, and also to dampen demand so that firms do not expand, and demand additional capital causing market rates of interest to rise. It hasn't, and will not work, in current conditions, for the reasons I have set out in previous posts. The real means of reducing inflation would be to curtail liquidity by reversing QE, and implementing QT, but central banks will not do that aggressively, as it would lead to a squeeze on profits from higher wages.

So, they are stuck. They have to keep raising their policy rates, but, doing so hits asset prices far more than it slows the economy, or dampens inflation, as the current data on jobs, retail sales, and inflation shows. As asset prices fall, the true extent of under capitalisation of banks and financial institutions is again revealed, and especially, when, as with SVB, they are forced to sell those assets at market prices, which are now much lower than the book value of those assets on the balance sheet. That is also what happened in 2008. It is also what happened on an even bigger scale in Japan in 1990, when asset prices crashed, and with property prices crashing 90%.

SVB has been highlighted, because it is in Silicon Valley with a lot of high net worth customers. It has also suffered, as a creditor to a number of tech start ups, from the fact that following the ending of the tech boom created by enforced lock downs, the share prices of many of those companies has crashed, and the large expansions they undertook have been cut back. If you had invested in a bond fund that you saw producing a yield of just 1.79%, whilst you see the possibility of getting 4%, by simply buying a US Treasury, you will want to take your money out of the fund, and buy the Treasuries. That creates pressure from redemptions on the fund, an so, when banks and other financial institutions, then, have to sell the bonds in those funds, to meet the redemptions of customers, they have to sell them at current market prices, and not the face value. That is what happened to SVB, but it will no be alone.

And, nor is it just in relation to bonds. As interest rates have risen so also share prices have fallen, though by nowhere near enough to remove the froth in that asset class. 90% of the lending of banks has gone not to finance capital investment by businesses, but to finance property purchases and speculation. Recent UK data shows that sellers have been reducing asking prices for houses by an average £14,000 in recent months, as the effects of rising interest and mortgage rates take effect. Yet, you still see the adverts for all of the equity release scams. This time the lenders on these scams are likely to be the ones burned. They lend money to the unwary against the value of their house, on the basis that when they die, the lender gets their money back plus a large wodge of interest on it, from the proceeds of selling the house. The premise, as with the 125% mortgages provided by Northern Rock prior to 2007, is that house prices continue to soar. But, a sharp fall in house prices would leave them trying to get their money back from houses whose value might, then, be lower than the amount they loaned.

It might be said, as with 2008, that the problem is the complexity of financial systems, but that complexity arose to try to get around the underlying problem. Mortgage backed securities arose to get around the problem that some mortgages were a bad credit risk, but by bundling them with other mortgages the risk was spread. It allowed the paper chase to continue, but the real problem was the fact that money had been lent to buy properties whose prices were way too high, and caused buyers to go into unsustainable levels of debt compared to their earnings. It is the fact that asset prices have been astronomically inflated, and that the balance sheets of banks and financial institutions are a fiction based upon those inflated prices that is the real problem, and as higher interest rates now cause those asset prices to fall, that underlying problem is again exposed.

Following the Eurozone Debt Crisis, and crash of a number of EU banks, I pointed out that the actions of the ECB in simply increasing liquidity, pumped into those banks was a sticking plaster over the real problem, which was their lack of adequate capital. The ECB produced one scheme of QE after another under different names, and continued to do so up until this year. Europe has a further problem, which is that it has too many banks, which need to be rationalised into a smaller number of bigger banks, with better capitalisation.

Following the sharp drop in US bank shares yesterday, the price of bank shares in Asia also fell sharply overnight, and as trading began in Europe this morning drops of around 6% were seen there too in bank shares. The shares of some of those banks whose precarious condition I have set out before, such as Deutsche Bank, fell even more. As with 2008, and as with the crisis faced with UK pension funds last year, the interconnected nature of banks and financial institutions means the danger of contagion is ever present. It hasn't just been bank shares that fell, but stock markets overall have fallen by around 2% in the last 24 hours. It shows the insane nature of this casino as against the real economy, and yet it is the casino that central banks and states have nurtured in the last 30 years, at the expense of the real economy. That is because the ruling class owns its wealth in these fictitious assets, rather than in the form of real capital.

As the gamblers in the casino again lose their shirts, workers should not be too worried about it, but must instead insist that the madness there not be allowed to affect the real economy. We need to ensure that the banking system, as a transmission mechanism for currency and means of payment, continues to function smoothly, which is why it should be separated from the lending and speculation sides of banking and finance. We should refuse to allow the state to impose austerity or other means of compensating the speculators for their capital losses, as happened in 2008. If banks collapse, their workers should be allowed to simply take them over, and run them as cooperatives, and we should bring hem all together in one large financial cooperative designed to meet the needs of workers rather than speculators.