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SVB’s collapse puts the Fed’s errors on display
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This time last week, Silicon Valley Bank (SVB), the nation’s 16th largest bank worth just north of $200 billion, was considered a zero-risk financial institution with an “A” rating from credit raters. By the end of the week, the bank was no more, taken into receivership by the State of California and the FDIC.
What happened in between has a lot to teach us about just how the top planners of the global economy are wrong and why their plans to crush wages have hit Silicon Valley instead.
First things first: how did SVB fall apart? To repeat Ernest Hemingway’s oft-quoted line about bankruptcy: gradually, then suddenly. SVB is the preferred institution for venture-backed startups -- about half of the VC-funded tech companies in the U.S. banked with them before Thursday. A big beneficiary of the 2020-2021 tech boom fueled by central bank Zero Interest Rate Policy (ZIRP), SVB bet on continued low interest rates, buying up $21 billion in long-term bonds yielding an average of 1.79%.
But rising yields mean falling bond prices, and now the Fed is trying to fight inflation by raising rates -- the Ten-year Treasury bond is now yielding close to 4%. This would be bad enough, but SVB doubled down on their wager by failing to hedge their investments with the kinds of “swap” derivatives banks would typically buy at the same time as the bonds to minimize any losses should rates go up.
When they announced a $1.8 billion loss on the bond portfolio and a $1.75 billion equity sale to shore up their balance sheet, several large venture capitalists advised their founders to pull their deposits, prompting a classic bank run. Recent mass layoffs across the tech sector amped up worries that SVB’s position would only get worse in the near future. By Thursday, the bank had failed, prompting the FDIC takeover.
The bank’s collapse overshadowed what would have otherwise been the biggest economic news of the week: Friday’s February jobs report, which showed 311,000 jobs added for the month, the 11th time in a row that the monthly report has beat expectations. The unemployment rate ticked up from 3.4% to 3.6% as more workers jumped back into the workforce, still the lowest jobless level in 50 years. These two stories together -- the SVB collapse and continued strength in the labor market -- outline key failures from the Federal Reserve and other masters of the capitalist economy.
The Fed’s operating theory is that “hot” labor markets cause inflation, and the bank can cool things off by raising interest rates, making credit and capital more expensive, causing businesses to slow down hiring and expansion. But 15 years of market manipulation has created -- or at least exacerbated -- a bifurcation in the economy.
On the one hand, the vast majority of businesses, employing almost all private sector workers, operate on the radical notion of “make more money than you spend.” They likely have plenty of debt, but they only get access to this on the basis of their cash flows which have to stay positive or else they miss payroll, miss those debt payments, and go out of business.
On the other hand, an elite cadre of firms backed by venture capital have labeled themselves “growth” enterprises. Their thesis is that they have such brilliant innovations that they are guaranteed to make billions someday in the future, and so they are allowed to run losses now with the holes filled by VCs, lines of credit, and bond sales like the ones SVB bet the farm on.
As long as capital was free or outright subsidized by central banks, these growth firms were risk-free bets on paper. They could even go public with ongoing losses and early investors could cash out with massive gains. But as soon as the regime changed last year, the future date at which profits needed to come in moved up fast. The Fed’s theory held true, as credit and capital became too expensive for many of them, leading to more than 121,000 tech layoffs in just the first two months of 2023.
Thousands of other businesses saw much less benefit from ZIRP, however, and so their impacts have been proportionally much smaller. They are nearing the end of a reallocation shock that began with the COVID lockdowns in 2020 with both aggregate demand and labor shifting away from services and towards goods, especially durable goods. Not only are these relatively better paying jobs, this means a shift away from businesses that consume the overall surplus (service) to those that produce surplus (goods).
And this is where the Fed ultimately gets it the most wrong. They believe mainstream economics which says that money comes first, and if you pump enough money into the economy, production ramps up and jobs and aggregate demand follows. Make money more expensive, and the opposite happens.
But the reverse is true: production comes first, and labor produces value which comes out as capital on investor balance sheets. The Fed’s position says that bankers and money-holders are primary in making the economy run, but their own failure to move the needle on employment reminds us that production and labor power drives the economy.
They’ve been explicit that their plan is to crash wages by throttling the economy, but so far the only thing they’ve killed off are the tech company geese that have been laying empty golden eggs for years now. SVB bet that the winning streak would keep going. Thursday’s debacle proves that the experts have no idea what’s really going on.
Our only investment advice: Stay chill.
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