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Sunday, March 12, 2023

With the FDIC auction underway, the Silicon Valley Bank Crisis may either be over or raging uncontrollably when you read this. I lean towards the scenario of excitement winding down, but at the same time, I know literally nothing about the quality of SVB’s asset book. Rather than speculate, I just want to point out what I see as key: credit market conditions (including wholesale funding) are the only thing the Fed really cares about. Even if one worries about other large regional banks, credit investors — and existing lending facilities for banks, like the discount window and FHLB advances — can pump money into the back door of a solvent bank faster than a bunch of people who read stuff on Twitter can withdraw it out the front.

I do not pay for access to credit market data, and I do not have any contacts in that market. As such, I cannot gauge what is happening there. That said, if things were going seriously wrong, I assume that I would have heard about it. (From what I have seen, it looks like usual choppy markets that happen whenever equities tank, but nothing too exciting. Anyone familiar with credit markets knows that things shut down periodically while the secondary market re-prices, and such events are taken into account by competent issuers.)

So long as the credit markets are at least somewhat functional, the circular flows between the formal banks and the non-bank sector (“shadow banks”) will continue, albeit with hiccups. Rising credit spreads is not disastrous from the perspective of the authorities — we need to scare risk takers periodically to keep everybody on their toes. As such, the concern is not an increased cost of credit, rather the situation where credit is not available at any price. The magnitude of realised defaults so far seems to be nowhere near enough to trigger that reaction.

The United States might lose a few more smaller banks. Well, the American regulators are adept at shutting down banks. Such casualties are exactly what the brain trust who loosened regulations on these banks should have expected. As the young people say, they are in the finding out stage of bank deregulation.

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(c) Brian Romanchuk 2023

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