Episode 217 – Bank Failures 101 with Brian Romanchuk

Macro N Cheese – Episode 217
Bank Failures 101 with Brian Romanchuk
March 25, 2023

[00:00:00] Brian Romanchuk [intro/music]: The US banks have their own bankruptcy insolvency procedure, and for them, there’s no negotiations. It’s just the FDIC steps in and they take over and they handle everything. You can come in and say, here’s all our claims, but you can’t tell the FDIC what to do.

In the pandemic, it was very reasonable to expect a lot of business failures. The unemployment rate spiked, but to a certain extent, that was temporary. There weren’t as many business failures because you had a lot of stimulus.

[00:01:35] Geoff Ginter [intro/music]: Now, let’s see if we can avoid the apocalypse all together. Here’s another episode of Macro N Cheese with your host, Steve Grumbine.

[00:01:43] Steve Grumbine: All right. This is Steve with Macro N Cheese. It’s another great episode for you. In light of the recent collapse of the Silicon Valley Bank, we’ve had several individuals come through via the Rogue Scholar with Steve Keen, and we’ve heard from Rohan Grey with Nathan Tankus, and we’ve heard many of the other familiar voices in this movement talking about this collapse.

However, my guest today is Brian Romanchuk, who is of Bond Economics. And he has a substack, which is the Bond Economics newsletter, and it’s really amazing. And luckily I subscribe. So by being a subscriber, I saw it pop up. Primer, American Bank and Solvency losses, and I know so little about the mechanisms within the banking system other than the standard accounting stuff that we learned through modern monetary theory.

And Brian is a guru of bonds and these sorts of technical details, and I’m grateful because he’s able to slice through them and provide great clarity. And with that, Brian, thank you so much for joining me on what I consider to be extremely short notice. Much appreciated.

[00:02:56] Brian Romanchuk: Thanks. It’s no problem. Just as an added note on the newsletter, it’s a free newsletter. I support my writing by selling books, so you get the newsletters free. But yeah, you gotta pay for the books.

[00:03:10] Grumbine: I buy your books too, by the way,

[00:03:11] Romanchuk: Well, thanks. Yeah. It’s always what I want to hear.

[00:03:14] Grumbine: And I appreciate your work. You’re the only guy I know and the title says it all. You genuinely focus on bonds, and this is an area of study that I think we gloss past because in the MMT community, folks like Randall Wray and Warren Mosler frequently say, we don’t really need to sell bonds anymore, but we all want safe assets and investments and bonds produce that. Supposedly.

Somehow we’re looking at what amounts to be a bond collapse. The interest rate on the various bonds didn’t work out so well for this bank, and the results of that turned into a global panic for about 72 hours. Can you set the stage for us and lay out what happened here?

[00:04:01] Romanchuk: As an immediate disclaimer, I was never a credit analyst, but during the financial crisis I learned about credit risk. Cause I dealt with basically default remote things. Nothing was supposed to default. I was supposed to just worry about interest rate risk, which, spoiler alert, Silicon Valley Bank didn’t.

But all the portfolio managers used to work at banks and bank treasuries. So I picked things up by osmosis and I learned about credit risk. In addition to hanging around credit analysts, I took an intensive course on bankruptcy procedures around the world. So that’s sort of my background.

I’m not, “oh, this is exactly what happened,” because also we don’t know exactly what happened. But based on the available information that I have is that Silicon Valley Bank, it’s very unusual. And one thing to note, the American banking system is unusual relative to other developed countries.

Generally speaking, in Canada, it’s dominated by Big Five banks, and it’s an oligopoly, but they’re diversified. They’re so big. They cover the whole country, all the industries, households, so they’re diversified. Silicon Valley Bank was different. It was a small bank.

It grew rapidly, which is always a problem, but it was focused, as the name suggests, on venture capital or VCs. I’m probably just gonna say VC. That’s the way everyone writes. But they were very specialized in that industry and so they did loans that are unusual. So it’s an unusual business.

But the US you have big banks or most of the banks diversified, but the whole banking system, it allows for a specialty bank to exist because there’s a variety and so they were around for a few decades. But what happened was, there was a lot of money raising in the venture capital industry, and they got all their clients to leave large amounts of money on deposit at the bank, and that was great.

But see, venture capital firms are different. Normal firms try to make a profit and they’re supposed to be profitable, and so they don’t need to have a huge cash pile. The profits cover expenses, and you don’t need a huge amount of cash. You have it as a buffer, but you don’t need a huge amount of cash.

But for these venture capital firms, they’re burning cash. They’re losing money while they’re in the development stage. And then hopefully they sell at a profit in the future once they actually develop their project. So they raise huge amounts of cash that they need for the future because they’re gonna cover those intermediate losses.

Normally banks don’t like clients like this. Banks want to lend to profitable companies, not money losing ones, but it was structured in such a way that they could make safe loans to these things. But the net effect was, is they got everyone, all these firms and the rich individuals that owned the firm, CEOs, the founders.

They had all their money with Silicon Valley Bank. But see, the thing is, if it’s on deposits, the deposit’s a liability. So basically the Silicon Valley Bank, they would have cash. Initially they’d say, okay, if you have money coming in the initial stage, it would be reserves. It’d be a deposit settlement balance at the Federal Reserve.

But that doesn’t earn very much money. That would be in the safest option. If they’d done that, there’d be no problem. But they’re providing a service, but they’re not earning any interest on those assets and they might even be losing money on the whole thing.

So they need to buy assets that generate higher interest. And so what they did was they bought a whole bunch of long dated bonds, because at the time, a 30 year mortgage, 30 year Treasurys, they might not have gone out 30, but 10 years, probably more likely for the Treasurys.

So they had a higher yield back when the money was coming in at the bottom when interest rates were still basically zero. They bought a bunch of these bonds because they had a higher interest rate on them, but then the Fed went nuts and started hiking rates like mad and the short rates are actually higher than the yield on those bonds and the value of those bonds plummeted because if the yield goes up, the price of a bond goes down.

So they had a lot of losses on those bonds and they could say, oh, we’re gonna hold these to maturity, so it doesn’t really count. It’s the way the accounting works. They want to smooth out. They say, look, oh, we’re not gonna sell these things. Sure. Right now in the market they’re worthless, but we’re just gonna keep them at the price we bought them because we’re gonna hold them all the way to maturity.

And that sounds like a dodge, but to be honest, almost everything else on the bank balance sheets is valued that way. So held to maturity, it’s part of it. But the problem is, is he had too much. The held to maturity was too big relative to the size of the bank. And then at the same time, while the Fed was raising rates, the inflows into venture capital slowed down.

And these companies well, they gotta pay salaries, buy foosball tables or whatever venture capital does. They were burning their cash, so their deposits were going down. And so the thing is as the deposits go down, they’re going to other banks. And so if it goes to Acme Bank, Silicon Valley Bank has to transfer cash reserves to Acme Bank when the depositor sends the money out.

Silicon Valley Bank needs the money, so they gotta get it from somewhere. So they had to sell bonds and eventually it’s like, oh, all the bonds that they had that were available for sale basically ran out. Uh oh. They basically were getting closer and closer to the only assets, liquid assets they had were all these things that they said they’re holding to maturity.

And those had large losses. So then, from the accounting statements, because those losses were not yet recognized, it says, yeah, we have lots of equity according to accounting standards, but if we add in the losses we know happened on the portfolio, the equity of the bank, which I think we’ll get back to, oh, well actually the equity in the bank is in a lot of trouble.

And this was known. This isn’t some super secret thing. This was on their financial statements, right? And there was a little bit of article saying, Hey, wait a second. And everyone assumed they’ll do a capital raise. They’ll just issue new equity to fill up any hole and the problems will go away because they’re otherwise making profit.

And when the other profits will sort of cover up those losses from the portfolio over a span of years. It was just gonna work out, which is how banks do it normally. They get in a bit of trouble, but then they just make money on their activities and they cover up their losses. And that was it.

But then the problem was that a bunch of people got together in Slack and they said, oh, we’re taking all our money out. They panicked. They took their money out and they caused a run on the bank, and that was it because suddenly they were forced to dump all these securities and they blew up.

There was no way to raise equity in that environment. They wanted to raise equity, which would’ve bolstered the bank, but they couldn’t do it, and the equity sale fell and it was just chaos and chaos on social media. And so what happened is you’re left with the FDIC, Federal Deposit Insurance Corporation, had to swoop in during the day to shut the bank down.

Normally they do it after the close on Friday, and then they reopen the bank on Monday. This is one of the few cases they had to go in, in the middle of the business day and shut it down because it was deteriorating so quickly.

[00:12:33] Grumbine: Wow.

[00:12:33] Romanchuk: So that’s how the panic started and it’s an unusual situation because most banks don’t have a concentrated client base like that, and they don’t have this huge wall of deposits that they have to put to work somewhere. So they really dug themselves into a hole with their decisions.

And I’m writing, well, a primer. My articles on banking are gonna turn into a primer book on banking, and I spend most of my time talking about what effectively are called GSIBs, globally systemic important banks. GSIB. And I go on, oh, they have all this risk management to deal with.

What about interest rate risk, what about liquidity risk? And it’s all serious and they do all this work. I always have a disclaimer. Well, there’s all these small banks in the US that don’t do this, and it turns out you could have a 220 billion dollar bank that actually didn’t do that as well, so it’s not as small as they originally suggested.

So now I’m gonna have to rewrite sections of my book, but at least I have more detail to put in the book. The big banks, which is what you see in Canada. All the big banks, they have much tougher regulations on liquidity risk and interest rate risk, and they never would’ve been allowed to do what Silicon Valley did.

So that’s why the crisis was localized to like these regional banks, maybe community banks that were exempted by Congress from those GSIB rules, and so that’s how you got there anyways.

[00:14:15] Grumbine: I often hear people talking about how we want to have smaller public banks, and I understand the appeal because they’re trying to get away from the predatory nature of the big corporate banks. But there’s a certain knowledge that needs to be there for risk management clearly, and I’m hearing others, and they’re not necessarily within our sphere of people that we frequently talk to.

I am hearing others saying that this could be more systemic than just that localized thing, that there’s a lot of banks around the world that we’re finding are leveraged in this way. I have no evidence to back that up. I’m just merely saying the things that I’m seeing in the Twitter sphere and in other writings and other substacks.

So I know you’re saying this is bit of an anomaly. The US in general is a bit of a special case because we have terrible regulatory environment. But that said, what do you think is the risk of a more systemic issue?

[00:15:13] Romanchuk: Well right now the systemic worries after the US regional banks because there’s still issues with some of the regional banks in the US are claimed. But outside the US the big scare story is Credit Suisse, but they’ve been an ongoing horror show for a long time.

I guess since they’re a public security, I guess, I don’t wanna say too much about them, but they’ve been continuously stumbling from problem to problem. They’re a bit of a black sheep of the European banking family. They’re in the process of restructuring, trying to get their businesses better set up, and it’s just being slow.

Eventually, the Swiss National Bank just said, okay, we’re just putting a huge loan to Credit Suisse so they don’t have liquidity issues and whether it goes away, I don’t know. For other banks, all the banks have losses on their assets because the banks have to own something on their balance sheet. And so they will own bonds.

They’re supposed to own bonds and they own mortgages and the value of those will have dropped. But the thing is, on the other side of their balance sheet, they have liabilities and they issue bonds. A lot of their loans are floating rate, so they don’t care. And they issue bonds and they also do swaps.

And basically for the professionally managed banks, one of the key things to understand about the big banks, it’s a bunch of warring fiefdoms. And each group within a bank worries about its own profitability cause that’s their own bonus and they don’t want the other groups in the bank to blow up their own gravy train.

So they have the risk managers watching ’em, but they also have the other groups watching the other groups because they don’t want the other groups causing difficulty. But see, when it comes to interest rate risk, that goes to the treasury, there’s a treasury management.

Treasury group within a bank, they’re gonna handle funding and interest rates, and they get the profit and loss from interest rate list. The losses just don’t happen because you’re paying bonus on the profit and oh, you have a loss if there’s a loss at the bank. It’s gotta be allocated to one group’s profitability.

And so if the bank loses money on interest rate risk, well, that’s the treasury group’s problem. It’s coming out of their bonus pool. And that’s the thing is they don’t want their bonus pool wrecked. So the big banks are gonna say, whoa, we’re not gonna take all this interest rate risk.

And what they can do is use swaps. And that’s quite often what they’ll do is they can use swaps to get rid of the interest rate risk and they push it to pension funds who want to take that risk.

[00:18:21] Grumbine: Can we take a second and just define swaps for the unknowing people out there?

[00:18:28] Romanchuk: That’s basically what I spend most of my day looking at. It’s a contract. Basically, you could look at it as a side bet on interest rates. I pay you a fixed interest rate, you give me the floating interest rate, and what it does is if I’m a bank, I use a. I take a fixed rate bond and I convert that.

I do a swap that cancels out the fixed payment, so I get floating. I still own the bond. It’s on my balance sheet, but the swap is just contract. It costs nothing to enter, and it’ll have a value. Depending on where interest rate go, it’ll value goes up and down. But you enter at zero cost.

And so what they’ve done is they’ve gotten rid of the interest rate risk. It just floats. And banks really live in a floating rate world. They don’t really care if the interest rate goes up and everything floats. Well, okay. The interest rate on their assets go up.

The interest rate on their liabilities go up. It’s a wash. They don’t care. What they worry about is where one side is fixed, you have fixed assets, and then your floating rate liabilities go up. That’s where you get squeezed.

[00:19:39] Grumbine: That’s what happened here.

[00:19:41] Romanchuk: Uh, yeah, roughly. Yeah, but see more because they had parked it as an investment and they were forced to sell. It wasn’t so much that they got burned on their liability. It wasn’t a question of paying the money. It wasn’t the interest rate cost.

It was just that they lost money on a portfolio that they were being forced to liquidate because money was flowing out. For other banks, where it’s stable, you’re neither gaining assets nor losing assets. It’s just one interest rate on your assets versus liabilities if you keep them matched and it’s pretty easy to tell.

This is very easy risk measure. And if you look at the blow up in the UK, the trust thing, well what happened there? The pension funds blew sky high cause they were using swaps. What they were doing is the opposite of what I said the banks did. They were taking basically a floating rate asset and they used a swap to turn it into a long dated bond, a gilt.

So basically the opposite. The pension funds, they don’t wanna stick their capital in boring bonds. They wanna buy equity, they wanna buy stuff that has a higher rate of return, but they buy by the pension regulation they needed exposure to long dated interest rates.

And the way they did that, oh, we’re just gonna do a swap. So, in essence, you have the whole pension fund industry willing to take the opposite side of the banks, lay off their fixed interest rate, and they dump it on the pensions. So, that’s the way the system is supposed to work.

So that’s the thing is that the other banks. They should be posting this in their financial statements. How much is their interest rate risk? And maybe some of them messed up, but in most cases, banks make money by lending money. They allocate credit and they also buy and sell liquidity.

That’s the core business of a bank, a normal bank, lines of credit, things like that. We give you a line of credit, you can take money out of wherever you want that. If you just suddenly decide, oh, I’m gonna take $50,000 on my line of credit on Friday, the bank’s gotta find $50,000 fast to match that.

Technically, if it leaves their balance sheet, they’ve gotta cover that outflow. So they’re in the liquidity management business and they’re in the lending business. They’re not in the, hey, let’s make big bets on interest rate business. This is one of the defects of economics 101, is that that’s what they say.

They did mess this up in the seventies and even 1994, but after 1994, all this has changed and everyone realized we’re not in the interest rate betting business, and so they don’t, the good banks don’t make big bets. There’s gonna be some interest rate risk that they can’t hedge, especially in the US with all their mortgages, which other countries don’t have with the prepay risk, but broadly speaking, that’s not their job.

No one wants to say oh, we’re YOLO-ing to long bonds. Bank analysts wanna see the bank making money off their credit activity and other financial services. They want them just generating profits as a service flow, not by making bets on bonds.

So maybe there’s skeletons in the closet, but to scare me, what you need is credit losses. Maybe the people borrowing from banks blow up. To me, that’s the scary thing. Maybe it’s happening. I’m not a market commentator really, so maybe it’s happening and I’m unaware of it, but that’s what you need.

[00:23:33] Grumbine: So I wanna look back to what generated the increased interest rates, and that is this inflation post covid during covid supply chains, price gouging, government paying higher prices. There’s all these different factors. Some of them are relative value stories, but the hammer for the nail when it comes to central banking is raising interest rates, create a bunch of layoffs.

Try to generate a downflow in the economy and put the economy in a coma to bring down inflation. And we saw this happen horribly in the seventies, and they tried to pull the Volker playbook out and start jacking rates, but never made it into the Volker range, but they’re still raising rates.

I’m not sure that we can say we’re out of the woods yet on that. But with that in mind, what is the role of interest rates in their mind. What precipitated the rising interest rates and did the central bank not see the potential for this disaster?

[00:24:35] Romanchuk: Well, I think the rise in interest rates, the problem to a certain extent was the rapidity of the rates. If they had maybe started earlier at a more sedate pace, would be better. But from my point of view, I didn’t have an inflation forecast. Everyone said, oh, inflation’s transitory.

The central banks are saying, I just deferred to them. It’s their job to worry about it. I’m not worrying, but I’m writing primers. But from my point of view, in the pandemic, it was very reasonable to expect a lot of business failures. The unemployment rates spiked, but to a certain extent, that was temporary.

There weren’t as many business failures because you had a lot of stimulus. And that’s the thing is that at the time, like 2008, if we had mass business failures, we would’ve had the 2010 repeat.

[00:25:34] Grumbine: Right.

[00:25:34] Romanchuk: And to a certain extent, my book is not looking in terms of my discussion of the business cycle. That’s what I had the back of my mind. And it turns out that wasn’t the issue. So, oops. But the thing was, is that it was a bet. And the policy makers, basically, they didn’t know, there’s no way of calibrating this thing.

So they said, well, we wanna avoid those mass bankruptcies. They did it, but then the snap back inflation was somewhat inevitable. If you keep everyone’s income stable, but there’s disruption in the supply chain, well look, you’ve got the same demand less supply.

Even I know a lot of heterodox people are screaming in bloody murder, but supplying demand model curves, this is bad, but it’s a shortage. People can quibble how you phrase it. If you have shutdowns of supply, but you keep the demand going, you’re going to get price spikes.

It’s just a question of how you want to describe it. And to a certain extent, some of these heterodox critiques turn into a little bit of word games. Yeah, it was a spike and they were slow to react to it. The central banks were slow, so it was a bit more violent, so bonds sold off more.

But look, it was sort of inevitable because the alternative was worse, right? What’s worse having high inflation now versus mass unemployment? They said, look, we did the mass unemployment thing. Let’s go with the inflation spike and see if they can control it.

And, obviously you could say, wow, it could have been better, but there was no way to calibrate it, so it’s a bit silly. But the thing is, inflation is politically unpopular and so they don’t really have a choice. They want to get inflation down, and my feeling that it is coming down, it may not be back to 2%, but they don’t need that much in the way. Right.

Things are slowing down. The side effect on the banking system. Well, I don’t know. In 2008, the personnel at the Fed would’ve been blindsided by this by now. I think everyone was aware that there was gonna be a bit of damage. But see, everyone was looking at the big banks and they managed their interest rate risk.

So the big worry was a systemic collapse. And that’s the thing, the global systemic important banks. They’re generally not the problem and for Credit Suisse, it’s not an interest rate. They’re in too many businesses needing to restructure. I think. I don’t really follow them, but I think that’s the story.

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[00:29:21] Grumbine: Okay, so I want to pivot back to your primer, and I want to start by giving a voice to the people that would like to see the bank crash and burn. Banks have not been friends to regular people, they’ve typically been there waiting to foreclose on people. At least this is the perception.

They’re waiting to run you right outta your home and sell it off at auction. And people don’t have very high opinions of banks, and they would like to see banks nationalized. There’s schools of thought with the sole focus on reforming the banking system, but people in general hate banks.

And the impulse is this is a bank bailout, and in reality it’s a depositor bailout, which doesn’t feel much different because everybody else has covered 250,000 and below. Most people don’t have $250,000 in the bank, so this is rich people problems to them let ’em burn.

The answer to burn is typically bankruptcy and most people don’t understand bankruptcy, but you start your primer out defining that. I think partially to set the stage for explaining how a bank might go bankrupt and how it may be sold off, et cetera.

Can you start there and help us understand, given the fact that most people would have to file bankruptcy if they had a problem like this, they wouldn’t be in a position where they could get bailed out. So let’s start with the populist perception and then dive into bankruptcy.

[00:30:54] Romanchuk: Personal bankruptcy is a little bit different basically because you have a bank which is lawyered up versus an individual. So it, it is a slightly different procedure, but I’m discussing for a firm. See a bankruptcy as I’d say in my article, everyone says bankruptcy protection.

And why do you call it bankruptcy protection? It’s just a buzzword. Acme Corp is entering bankruptcy protection, and you see it in the business press. I’ve seen it so many times. I never thought about who’s being protected. Well, it’s protecting the firm in the broad sense, because the bankruptcy law is looking at the business management, employees, the lenders to the firm.

There’s the suppliers, it’s the whole group. It’s society connected to that business. What can happen is, let’s say a business doesn’t pay you, and this happens all the time. Well, you take ’em to court and you get a judgment. If it’s a big business, let’s say I got in a fight with, I don’t know, Google for some bizarre reason.

And they owe me $10,000 somehow, and I get a judgment. In the absolute worst case, I’ll get a bailiff to go into the Google headquarters and hand me a $10,000 piece of equipment to settle the debt. But obviously this is not gonna blow out Google as a firm.

[00:32:22] Grumbine: Right.

[00:32:22] Romanchuk: But it’s just a legal dispute. A certain ex-president has this with all the suppliers, but they can continue. But see, the problem is, is when a business is starting to fail, it’s getting a lot of people it is not paying, and it would just be complete chaos.

It would be just first come, first served, and it would just be an uncontrolled demolition of the firm. So what you do is the firm enters bankruptcy protection and it’s a legal status and it stops anyone who wants to make a claim for a payment.

They end up as part of this big legal process and they join the line with everyone else, and then everyone with claims gets together and then they have to figure out who gets what. And from a societal point of view, the objective is you wanna negotiate.

What you want to do is keep the business going in some form is probably gonna lay off some workers, management’s gonna get sacked. But basically all the people who are owed money, everyone gets together and say, well, we’ll work this out.

And you create a new business and some people who were owed money, they’re the ones who get equity. They’re now the new owners, the new capitalists for this business, and it can keep going. And that’s preferred because the alternative is liquidation. Forget it. This business. There’s nothing that’s gonna save it.

We’re just gonna take all its assets and auction them off. And what’s gonna happen there is when you do the auction, no one in their right mind bids a lot in a bankruptcy auction, you don’t. It’s a forced sale, or even if it was a bond portfolio, it would probably be done the same.

But if you had something, even if it’s real estate, well do a 20% discount. And so you’re gonna get a lot less value than if you kept the business going, particularly for equipment that’s used. But when you go into liquidation, all the people owed money, you divide them into classes and there’s certain classes there at the top, the seniority list, and then intermediate ones.

Then you have the equity holders at the bottom. You do the auction, you sell all the assets. This is sort of simplified. You just sell it all at once, and then you say, look who’s at the top of the food chain they get paid back. If they get paid back in full, great. They just go away.

Then if there’s still money left over from the auction sale, you go to the next group. Do they have enough? Yep, they get paid off a hundred percent. Then you get the next group. Whoops, they’re owed $2 million, but you only got a million bucks. Well, guess what? They get 50%.

Everyone below them get nothing and the equity, the original owners would only get money if everyone above them get paid off. Equity is last, and let’s say it had real estate. The real estate might be worth more than the debts. So the debts get paid off and then the equity holders get what’s left and that’s it.

So that’s the procedure and that’s what informs the negotiations. The people who are senior, have a lot better negotiating position with the people junior. So it becomes a fight between the groups. But the senior people can’t be too pushy because the bankruptcy lawyers don’t like it.

And the junior people can threaten to drag it out in court, which makes it more expensive. You know, they get a compromise. But generally speaking, the senior people get the bulk of the settlement and then everyone else gets the dregs. So that’s how it works. And in certain countries, a bank might be resolved in the same way, but the difference is the US banks have their own bankruptcy insolvency procedure, and for them, there’s no negotiations.

It’s just the FDIC steps in and they take over and they handle everything. You can come in and say, here’s all our claims, but you can’t tell the FDIC what to do. They follow procedures. The FDIC decides what is in the best interest of the depositors and the fund, and then after that, the creditors.

So they have a particular procedure, they follow it, and usually what they would like if you have the bank assets, ideally you sell the bank to another bank and then basically the buying bank, they assume the deposit liabilities. The old bank had various deposits.

They’re gonna take the deposits with the bank, so that reduces the value. They get the assets of the bank and those deposit liabilities, and so they might pay nothing. There’s no actual cash transaction. They just assume the assets and deposit liabilities and boom, it’s a new bank and it’s open.

They might have to inject capital, but it just opens for business on Monday and that’s it. And the bond holders, oh, did they get any money? Then it’s just dribbled out to the old bond holders, the old equity holders, and they can just get wiped out. But if necessary, if they can’t sell the bank, they have to sell off the assets.

So if we go to Silicon Valley Bank, what you see is they swoop in and then we’re gonna try and sell it. And the thing was is they couldn’t find a buyer. So on the weekend they weren’t able to sell the assets and Monday comes. There’s no bid for the assets of the banks.

There’s no money to pay for the deposit. You split the deposits first 250,000 insured. The rest is uninsured. The FDIC guarantee the insured part, but the uninsured, they’re creditors and Oh no. What they could have done is they could said, oh, we’re just gonna let this thing go.

There’s the new bank, the insured part of the deposits. You can withdraw those freely. And the FDIC covers that. But for the uninsured, nope. The money is now frozen and they just get a claim. If you had a million dollars, you get 250,000 in the new bank and you got a claim on $750,000. Congratulations.

So you have this claim, which if you want, you can sell to somebody if you need cash now you can sell that certificate to raise cash. Otherwise, you wait to see when the bank is resolved. How much do I get paid? Do you get all the money back or 80%, 50%. That’s the question.

But you have to wait until the bank is resolved and a week later it hasn’t been resolved yet. So the FDIC said, what we’re gonna do is we’re gonna treat the insured and uninsured the same. They’re just giving a separate guarantee. The uninsured deposits, they’re money good. You can just withdraw it.

And they’re trying to then sell the business so it’s a bailout because the bank ceased to exist. Everyone else, they’re not bailed out like that was a problem in 2008. Everyone else, other than those uninsured depositors, they gotta hope that someone wants to buy Silicon Valley Bank.

They want to buy all those assets and pay enough to meet the depositors, and then pay off the bonds and the equity. That’s what they’re hoping for. Hmm. And that has to be resolved. But the thing is, the FDIC has to find a buyer and that’s it. So what’s happened is we’ve effectively said, okay, the uninsured, we’re ensuring them for free.

And it’s bailing out people with a lot of cash in the bank. But if you wanna look at, uh, a cost. I know MMTers say, oh, whatever. It’s not a real cost. But if you wanna look at the cost of the bailout in accounting sense is gonna be when the bank is sold, are the proceeds, the assets greater than the amount of the deposits?

Because they get paid off first. If you pull the money outta the bank, the FDIC gets that claim. So the FDIC becomes the credit. If they sell the bank assets for more than the value of the deposits, the FDIC is not taking a financial loss on this because the uninsured depositors would’ve gotten paid anyways.

So in terms of a cost, if you wanna say, well, this is an X billion dollar bailout, you don’t know what that is until the bank is sold. And then the question is from a fairness point of view, the problem was if they hadn’t guaranteed it, you would’ve had all these loud mouths screaming on Twitter about bank runs and bank failures, and it would scare people.

[00:41:52] Grumbine: They are doing that stuff by way.

[00:41:54] Romanchuk: They’re still the, yeah, they’ve pivot to new banks, but because they’re in limbo and they have no information when they get their money back and yeah, it’s going damage confidence for anyone else who is silly enough to have an uninsured deposit in another bank.

So rather than deal with that cost in the sense of that’s not good for the banking system, that’s not for the economy, we got rid of that. And the other problem is that I don’t know if I’ve not seen a whole lot of discussion. The FDIC allegedly blocked bids for Silicon Valley Bank.

They said to a lot of big banks, no, you can’t have it. Well, look, if there was a good bid, if a bank was going to buy the Silicon Valley Bank, let’s say just for the value of all the deposits, if they had that on the weekend, they would’ve been paid out on Monday. And the FDIC blocked that.

This is all allegedly, well, think about it. The FDIC is not acting in the interest of the depositors if they did that. So wait a second. But they’re supposed to, they’re obligated to look out after the interest of the depositors, and if they say, no, no, we’re not gonna sell at the best price, well they’re not looking out for the interest of the uninsured depositors.

So my feeling is that’s why they said we’re gonna do it because we are confident that the losses are not gonna be enough to reach the insured depositors, and we get rid of the financial crisis angle, and we don’t have to worry about the treatment of the uninsured depositors. They’re paid off.

They no longer have an interest. So now it’s just a question of maximize the value of the recovery they can take as long as they want to do it. If they left the thing hanging, the longer it goes, the worse it is for the uninsured depositors. So they’re damaging the interest of the uninsured depositors.

And if they had sold at a fire sale price, the only people they’re able to buy is an even bigger bank. It’s not gonna be like a couple guys gonna put together a few thousand bucks to buy the bank. A big bank is gonna be buying this thing at a really cheap price.

[00:44:15] Grumbine: Jamie Dimon swooping in.

[00:44:17] Romanchuk: Well, he doesn’t wanna do this, and they had a lot of bad experience with it. And to be fair, they have a point. They were pushed to take over banks and then they got fined for the activities of the banks they took over. So they weren’t happy with that, but that’s thing.

Yeah, it’s a gift. If the bar on the weekend, whoever bought the bank, would be doing it at a real discount. And so it’s free money for them. So you are handing a big gift to a big bank or a PE firm. So it’s not like it’s gonna be a victory for the little guy. The big depositors.

Yeah, they get whacked boo for them, but you’re handing a gift to another big bank, so it’s not like it’s gonna shower down on the little guy. The rich get richer. So the way they did it is defensible with the information I have now, maybe it didn’t happen that way, but based on the state of the rumor situation, yeah it’s defensible because all the alternatives stank and they went with the one that is probably the least bad option.

[00:45:21] Grumbine: Gotcha. I want to take a slight departure from what we’ve been talking about and discuss what the Positive Money gang has been saying. Michael Hudson, Steve Keen, and in fact, we had Steve Keen on here right after this happened, and they basically have elevated the role of quantitative easing for setting the stage for this predicament. To what degree, from your understanding, does quantitative easing impact this particular scenario?

[00:45:55] Romanchuk: I think, well, I’m not sure what they said, but the only thing I can see is quantitative easing, it creates a log deposit in the banking system because the Fed buys things and instead of draining the reserves out with other actions, it leaves it in the banking system.

And so the banks have excess reserves. They can’t get rid of them. They can trade reserves amongst themselves, but they always equal the same. The only way to get rid of reserves, well, I guess you could destroy them if you’re an idiot, but the only way to get rid of a reserve is you have to send it to the Fed.

That’s the only way to do it. Technically, you could send it to the Fed and exchange, get dollar bills and leave it in your vault. But no one wants to leave billions of dollars in a vault because that’s just fodder for action movies. So by creating excess reserve, there’s excess deposits sloshing around the banking system.

And the thing is, is you’re reducing the deposits. And so what you might get is certain banks, which had them before, deposits are created by lending. But what’ll happen is you might have a disparate, certain banks get hit more by this than others, but it’s not clear.

In this case, the deposits all ended up at Silicon Valley Bank because of the mass inflows into venture capital funds. The people were allocating money. They didn’t need QE to allocate capital towards venture capital funds. They were a magnet.

It was an investment bubble is a word, but there’s a fad for investing in venture capital. And the way it was structured, it was all gonna end up at Silicon Valley Bank anyway. So this specific case, I don’t know if a lot of other banks get whacked due deposit loss. Okay.

Maybe the QE is part of it, but it’s not clear to me. A lot of those deposits would’ve been with the money center banks anyways. Cause who were the bond holders? They were probably banking with the money center banks. And they’re not having any problems with this.

[00:48:09] Grumbine: Very good. So Brian, why don’t you take us out with a closing argument for the bank primer and the collapse of banks, and basically the depositor, bailout, et cetera. Give us a closing statement.

[00:48:22] Romanchuk: Well, one interesting thing that we didn’t have time to get into is how is this different? The US is very atypical. It has a lot of small banks, and the thing is when you have a lot of small banks, they’re hard to regulate. Canada is dominated by the Schedule one banks.

There’s the Big Five and there’s sort of a sixth in Quebec. But, basically, the country is dominated by five big banks and they’re GSIBs and they’re regulated on a no way are you ever gonna be allowed to fail basis. And they have deposit insurance. I guess if you’re a big investor, you’re supposed to worry about this.

If I was on a billion dollar fund, yes, we have to worry about bank failure. The feds aren’t gonna let ’em fail, so they’re regulated tightly. But see, it works because the big banks are hierarchical. You have a headquarters and then they have regions, and then you’re down to the branch and each layer of the hierarchy has a certain amount of lending authority, and the headquarter doesn’t trust all those little branches, you can have a rogue branch manager.

And so they have to watch the branch managers like a hawk. So to a certain extent, the regulators could just insert themselves at the top level and take advantage of that central monitoring of all those branches. But the US system has all these little banks.

They’re basically just branches and they don’t have central headquarters. So you need a massive number of regulators to reach that you’re not gonna default state. It’s gonna be haphazard. Some small banks might be brilliantly run, other ones are just amateur hour.

But they don’t have the ability and they’re never gonna have the ability to capture everything because you just don’t have enough regulatory manpower. It would take a lot of resources to regulate all those banks at the same standard. And so if you want a banking oligopoly, yeah, sure, no problem. They could ensure all the deposits.

It’s the same difference because they’re too big to fail. But the US for good or for ill has these small banks, doesn’t have a banking oligopoly. They have the big money banks, but it’s not an oligopoly. And you have to say, well pick your poison. You’ve got various problems, and from my point of view, I just can’t build up any sympathy for anyone having more than 250 K in the bank.

[00:50:52] Grumbine: Amen.

[00:50:53] Romanchuk: If you get 250 K in a bank deposit, you should have an accountant and say, by the way, this is at risk and you can get a sweep to get rid of that risk. For a normal person, the only way you’re gonna get near there is when you sell a house. For me, I’m getting close to retirement.

I have a self-directed retirement account. If I wanted to, I could blow through the hundred thousand dollars limit, but I don’t. It’s a hundred thousand in Canada. I don’t do that because I’m not an idiot. The only time I would’ve done it, maybe in the one day when the proceeds of a house sale is going through the banking system and that’s it.

Because you have to pay for a house. So you need a lot of money. But beyond that, there’s no reason to take that risk so, it’s just no, they made a mistake and they gotta put on their grownup pants and deal with it. Because otherwise the government could be easily underwriting scams. They can afford to do it, but do you want to do it? That’s the question.

[00:51:56] Grumbine: Didn’t we already do this in 2008-09 with Countrywide here?

[00:51:59] Romanchuk: Yeah.

[00:52:00] Grumbine: Didn’t the entire mortgage collapse come as a result of elite control fraud based on that very thing?

[00:52:06] Romanchuk: Yeah. I mean, that’s the thing. 2008, even for the systemic banks, was a bit amateur hour regulation. And they said, no, never again. Going to 2008, everyone believed, oh no, the banks would not gonna take risks, its not in their interest. Well, guess what?

So they tightened up the regulation a lot on those banks. They’re way more boring than they were. So from my point of view, I’m an outsider. I’m in the country, it’s an oligopoly. It’s a different set of problems, but I would not spend any time worrying about an insurance thing because they’re all too big to fail.

And so it’s not my problem. So I don’t spend much time worrying about it. But that’s what you’re up against. I think it’s the US is very different than other countries dominated by big banks. But in terms of writing, I was working on inflation book. I wasn’t entirely happy with it as an inflation primer.

Very basic one. And I wasn’t happy with it. And I put it on the side and I started a banking primer and I realize now I should have had the banking primer ready first. So I’d been ready for this crisis , but I basically worked in parallel on the two. I can’t guarantee which is gonna come out first.

The inflation one was close, but I’m not incredibly happy. I might just say, ah forget it, I’m just gonna get this thing out. Just cut down the scope and just say, this is it. It’s just covering a lot of the basics of inflation. It’s not really explaining how do you model it, it’s just what is inflation and just some basic things covering stuff like various conspiracy theories, about inflation and some basics.

But not really how do you model it? The banking one, it’s not like how to be a bank analyst. It’s things like this primer on bankruptcy. How do banks fit in with the macro economy? And dealing with various banking conspiracy theories. So I don’t know. Basically I put the drafts up on my substack for free, and eventually I just cut and paste into a Word document, and then I sort of have it planned out.

I just basically say, what sections am I missing and I could do it. So I have to decide, which I do first. The inflation one, I’ll have to take a look. I might just say, look, the banking one is more fun to write and I might finish it first and just leave the inflation one to stew for a bit. But that’s what’s on the agenda.

[00:54:33] Grumbine: Well, we’ll be looking forward to hyping that thing up.

[00:54:36] Romanchuk: Okay, thanks.

[00:54:37] Grumbine: I really appreciate your time today, sir. This is Steve Grumbine with Macro N Cheese. My guest, Brian Romanchuk. Thank you so much for joining us. Please consider becoming a monthly donor. We are a nonprofit. It depends on people, not only listening and sharing our podcast, their friends, but also becoming donors as need be.

And we’re an organization that tries to elevate heterodox voices and their work. We really could use your support. We’re just volunteers trying to make a go of it in this world. So if you can help us, we’d really appreciate it. Thank you so much, Brian, for joining me today, and thank you all for joining another episode of Macro N Cheese. Again, Steve Grumbine is my name and we are outta here.

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