The real question is there enough confidence in UBS to absorb the Credit Suisse balance sheet?
This is not an automatic because UBS ' stock has nosedived along with the rest of the banking sector of late. If UBS is not seen as a credible solution the deposit outflows will continue and may even impact UBS deposits.
To stop the crisis the withdrawals must cease. Can UBS make that happen?
Remember after the dust settled from the Great Financial Crisis of 2008-09, and analysts were dissecting what happened and why? The consensus was that no, nothing had really been ‘fixed’ by all the quantitative easing and bailouts, but the problems had been just kicked down the road. Even worse, down the road the situation was going to be many times more dire, and the financial authorities would have far fewer and less effective tools to use.
There have been many recessions in my lifetime when it looked as though the financial house of cards was really going to collapse - but each time, astoundingly enough, there emerged creative mechanisms to forestall the reckoning. Have they really run out of financial mechanisms this time? If so, it’s Great Depression 2. If not, the mechanisms are likely to require a large group of major ‘losers’ - the taxpayers, the stockholders, the pension funds, etc. Who’s going to get walloped on the chin this time? I’ll bat there are some major players this weekend trying to throw each other under the bus...
The core problem in 2008 was people couldn't pay their mortgages. Any solution that didn't involve resolving those unpaid mortgages was not a solution -- and resolving the unpaid mortgages was the one thing not addressed by the bailouts then.
The core problem today is banks have at least $620 billion in capital/liquidity tied up in low yielding assets. Which means the banks need that much fresh capital.
Not loans.
Not deposits.
Capital.
Of course, as SVB found out, asking for more capital freaks investors. But freaked or not, investors can either come up with the additional capital or watch their bank stocks crater. They can suffer a little dilution now or a wipeout a few weeks from now.
The crux of the problem is that those low-yielding assets cannot currently be sold for the amount the banks have them on their books for. This problem was entirely predictable when interest rates started to rise, yet somehow, they did nothing.
In an honest system, banks would be required to mark all assets to market at the close of every business day and publish the results. In this age of computers, that would not be particularly difficult to do. Then the moment a bank drops below regulatory capital requirements, it should be liquidated. That way, depositors would never be at risk.
From an accounting standpoint, there is a "Catch-22" in that many of these assets are designated as "held to maturity". The bank isn't technically intending to sell them, but to hold them, reap the interest income, and take the return of principal at maturity--which thus allows the security to "roll off" the books, freeing up the capital tied up in the assets.
Under those conditions, mark to market would not be the appropriate accounting treatment, as there would be no loss. The investment would deliver exactly what was expected: an interest income stream followed by a return of principal.
However, that treatment also means that such assets should not be sold to satisfy liquidity concerns. The funds represented by those assets should be treated akin to an individual's 401(k) or IRA fund: the money is there but you can't touch it right now.
Which means that all held-to-maturity assets should have no place in bank liquidity calculations, there should be no fear of loss of market value (since the assets won't be sold), but banks need to find other funds to provide coverage for bank deposits.
This is why I say what the banks need to cover the unrealized loss of $620 Billion on investment securities is $620 billion in fresh capital. Hold these underwater investments until maturity, let them roll off, and raise new capital to provide liquidity.
The banks are doing all they can to avoid taking either step.
If SVB had been working on raising capital all along they never would have had to worry about selling their underwater investment portfolios. Just move the assets into held-to-maturity status if not already, amortize whatever markdowns to fair market value are appropriate over the remaining life of the assets, raise new capital, and be done with it.
If the banks are going to leave open the possibility of selling these assets, then regular mark to market accounting has merit.
As interest rate rises have predictable effects, managing the investment losses recognized by mark-to-market accounting should still result in raising fresh capital to cover depositors.
Instead, everyone kept kicking the can down the road and they've finally run out of road.
IMO, being able to "balance" demand deposits against HTM assets is legalized accounting fraud. I can't think of any reason why they'd be designated as HTM to begin with unless the bank knows they can't currently sell them at a price anywhere close to their book value. Now if such assets were only used to balance against time deposits with average maturity dates that matched the assets, then that would be different. But that not how it currently works.
There is no doubt that assets used for liquidity calculations should be carried at fair market value. And if assets are going to be held to maturity the tied up capital needs to be replaced in the balance sheet.
The banks are digging their own graves by doing otherwise.
I don't believe either requirement is even being considered as regulatory policy or standard banking practice.
I can’t image where $620 billion in fresh capital would come from other than the Fed/Treasury. Which would create more inflation, which is there very thing Biden must tame if the Democrats are going to win reelection. It seems they have painted themselves into a corner....
Boy, that’s a lot of money to me. Is there a precedent for the government to offer investors some kind of incentive - tax credits, tax write offs, whatever - to ensure that enough capital would be raised before more banks fail?
But here's the kicker. If these underwater assets are held to maturity and allowed to roll off the books the tied up capital is automatically released. There would be no losses needing to be recognized, because there is no sale on which there can be gain or lose.
Once the capital was released, banks would have surplus capital above and beyond regulatory requirements.
Update: looks like the UBS deal has made it over the finish line.
https://archive.md/H7upl
‘Over $2 billion’? That seems low; I wonder if bank-stock investors will still be spooked tomorrow because of the low valuation. We’ll see!
The real question is there enough confidence in UBS to absorb the Credit Suisse balance sheet?
This is not an automatic because UBS ' stock has nosedived along with the rest of the banking sector of late. If UBS is not seen as a credible solution the deposit outflows will continue and may even impact UBS deposits.
To stop the crisis the withdrawals must cease. Can UBS make that happen?
We shall see by this time tomorrow.
Remember after the dust settled from the Great Financial Crisis of 2008-09, and analysts were dissecting what happened and why? The consensus was that no, nothing had really been ‘fixed’ by all the quantitative easing and bailouts, but the problems had been just kicked down the road. Even worse, down the road the situation was going to be many times more dire, and the financial authorities would have far fewer and less effective tools to use.
There have been many recessions in my lifetime when it looked as though the financial house of cards was really going to collapse - but each time, astoundingly enough, there emerged creative mechanisms to forestall the reckoning. Have they really run out of financial mechanisms this time? If so, it’s Great Depression 2. If not, the mechanisms are likely to require a large group of major ‘losers’ - the taxpayers, the stockholders, the pension funds, etc. Who’s going to get walloped on the chin this time? I’ll bat there are some major players this weekend trying to throw each other under the bus...
The core problem in 2008 was people couldn't pay their mortgages. Any solution that didn't involve resolving those unpaid mortgages was not a solution -- and resolving the unpaid mortgages was the one thing not addressed by the bailouts then.
The core problem today is banks have at least $620 billion in capital/liquidity tied up in low yielding assets. Which means the banks need that much fresh capital.
Not loans.
Not deposits.
Capital.
Of course, as SVB found out, asking for more capital freaks investors. But freaked or not, investors can either come up with the additional capital or watch their bank stocks crater. They can suffer a little dilution now or a wipeout a few weeks from now.
Guess what none of the "experts" are proposing?
The crux of the problem is that those low-yielding assets cannot currently be sold for the amount the banks have them on their books for. This problem was entirely predictable when interest rates started to rise, yet somehow, they did nothing.
In an honest system, banks would be required to mark all assets to market at the close of every business day and publish the results. In this age of computers, that would not be particularly difficult to do. Then the moment a bank drops below regulatory capital requirements, it should be liquidated. That way, depositors would never be at risk.
From an accounting standpoint, there is a "Catch-22" in that many of these assets are designated as "held to maturity". The bank isn't technically intending to sell them, but to hold them, reap the interest income, and take the return of principal at maturity--which thus allows the security to "roll off" the books, freeing up the capital tied up in the assets.
Under those conditions, mark to market would not be the appropriate accounting treatment, as there would be no loss. The investment would deliver exactly what was expected: an interest income stream followed by a return of principal.
However, that treatment also means that such assets should not be sold to satisfy liquidity concerns. The funds represented by those assets should be treated akin to an individual's 401(k) or IRA fund: the money is there but you can't touch it right now.
Which means that all held-to-maturity assets should have no place in bank liquidity calculations, there should be no fear of loss of market value (since the assets won't be sold), but banks need to find other funds to provide coverage for bank deposits.
This is why I say what the banks need to cover the unrealized loss of $620 Billion on investment securities is $620 billion in fresh capital. Hold these underwater investments until maturity, let them roll off, and raise new capital to provide liquidity.
The banks are doing all they can to avoid taking either step.
If SVB had been working on raising capital all along they never would have had to worry about selling their underwater investment portfolios. Just move the assets into held-to-maturity status if not already, amortize whatever markdowns to fair market value are appropriate over the remaining life of the assets, raise new capital, and be done with it.
If the banks are going to leave open the possibility of selling these assets, then regular mark to market accounting has merit.
As interest rate rises have predictable effects, managing the investment losses recognized by mark-to-market accounting should still result in raising fresh capital to cover depositors.
Instead, everyone kept kicking the can down the road and they've finally run out of road.
IMO, being able to "balance" demand deposits against HTM assets is legalized accounting fraud. I can't think of any reason why they'd be designated as HTM to begin with unless the bank knows they can't currently sell them at a price anywhere close to their book value. Now if such assets were only used to balance against time deposits with average maturity dates that matched the assets, then that would be different. But that not how it currently works.
There is no doubt that assets used for liquidity calculations should be carried at fair market value. And if assets are going to be held to maturity the tied up capital needs to be replaced in the balance sheet.
The banks are digging their own graves by doing otherwise.
I don't believe either requirement is even being considered as regulatory policy or standard banking practice.
I can’t image where $620 billion in fresh capital would come from other than the Fed/Treasury. Which would create more inflation, which is there very thing Biden must tame if the Democrats are going to win reelection. It seems they have painted themselves into a corner....
It would have to come from investors. That was what SVB was trying to do when they spooked Wall Street with their losses.
If SVB had confronted the issue early on they could have executed the capital raise before they had to unload their debt securities portfolio.
The longer they avoid dealing with the need for fresh capital the more capital they are going to need.
Boy, that’s a lot of money to me. Is there a precedent for the government to offer investors some kind of incentive - tax credits, tax write offs, whatever - to ensure that enough capital would be raised before more banks fail?
None comes to mind.
But here's the kicker. If these underwater assets are held to maturity and allowed to roll off the books the tied up capital is automatically released. There would be no losses needing to be recognized, because there is no sale on which there can be gain or lose.
Once the capital was released, banks would have surplus capital above and beyond regulatory requirements.
An accounting mechanism! That sounds hopeful!