A few years back, in what seems like several lifetimes ago, I came up with a spiffy title for my weekly musings.
The Blognormal Distribution.
Thinking it a clever play on words, I ran it by my company’s Chief Arbiter of Taste (CAoT) – one Charles P. (Chip) Hutton, III.
I had elevated him to that cushy C-Suite post for having called me out on my preceding, somewhat unhinged and published moonings after then-Secretary of State Condoleezza Rice, and more specifically for phrasings such as “that sister really puts led into this boy’s pencil”.
And he was right. I shouldn’t have committed that sentiment to writing, much less in a highly public forum. And I most certainly should not be busting it out again in this, most touchy and sensitive of eras.
But like I said above, that was all was several lifetimes ago. So (I figure) why not let ‘er fly and see what happens?
Meantime, about the title and all, it’s a riffing off of the wonky mathematical concept of lognormal distributions, to which securities prices are said to adhere.
Rather than assuming the boring, symmetrical form of a normal bell curve, a lognormal distribution looks something like this:
No wonder trading is such a hard job. I mean, what in God’s name is going on with this here graph, of which there are, by my count, 4 different renderings?
And, apparently, this s factor is pretty important, because if you set it to 2, it looks like the Black Diamond runs at Jackson Hole. Fix it at 0.5, by contrast, and it morphs into a mathematical depiction of the Bunny Slopes at Alpine Valley.
Either way, I am far from sure that stock returns adhere to this logic.
Consider, if you will, the recent performance of the benchmark Banking ETF – The KBW Index, which has (rather indecorously in my opinion) plunged more than 25% over a handful of trading sessions.
Which is a lot for a Banking Index to drop:
The results are not overly surprising, however, as dumping shares of banks and bank holding companies has become something of a Cottage Industry these days.
I do hate to pile on to what is among the most over-analyzed of dynamics in at least a month, but duty calls. So, about SVB – I have a few beefs with what’s been written. First and perhaps most annoying are these breathless revelations about “gap” and/or duration risk. Seems like everyone just figured out that, like any bank, SVB sourced its funds through deposits that feature instantaneous liquidity and invested the proceeds in securities with maturities of approximately ten years.
C’mon people! Smarten up! The whole Treasury Market runs this way. Nobody buys 10-year Notes with money that is locked up for equivalent time periods. If investors didn’t pay cash for this paper, then there wouldn’t be a market for it at all – causing, among other tragedies, the Green New Deal to go tits up. More to the point, the market liquidity of such a portfolio is equally instantaneous – the whole book can be sold in micro (if not nano) seconds. Thus, with the ability to move in and out of these securities at will, it wasn’t some unaccounted-for risk that caused the losses; it was a failure to trade out of bad positions in a timely fashion.
Much has been written about the vacant SVB CRO position, but to me, it looks like they didn’t even have a Treasury function.
Which is pretty bad for a bank – the financial equivalent of a marching band without a sousaphone.
But SVB’s problems were on the liability/deposit side, with their funding liquidity mostly deriving from animalistic, VC-backed enterprises with happy feet. A 1% loss on a poorly constructed securities portfolio impelled the lead underwriters of these vessels to call for everyone to abandon ship. Abandon they did, and down the Good Ship SVB went.
A review of SVB’s 2022 Balance Sheet reveals > 60% in cash and liquid, tradeable assets and\ standard debt amounting to < 10% of total assets. Trust me, folks, this is an exceedingly conservative banking profile. Longstanding regulatory protocols require depository institutions to maintain no more than 10% of cash and liquid securities to meet the potential demands of withdrawing depositors (fractional reserves in industry parlance), so SVB was off-the-spectrum above these requirements. The idea is that account holders are exceedingly unlikely to transfer or remove more than 10% of their funds at any given moment, and, thus, 10% reserves is deemed practically adequate. This is a system which (other than during annoying intervals like the Great Depression) has functioned efficiently for many centuries.
But apparently no more. And thus, a new kind of bank risk emerges in this amped up age of instantaneous telecommunications. Call it Thiel Risk – the losses that can accrue when a big VC whale orders his minions to move their funds out – en masse – of a financial institution — and to do so pronto. So formidable and fearful is this newfangled Thiel Risk monster that even a $30B cash injection by its (no doubt spooked) Wall Street buddies has failed to prevent First Republic Bank from losing 80% of its Enterprise Value and witnessing the degrading of its debt to junk – all in a matter of days. Other, financial institutions of similar profiles are no doubt quaking in their boots.
But out of all menaces – latent or manifest – some good does issue forth. Covid, after all, brought about a surge in new telecom and biotech innovation. And in this instance, a number of (perhaps mixed) blessings emerge.
The first of these, which I cannot unfortunately endorse, is that for now, the government, playing the role of a latter-day George Bailey, has issued a blank guarantee on ALL bank deposits. So, don’t worry, you pool-playing Building and Loan depositors, your funds are safe!
I’d like to designate this a righteous act but can’t. In fact, I struggle to contemplate anything worse, any step, which, if rendered permanent, would do more damage to our multi-century, on-going experiment in capital-based economics.
Financial risk is embedded in all our economic doings, and if individual economic agents are shielded from this reality, they will, literally, wreck the joint. This includes our banking relationships. If we, as its depositors, fail to regulate our financial institutions by selecting them, at least in part, based upon their soundness and good judgment, they will run rampant with risk. Why not let ‘er rip by issuing the riskiest of loans? Owning the most dubiously speculative of securities portfolios? Our friends in the Brooks Brothers suits will no doubt cut us in by paying economically stupid interest rates for our balances — but not to worry – it’s all backed by Uncle Sam.
Until, that is, something goes wrong – a series of defaults on those funky loans or the like, and the banks blows their wad. We’re then in comprehensive bailout territory (cira ’08) and/or full, inflationary economic collapse (ala the Weimar Republic).
As it is (and again, here, I am compelled to bust out some over-used, over-analyzed metrics), the steps taken in the wake of the SVB debacle – including new funding facilities provided by the Fed, have reversed several months of its long deferred and much needed efforts to reduce the size of its own Balance Sheet:
The other manifest blessing of the “crisis” is a righteous profit opportunity for large, solvent financial institutions choosing to use their resources to put impaired and potentially vulnerable competitors out of their misery. Sometimes it works; sometimes it don’t. But when it does, God Oh Mighty, what fun we have.
The biggest prevailing target, of course, is Credit Suisse, which has seemed, for years, to have bungled its way to the center of every financial scandal and supreme misstep that has transpired over the better part of the last decade. If one took a poll: a) most informed folks probably endorse its gathering to the dust of its yodeling forebears; and b) I might vote with the majority myself.
At the point of this writing, the master puppeteers – including the Swiss National Bank – are in a frenzy to consummate a takeover of CS by local frenemy UBS. The latter has offered 2 bits on the Swiss Franc (~$1B) for the whole show. However, to put this in perspective, as recently as 18 months ago, CS sported a market cap > $50B, so UBS is able to maybe scoop up its biggest rivel for about 2% of its recent peak valuation.
Oh, how the mighty have fallen.
Still and all, it brings a joyful tear to my eye to witness the frenzy of the stronger financial behemoths striving to cash in by shorting their stock, bidding down their bonds, and moving their OTC positions against them. Call me sentimental, but it all reminds me of those giddy days in advance of the collapse of Bear Stearns and Lehman Brothers.
Meantime, the regular mechanisms of the capital economy continue to operate, and, somehow, the numbers don’t look too bad. PPI – lost amid the SVB agita – came in gratifyingly weak. Atlanta GDP Q1 estimates recently surged past 3%.
The Fed, in whatever time it can spare from, yet again, rescuing (?) the banking system, will issue its rate proclamation on Wednesday. Lots of pressure on them to pause their rate-raising ways, and no chance that they go beyond 25.
So, our troubles notwithstanding, I think there’s a bid out there somewhere. Unless, of course, the banking system collapses – in which case there won’t be a bid it sight.
I would advise, however, against modelling for a lognormal return on any investments one makes; it’s just not on the cards. Too much Thiel Risk out there to hope for such an outcome.
CAoT Hutton, III has long ago moved to greener pastures. I haven’t, in fact, heard from him for years. Thus, I am left to arbitrate taste on my own.
So, The Blognormal Distribution is back.
And I still care a torch for Condi.
Because, Thiel Risk or no Thiel Risk, some things, after all, are transcendent.
TIMSHEL