Silicon Valley Bank – A Risk Of Contagion

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In his podcast addressing the markets today, Louis Navellier offered the following commentary.

If you wish to listen to this commentary, please click here.

Lethal Curve Inversion

I am an ex-banking regulator and back in the late 1970s and early 1980s, when the yield curve was severely inverted, I used to merge two money-losing financial institutions together so that they could qualify for FSLIC or FDIC insurance.

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Essentially, I would take the largest financial institution and merge it into the smaller one but would re-amortize its assets (e.g., loan portfolio) to make the combined financial institution look better.

Ironically, even though I could never fix the combined financial institution’s cash flow, I helped them kick the can down the road, since an inverted yield curve is lethal for banks. In other words, I used to put lipstick on a pig and my experience scared me for life, which is why you rarely see a bank in my portfolios.

The yield curve has been inverted since July, so it is no surprise that Silicon Valley Bank ran into problems. The next big bank to fall is First Republic Bank, which just got $70 billion in emergency liquidity from the Fed and J.P. Morgan.

In Palm Beach, there is a run on First Republic Bank’s deposits and some folks are incurring early withdrawal penalties on certificates of deposits (CDs). Naturally, the folks in Palm Beach are skittish after the Madoff disaster as well and many losing money in leverage municipal bond products sold by Citibank and other financial institutions back in 2008.

Contagion Risk

As long as the yield curve remains inverted, there is a risk of contagion that other banks may fail the Fed’s capital requirements. The good news is the Fed has opened their discount window for a year (up from 90 days) to any troubled banks.

A joint statement by the Treasury Department, the Federal Reserve and the FDIC said they are taking actions that “fully protects all depositors” in Silicon Valley Bank as well as Signature Bank (a state-chartered New York bank) helped to calm financial markets.

Plunging Treasury yields are also calming financial markets. In fact, Goldman Sachs now expects that the Fed may not raise key interest rates at its Federal Open Market Committee (FOMC) meeting on March 22nd.

Clearly, the Fed has a lot on its plate suddenly, especially if First Republic Bank and other financial institutions come to the Fed for emergency liquidity. The problem, of course, is the yield curve is still inverted, so the Fed has to un-invert the yield curve it if wants to remove the contagion risk from the U.S. banking system.

Coffee Beans

A survey by The Economist and YouGov showed that 66% of U.S. adults now think that Covid originated in a laboratory in China, whether intentionally or as a chance mutation.

Republicans were more likely to take this stance, with 86% agreeing with the statement (54% definitely, 32% probably), followed by Independents with 62% (26% definitely, 36% probably) and lastly Democrats with 54% (16% definitely, 38% probably). Source: Statista. See the full story here.