Today’s post is a joint effort, written with my friend and former teacher/colleague, Randy Wray. Randy was a student of Hyman Minsky (and author of many books, including Why Minsky Matters.) We were trading e-mails about the collapse of Silicon Valley Bank (SVB) over the weekend, and I suggested that we team up and write something for readers of The Lens. So here it is....The Lens
Magical Monetary Thinking at the Fed Killed SVB
L. Randall Wray and Stephanie Kelton
See also
Notes on the Crisis
Nathan Tankus
The consensus from various pundits is this was a liquidity crisis. SVB was euthanized.
ReplyDeleteNo mention of Fed policy change in RRR from 10% to 0%… no mention of Fed establishing RRP as competing deposit facility..,
ReplyDeleteWhat is”magical thinking!”?
ReplyDelete“ Stabilize interest rates—stop using them for demand management and instead focus on financial stability. ”
ReplyDeleteWait I thought stability creates instability?
I’m confused… 🤔
In psychology, magical thinking is a type of generalized anxiety disorder (GAD) if engaged in after childhood.
ReplyDeleteIt is related to superstition.
Feynman called it "cargo-cult science."
The first principle is that you must not fool yourself—and you are the easiest person to fool. So you have to be very careful about that. After you’ve not fooled yourself, it’s easy not to fool other scientists. You just have to be honest in a conventional way after that.
What I take stability creates instability to mean is that stability is a balance of risk and exposure. Stability balances risk appetite and risk adversity. But stability involves an emergent challenge as complacency combined with greed begin to decrease risk adversity and increase risk appetite. This continues until risk exposure result in a crisis, like failure of a major institution. Then risk adversity suddenly increases and rick appetite falls away. The result is a "rush to safety."
ReplyDeleteI understand stability creates instability as being a shorthand way of characterizing the dynamics of financial cycles that are endemic to monetary production systems under financial capitalism — which is different from industrial capitalism. Industrial capitalism is subject to business cycles that have a different dynamic.
Financial crises may initiate business cycles by affecting supply and demand through increasing liquidity preference, that is, propensity to save increasing over propensity to consume.
Minsky explained all this so his name gets attached to it.
Is that why they call a speed regulator on an engine, a governor?
ReplyDeleteTom they say here:
ReplyDelete“ In 2004, the Fed began a series of rate hikes that eventually culminated in the Global Financial Crisis. Washington Mutual failed in September 2008—the biggest bank failure up to that point. (Are you beginning to see a pattern?)”
Correlation…
But here is the wiki on magical thinking:
https://en.wikipedia.org/wiki/Magical_thinking
It says: “ Lévy-Bruhl explains that the indigenous people commit the post hoc, ergo propter hoc fallacy, in which people observe that x is followed by y, and conclude that x has caused y.[18] He believes that this fallacy is institutionalized in native culture and is committed regularly and repeatedly.”
Says corellation is a form of magical thinking.., are not these two engaging in same magical thinking?
They don’t ever explain the causation…
They say:
ReplyDelete“ But that raised a problem: banks that loaded up on safe government bonds and mortgage-backed securities had to either move them into the hold to maturity (HTM) category, or recognize losses due to largely non-hedged positions in longer term assets that could not be unloaded.”
The Fed knows what these unrealized losses are they used to report them as a separate line item in the H.8..
Now that number is summed in H.8 in system Residual (Total Assets - Total Liabilities)
The unrealized losses on available for sale are included in Total Assets…
System Residual is not at a low… it made a bottom in October 2022 and has increased since then…
Seems like they are saying that the unrealized losses somehow have caused the current problems without explaining why…
"Seems like they are saying that the unrealized losses somehow have caused the current problems without explaining why…"
ReplyDeleteSVB itself disclosed to the market that it had incurred losses of $ 1.8 bn because it decided to sell HTM bonds to strengthen its liquidity position (selling HTM is an exceptional operation as HTM bonds are not meant to be sold).
This was a huge number, but SVB had more than $ 16 bn of regulatory capital, way above the regulatory limit of some $ 10, so it could accommodate the losses in terms of equity.
However, many depositors started to form the opinion that SVB was not well managed, and if customers started withdrawing their deposits then SVB would be obliged to sell its remaining HTM bonds. They speculated that those losses could be huge, much greater than the $ 1.8 bn and larger than equity.
So they panicked and started the bank run. Then at some point SVB didn't have the cash to honor the withdrawals, and then it was its end.
That can happen at any bank…
ReplyDeleteThere were reports that depositors tried to withdraw 42B on Thursday when the run was on in earnest..,.
Also, if the dumb Fed had kept RRR at 10% of deposits and SVB had 180b deposits then they would have had to have 18B in reserves minimum…
So if somebody came in even unexpectedly and tried to withdraw 1.8B they could have easily covered that with reserves and would not have had to sell any other term HQLA at a loss..
It’s applied eighth grade algebra..
Too hard for Art degree morons at Fed…
But ask them what Plato said 2500 years ago and they are all over it…
#unqualified