Foreshadowed by Silvergate Bank going under, the weekend saw financial panic reminiscent of the Great Financial Crisis of 2008. But as two additional banks died off, Bitcoin price went up 18% over the weekend, crossing the $24k threshold from Friday’s $20k.
Is it time to rethink what it means to be a risk-on asset?
All Moral Hazard Roads Lead to the Federal Reserve
Over the weekend, we saw a financial avalanche in the banking sector. To understand it, one would do well to revisit the Great Financial Crisis of 2008:
- Easy credit under the Fed’s low-interest rate regime inflated the housing bubble. This spurred banks to lend to borrowers with low credit scores, limited income, and high debt levels.
- Banks, regulated by the Fed, packaged these subprime housing mortgages into derivatives, leading to the systemic exposure of the financial system.
- Many banks used high leverage for these complex financial instruments, drastically amplifying their losses when the housing bubble burst when the Fed hiked the interest rate.
In the aftermath, Lehman Brothers filed for a $639 billion bankruptcy, the largest in US history. The Federal Reserve also had to merge Bear Stearns with JPMorgan Chase, bailed out with Fed’s $30 billion loan for the acquisition.
Similarly, the Fed assisted in a $50 billion merger of Merrill Lynch with Bank of America. Overall, it is estimated that the Fed poured $498 billion into the banking bailouts. These historic bailouts triggered pseudonymous Satoshi Nakamoto to launch Bitcoin in 2009 as sound money outside the central banking system.
So much so that Satoshi embedded the UK’s bailouts headline into Bitcoin’s Genesis Block. Over the weekend, Bitcoin’s drastic price spike is a function of a similar banking dynamic.
What Happened to Silicon Valley Bank (SIVB) and Signature Bank (SBNY)?
On Friday, we explained why Silvergate Bank went under. As noted, most of the bank’s holdings consisted of bonds, treasury securities, and mortgage-backed securities. All of these assets are considered fixed-income securities – financial instruments that supply a predictable stream of income over a time period.
However, the Fed can disrupt this predictability when by raising interest rates.
During the switch to this new regime, fixed-income securities typically decline from a near-zero interest environment. As the interest rate rises, new securities’ yields also rise, making existing securities less attractive to investors. Therefore, the market value of existing fixed-income securities declines.
In short, the Fed punctured a hole in the bank’s balance sheet. In the case of Silvergate Bank, this was exacerbated by a bank run following the FTX exchange crash. Silicon Valley Bank (SIVB) triggered a bank run on its own by announcing a $1.75 billion capital raising round on March 8th.
SIVB’s reasoning was patching up the hole due to realized losses following the sale of its bond portfolio. Michael Cembalest, an analyst at JP Morgan, pinpointed both Signature Bank (SBNY) and Silicon Valley Bank (SIVB) as standing out from the banking crowd as VC-facing banks.
Of course, the least sticky deposits were first the jump ship after hints of financial trouble. Catering to large VC firms, the bank run was massive and rapid, grinding the once $200 billion worth SIVB into the ground. It held $120 billion in securities without hedging that interest rate exposure.
In the age of instant social media, bank runs are significantly amplified. In conjunction with SIVB, the crypto-facing Signature Bank (SBNY) followed suit, going down from $110.4 billion in December to $4.4 billion on Friday. New York regulators closed the Signature Bank on Sunday to prevent systemic contagion.
Likewise, the Federal Reserve, the Treasury Department, and Federal Deposit Insurance Corp (FDIC) issued a joint statement on Sunday that SIVB will also shut down. In both cases, customers’ funds are secured.
“All depositors of this institution will be made whole. As with the resolution of Silicon Valley Bank, no losses will be borne by the taxpayer,”
The question then is, how is it possible for taxpayers not to pay for multi-billion bank backstops?
Bank Bailouts by Different Names?
In a week, VC-facing Silicon Valley Bank went under. Combined with Silvergate and Signature Bank, this leaves the crypto sector with zero crypto-facing banks. However, the fallout is still ongoing. Many US regional bank stocks are in double-digit losses, with Western Alliance (WAL) and First Republic (FRC) leading at -75% and -78% freefall, respectively.
But if the Fed now backstops unrealized losses for its hiking cycle, it effectively begins to reverse the hiking cycle itself. Consequently, if the Fed pursues more hikes, it will likely lead to more breaks in the banking sector. On the other hand, if there are rate cuts as a pressure valve, this leads to increased spending, accelerating inflation, which leads to currency debasement.
In both cases, it appears that Bitcoin’s self-custody, decentralization, zero counterparty risk, and forever-limited supply are injecting into the potential Great Financial Crisis 2.0. The same event it was designed to address. With that said, Bitcoin also faces sell pressures as bad loans bought with Bitcoin will have to be sold.
Likewise, there are fewer fiat-to-crypto rails in the US, with Silvergate and Signature banks closed. Compounded, the Biden admin proposed a 30% tax on Bitcoin mining electricity in the 2024 budget proposal. Ultimately, the public’s perception of the nature of money will have to unscramble these signals.
Will they go to larger banks, greatly centralizing the financial system as an outgrowth of the Federal Reserve, or take advantage of a specific long-term solution in the form of Bitcoin?
This article originally appeared on The Tokenist
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