SVB would have passed the regulations of the Dodd-Frank Act that was repealed!

The political aftermath of the Silicon Valley Bank as of today March 13th 2023 is now looking for scape goats to pin the blame on to anything but the US government themselves.

The recent blame is on how Trump repealed the Dodd Frank Act for small to medium sized banks and this is the main reason why there was a regulatory oversight. This is bunch of bull-poop that is being spin doctored again.

What is Dodd Frank Act?

The Dodd-Frank Act is a comprehensive financial regulatory reform law that was signed into law by President Barack Obama in 2010 in response to the financial crisis of 2008. The full name of the law is the Dodd-Frank Wall Street Reform and Consumer Protection Act, and it was named after its two main sponsors in the U.S. Senate and House of Representatives, respectively.

The Dodd-Frank Act aims to increase the accountability and transparency of financial institutions, reduce systemic risks to the financial system, and protect consumers from abusive financial practices. Some of the key provisions of the law include:

1. The creation of the Consumer Financial Protection Bureau (CFPB) to regulate consumer financial products and services.
2. The establishment of the Financial Stability Oversight Council (FSOC) to monitor systemic risks in the financial system and to identify emerging threats to financial stability.
3. The requirement for financial institutions to hold higher levels of capital to better absorb losses in times of financial stress.
4. The implementation of new regulations on derivatives trading to reduce risk and increase transparency.
5. The prohibition of certain proprietary trading activities by banks, known as the “Volcker Rule.”
6. The requirement for companies to disclose the ratio of CEO pay to median employee pay.

The Dodd-Frank Act is considered to be one of the most significant pieces of financial reform legislation in the United States since the Great Depression. It has had a major impact on the regulation of the financial industry and has been the subject of ongoing debate and controversy since its passage.

Was the Dodd Frank Act Fully Repealed?

Nope. The Dodd-Frank Act has not been repealed in its entirety. However, certain provisions of the law have been modified or repealed since it was passed in 2010.

In 2018, President Donald Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act, which rolled back certain Dodd-Frank provisions for small-to-medium sized banks. The law raised the asset threshold for banks subject to enhanced regulatory oversight from $50 billion to $250 billion, exempted smaller banks from certain regulations, and provided some relief from reporting requirements.

In addition, in 2019, five regulatory agencies jointly announced a proposal to modify the Volcker Rule, which is a provision of the Dodd-Frank Act that prohibits banks from engaging in proprietary trading. The proposed modifications would loosen some of the restrictions on trading and investment activities for banks, while still maintaining the core principles of the Volcker Rule.

It is worth noting that while certain provisions of the Dodd-Frank Act have been modified or repealed, the law as a whole remains in effect and continues to be an important piece of financial regulatory reform in the United States.

So the main focus is on Volcker Rule.

What is Volcker Rule?

The Volcker Rule is a provision of the Dodd-Frank Act, which is a financial regulatory reform law passed in the United States in 2010. The rule is named after Paul Volcker, a former Chairman of the Federal Reserve who advocated for it.

The Volcker Rule prohibits banks from engaging in proprietary trading, which is the practice of trading for their own accounts rather than on behalf of clients. It also limits the ability of banks to invest in hedge funds and private equity funds.

The main goal of the Volcker Rule is to reduce the risk that large banks take on, by preventing them from engaging in risky trading activities that can lead to losses and potentially destabilize the financial system. By limiting banks’ ability to engage in proprietary trading and investing in risky assets, the rule is intended to promote financial stability and protect taxpayers from having to bail out banks that take on too much risk.

The Volcker Rule has been controversial since its introduction, with some arguing that it is overly complex and difficult to enforce, while others argue that it has been effective in reducing risk in the financial system. In 2019, the Volcker Rule was modified to ease some of its requirements and make it easier for banks to comply with its provisions.

Does Volcker Rule Allow banks to invest in MBS?

A BIG YES!! The Volcker Rule allows banks to invest in mortgage-backed securities (MBS) issued by Fannie Mae and Freddie Mac.

The rule provides an exemption for banks to hold MBS that are issued, guaranteed, or insured by a government-sponsored entity (GSE) like Fannie Mae or Freddie Mac. However, the exemption only applies to MBS that meet certain criteria, including that they are fully guaranteed as to principal and interest by a GSE, and that they are not backed by any non-conforming assets.

In other words, banks can invest in MBS issued by Fannie Mae and Freddie Mac, as long as those securities are fully guaranteed by the GSEs and meet the other requirements of the Volcker Rule exemption. However, the Volcker Rule still restricts banks from engaging in proprietary trading, which is trading for their own account, rather than on behalf of clients.

What are the Regulations on Small to Medium Banks?

Small-to-medium sized banks in the United States are subject to regulatory oversight from several different agencies, depending on their size and the type of banking services they offer. The primary regulators for these banks are the following:

1. Federal Deposit Insurance Corporation (FDIC): The FDIC is an independent federal agency that provides deposit insurance to protect depositors in the event that their bank fails. The FDIC also supervises and examines banks to ensure that they are operating in a safe and sound manner and complying with applicable laws and regulations.
2. Office of the Comptroller of the Currency (OCC): The OCC is an independent bureau within the U.S. Department of the Treasury that regulates and supervises national banks and federal savings associations. The OCC is responsible for ensuring that these institutions operate in a safe and sound manner, comply with applicable laws and regulations, and are able to meet the needs of their customers.
3. Federal Reserve System (FRS): The Federal Reserve is the central bank of the United States and is responsible for implementing monetary policy, supervising and regulating banks and other financial institutions, and maintaining the stability of the financial system. The FRS has supervisory authority over state-chartered banks that are members of the Federal Reserve System.
4. State Banking Authorities: State banking authorities are responsible for regulating and supervising state-chartered banks that are not members of the Federal Reserve System. These authorities are typically located within the state’s Department of Banking or Financial Regulation.

Small-to-medium sized banks are also subject to a variety of federal laws and regulations, such as the Bank Secrecy Act (BSA), the USA PATRIOT Act, and various consumer protection laws. These laws require banks to implement policies and procedures to prevent money laundering, terrorist financing, and other illicit activities, and to protect consumers from abusive practices.

So did SVB breach the Dodd Frank Act?

Assuming that the repealed Act was still in it’s existence in it’s entirety, SVB would NOT have breached the Act! SVB would still be compliant. So blaming it on previous administration is pointless! This is another “pass the hot potato” move by the Feds.

It is disappointing to observe that rather than taking responsibility for the laxity and lack of transparency resulting from the Federal Reserve’s failure to closely monitor the banks that were exposed to a coupon rate of 1.6% at par value for the MBS when the Fed’s interest rates were at zero, they are shifting the blame to everyone, including their grandmother and the milkman!

When you raise interests, you MUST monitor all securities that had a higher rate at zero-interest rates which will fall below when your Fed rates go above the coupon rate. This a basic economic monitoring measure you need to have in place. A 10 year MBS at face value, when you mark-to-market will obviously accrue losses on the books relative to book equity! You learn this in school.

This is not complex to understand. But the books are allowed to be opaque because the maturity dates are long and interest rates go up and down. So marking to market when you are not liquidating your accounts was not necessary. Here in lies the rub.

Also, NO, you do not have to be mandated by the Volcker Rule or Dodd Franck Act for stress tests when interest rate rises. This a regulatory requirement as part of OCC and mainly the FRS. They are accountable for these stress-tests when they raise the rates and especially when the assets are held in US govt sponsored securities whose coupon rates are lower than the fed rates!

If there was no bank run (I believe, this was purely caused by VCs advising their portfolio to withdraw) and SVB could have gone through with it’s $2.25 billion equity raise, we would not have bothered about it. But regulators cannot take this stand!

Aggressive Rate Hike is a Contagion Risk.

The Fed’s aggressive rate hike is a contagion risk. Period. This is an archaic machinery they use in the new age economy that is not working, and will not work.

Also, the Fed’s dual mandate does not mean that Fed is mandated to increase interest rates. That’s just a tool or a mechanism they have used time immemorial to control instead of the repo-rates and reserve ratio in the “hope” that it shall slow down inflation. This is not a mandate or a law.

The Federal Reserve has a number of tools at its disposal to promote economic stability. Here are some examples:

1. Monetary Policy: The Fed’s primary tool for promoting economic stability is monetary policy. The Fed can adjust interest rates to stimulate or slow down economic growth. Lowering interest rates can encourage borrowing and spending, while raising interest rates can encourage saving and discourage borrowing.
2. Reserve Requirements: The Fed also has the power to set reserve requirements for banks. By requiring banks to hold a certain percentage of their deposits in reserve, the Fed can influence the amount of money that banks have available to lend out.
3. Open Market Operations: The Fed can also engage in open market operations, which involve buying or selling government securities in the open market. By purchasing government securities, the Fed can inject money into the economy, which can stimulate economic growth. By selling government securities, the Fed can reduce the money supply, which can help to slow down inflation.
4. Discount Rate: The Fed also has the power to set the discount rate, which is the interest rate at which banks can borrow money from the Fed. By adjusting the discount rate, the Fed can encourage or discourage borrowing and spending.
5. Lender of Last Resort: As a lender of last resort, the Fed can provide emergency loans to banks and other financial institutions during times of crisis. This can help to prevent bank runs and stabilize the financial system.

The Fed has a range of tools at its disposal to promote economic stability, and it can use these tools in combination to achieve its objectives.

What about bailing out SVB on Tax Payers Money?

In the United States, the power to bail out banks using taxpayer money resides primarily with the Treasury Department and not with Feds. Although the Federal Reserve can also play a role in providing emergency funding to banks during times of crisis. Which is what they are doing with the new indirection called BTFP (Bank Term Funding Program) that Fed’s have setup for SVB and Signature Bank holders

Under the Emergency Economic Stabilization Act of 2008, which was passed in response to the financial crisis, the Treasury was authorized to establish the Troubled Asset Relief Program (TARP), which provided funds to banks and other financial institutions to help stabilize the financial system.

The Federal Reserve, meanwhile, can act as a lender of last resort, providing emergency loans to banks and other financial institutions during times of crisis. The Fed’s ability to provide emergency funding is designed to prevent bank runs and other forms of financial instability that can threaten the broader economy.

It’s worth noting that the decision to bail out a bank using taxpayer money is generally a controversial one, and there is often significant debate and disagreement among policymakers and the public about whether such bailouts are necessary or appropriate. In general, the use of taxpayer funds to bail out banks is seen as a measure of last resort, to be used only in extreme circumstances when the failure of a bank or financial institution could pose a serious risk to the broader economy.

Note that the US government regularly does invest some tax revenue that it collects from taxpayers. The government invests these funds in a variety of financial instruments, such as US Treasury securities, which include Treasury bills, notes, and bonds.

These investments help the government to manage its cash flows and to finance its operations. The government also invests some of its tax revenue in a range of other programs and initiatives, such as infrastructure projects, education and job training programs, and research and development initiatives.

I Personally Favor the Bail out

Here is the full asset breakdown of SVB as of March 08th 2023: Strategic Actions/Q1’23 Mid-Quarter Update. The following slides are worth noting.

The fundamentals of SVB were quite strong (If not for the bank run). They had a $627M in net interest income with a net margin of 1.89% and $74m in securities revenue. They were well above compliance minimums on caprial ratios. The catch was the $91B in MBS accruing losses which would have been covered with the $2.25b equity raise. IF NOT THE BANK RUN.

I am in favor of a bail out given the assets at SVB at full maturity does not have risks as it’s $91B is held in government sponsored MBS. The treasury, post investment (bail-out) can issue warrants to tax payers for all the dividends and upside on the book equity generated from SVB.

With this, you save the bank, retain the customers, retain book equity, allow SVB to raise it’s $2.25 billion equity deal in capital markets with offers to hedge funds and PE, and get a full rider on the premium paid back to Tax Payers! We would have had a 2x or 3x upside on our investment in the tax payers pool. I see this as a win actually.

Conclusion

Overall, the regulators failed to provide oversight, and the system is not conducive for organic corrections when the asset of a $200B bank gets frozen. Now all hell has broken lose and you will see a lot of political spin doctors controlling the narrative and shifting the blame. Sigh! Nothing seems to have changed since the 2008 debacle.