Speaker 1: Hey, they're ad Loots listeners. It's Tracy Alloway.
Speaker 2: And Joe Wisenthal.
Speaker 1: We are very excited to announce that Oudlots is going
Speaker 1: to Washington That's right.
Speaker 2: For the first time, we are going to do a
Speaker 2: live public Odd Lots recording in our nation's capital. That's
Speaker 2: going to be March twelfth in Washington, DC at the
Speaker 2: Miracle Theater and guests will be announced in the coming days,
Speaker 2: but in the meantime you can find a ticket link
Speaker 2: at Bloomberg dot com, slash odd.
Speaker 3: Lots, Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello and welcome to another episode of the Odd Lots podcast.
Speaker 1: I'm Joe Wisenthal and I'm Tracy Alloway.
Speaker 2: Tracy remember SVB.
Speaker 1: I vaguely remember something happening with a bank called Silicon Valley.
Speaker 2: Here's actually sort of something I've been wondering about, is like, Okay,
Speaker 2: there was this moment where suddenly people got anxious about
Speaker 2: regional banks and stuff like that. You know, we like
Speaker 2: did episodes like how should we reform banking? And should
Speaker 2: banking be semi public and all this stuff, but like
Speaker 2: nothing happened in the week of it.
Speaker 1: Right, No, And in fact, I mean, the basel endgame
Speaker 1: stuff seems to be pretty much off the table at
Speaker 1: this point.
Speaker 2: But yeah, what, actually I haven't been following that. What's
Speaker 2: happening with that?
Speaker 1: I don't think it's happening. Michael Barr has like he's left,
Speaker 1: hasn't he? So yeah, I mean it seems like there's
Speaker 1: not going to be a big change on that front.
Speaker 1: I will also say, like one of the interesting things
Speaker 1: when it comes to bank regulation is there was a
Speaker 1: twenty eighteen change where I think the Trump administration made
Speaker 1: it easier for regional banks to do some potentially riskier stuff.
Speaker 1: And the argument there was that regional banks should be
Speaker 1: treated differently to large banks, they should be able to
Speaker 1: do certain things blah blah blah blah blah. And I
Speaker 1: guess you could argue that that might have fed into
Speaker 1: some of the SVB drama as well.
Speaker 2: Actually it's good that we're talking about this because when
Speaker 2: we talk about financial markets these days, like so much
Speaker 2: of it is about tech in particular. But if you
Speaker 2: go back and look at a chart of KRE, the
Speaker 2: regional bank ETF, that is another one that was just
Speaker 2: a straight line up on November fifth, and there's a
Speaker 2: widespread expectation, and I think pretty well founded that the
Speaker 2: Trump administration is going to have a much more sort
Speaker 2: of liberal attitude towards financial market regulation than the last administration.
Speaker 2: And so we shouldn't go too long with, you know,
Speaker 2: take our eye off the ball of financial regulatory issues
Speaker 2: because also, if history is any guide, like the next
Speaker 2: thing that happens, like we'll get no warning of it. It
Speaker 2: will just happen one day. Yeah.
Speaker 1: Also, I love talking about banks, like let's just do
Speaker 1: it for bank purposes.
Speaker 2: Okay, Well, I'm very excited about this episode. It's a
Speaker 2: guest I've actually wanted to have on for a very
Speaker 2: long time. We're going to be speaking with Elham Saidenishon.
Speaker 2: She's a term assistant professor of economics at Bernard College
Speaker 2: at Columbia as well as an adjunct professor at NYU,
Speaker 2: and also the author of a recent paper sort of
Speaker 2: revisiting the collapse of SVB and plying a new lend
Speaker 2: to it. The paper is called Banks a Synthetic hedge Fund. So, Elham,
Speaker 2: thank you so much for coming on out lots.
Speaker 4: Thank you so much for having me. I'm very happy
Speaker 4: to be here.
Speaker 2: Absolutely, I'm not used to this phrase. So this term
Speaker 2: synthetic hedge funds, I could sort of take a stab
Speaker 2: in my mind of what it means. But what is
Speaker 2: this term synthetic hedge funds mean?
Speaker 4: A synthetic hash fund is a type of activity and
Speaker 4: rather than being a specific type of like firm. And
Speaker 4: this is when a non hedge fund wants to replicate
Speaker 4: the activities of a hedge fund and therefore get the
Speaker 4: same type of return. And this is about a replication,
Speaker 4: but it's about the replication of the return and risk
Speaker 4: of a hedge fund without being an actual hedge fund.
Speaker 4: So this is when we call an institution doing what
Speaker 4: we call SYNTHETI had fun type of activity.
Speaker 2: Tracy. I already like this conversation because normally we talk
Speaker 2: about shadow banks, right, and so the idea that there's
Speaker 2: banks inside regulated institutions and then other non banks sort
Speaker 2: of replicate their activity. And it feels like we're looking
Speaker 2: through the other end of the telescope here talking about,
Speaker 2: you know, hedge funds being replicated inside regulated institutions.
Speaker 1: Yeah, it's replication all the way down. But okay, talk
Speaker 1: to us about how SVB fits into the category of
Speaker 1: synthetic hedge funds because I think that'll help us understand
Speaker 1: exactly what's going on.
Speaker 4: So basically, a SVP kind of like FeAs in this
Speaker 4: category from two different perspectives, and like one type of
Speaker 4: activity is actually being generated through the unbalanced it kind
Speaker 4: of like operation, and the other one is being generated
Speaker 4: through off balance it operation. So I want to start
Speaker 4: with the off balance it operation and then I kind
Speaker 4: of like continue the conversation to discuss what SWEP has
Speaker 4: done and the balance it as well. When it comes
Speaker 4: to the off balance it operation, it is like the
Speaker 4: way as we have used interest rates, SWAB replicates what
Speaker 4: a hedge fund does in order to conduct a fixed
Speaker 4: income arbitration strategy, rather than what a bank does in
Speaker 4: order to protect itself against interest rate risk. So, to
Speaker 4: be more specific, what do I mean by that? Like
Speaker 4: when you try to kind of like match the activities
Speaker 4: of the SVB risk managers with the narratives of the
Speaker 4: CFO of the SVB, we see that the timing of
Speaker 4: entering and exiting the interest rates toob by SVP really
Speaker 4: replicates what a hedge fund would do in order to
Speaker 4: kind of like exploit the so called mispricing in the
Speaker 4: bond market. And that mispricing in the bond market would
Speaker 4: generate this so called like arbitrage opportunity that a hedge
Speaker 4: fund wants to naturally exploit. So I want to start
Speaker 4: with what happened to the SVB in order to decide
Speaker 4: to exit the interest rates to oppositions. So when you
Speaker 4: look at like the timing of the exit, it just
Speaker 4: doesn't make sense if you think of a VB as
Speaker 4: a bank that wants to actually hedge itself against interest
Speaker 4: rate movements, but if you think of it as a
Speaker 4: hedge fund who has entered this particular position of having
Speaker 4: a long position in the US treasuries and a short
Speaker 4: position in interst rate swap because it was actually thinking
Speaker 4: that the swop rate, which is the difference between the
Speaker 4: swap spread, which is the difference between the swap rate
Speaker 4: and the US treasure rate, is too narrow, and like
Speaker 4: the hedge fund was predicting that this spread is going
Speaker 4: to widen in the future. But at some point it
Speaker 4: realizes that that prediction was wrong and the swab spread
Speaker 4: is not actually going to widen, and in order to
Speaker 4: minimize as the losses, it tried to kind of like
Speaker 4: exed that particular position sooner rather than later. This is
Speaker 4: the narrative that the SVBCFO was kind of like offering
Speaker 4: to the rest of us that they tried to minimize
Speaker 4: losses and that's why they exist the interest rate stop position,
Speaker 4: which again matches with what the very same CFO and
Speaker 4: very same type of like people from the SVP group
Speaker 4: were telling us about their prediction about the shape of
Speaker 4: the yield cave, which informs such a strategy, But it
Speaker 4: does not align with what a typical bank risk manager
Speaker 4: would do if it wanted to actually protect itself against
Speaker 4: interest rate risks because it was holding very long term
Speaker 4: US Treasury securities. So in short, when it comes to
Speaker 4: the off balanceet operation, the timing of entering and exiting
Speaker 4: the swap positions, and the reason the SVIB has actually
Speaker 4: conducted both operations matched with their understanding of what the
Speaker 4: yield care should be and what the yield cave is
Speaker 4: rather than what the interesst rate risks are, and they
Speaker 4: wanted to protect themselves against those type of risks. So
Speaker 4: if you want to understand it from the traditional bank
Speaker 4: risk management, this doesn't make sense. If you want to
Speaker 4: understand it through a hedge fund strategy that want to
Speaker 4: actually exploit mispricing in the bond market, and then realizes
Speaker 4: that that mispricing was mistake, that estimation of a mispricing
Speaker 4: was mistake, then it does make sense to do what
Speaker 4: the SWEB did. At the same time, when it comes
Speaker 4: to the unbalanced operations, when we look at the asset
Speaker 4: side of the SVB, there is this item in the
Speaker 4: asset site which I think we should explore more and
Speaker 4: we haven't done so yet. And that's what we call
Speaker 4: the subscription line or a capitol call line of credit,
Speaker 4: which is something that I think is growing in the
Speaker 4: commercial banking world, and in terms of the economics of
Speaker 4: this credit line is a very unusual type of bank credit.
Speaker 1: I just want to ask a question on the swaps, right, So,
Speaker 1: I remember this came up a lot when the vocal
Speaker 1: rule was coming into being. But a reality of the
Speaker 1: way banks are operate is that the line between a
Speaker 1: hedge and a trade can be pretty thin, and hedges
Speaker 1: can end up being very profitable or they can end
Speaker 1: up losing a lot of money. How do you actually
Speaker 1: distinguish between the two, because again, one man's hedge is
Speaker 1: another man's trade.
Speaker 4: Right, that's a very very good question. Like, one way
Speaker 4: to distinguish between the two is that again listening to
Speaker 4: what they are saying and the reasoning behind their entrance,
Speaker 4: and they entering a particular position and they exit from
Speaker 4: that particular position. So it's really about collecting narrative. That's
Speaker 4: one thing. The second thing is to match what they
Speaker 4: are doing with what they also doing in peril and
Speaker 4: saying in peril about their prediction of what the shape
Speaker 4: of the yield care should be. Because when it comes
Speaker 4: to like most hedge funded strategies, especially the fixed income
Speaker 4: hedge funded strategies, is all about what a particular head
Speaker 4: fund manager thinks they yield curve should be and what
Speaker 4: the yield cave in the market actually is today. And
Speaker 4: if there's a difference between the two, a hedge fund
Speaker 4: is going to conduct a sort of an intere and
Speaker 4: compose a portfolio that enables the hedge fund to actually
Speaker 4: exploit that's so called mispricing. So what I would say
Speaker 4: is that the defining point here is whether that particular entity,
Speaker 4: it can be a synthetic hash fund such as a
Speaker 4: bank or an actual hedge fund, is connecting is activity
Speaker 4: with the mispricing in the bond market. And what the
Speaker 4: shape of the yield cave should be versus what the
Speaker 4: shape of the yield cave is or what they do
Speaker 4: think about, like a particular direction in the prices, and
Speaker 4: then they want to actually kind of like very immediately
Speaker 4: and short term exploit those particular directional benefits.
Speaker 2: So I take your point about Okay, the if I
Speaker 2: were saying one thing, we're doing a hedge, but some
Speaker 2: of the stuff doesn't line up, could it be inconfidence? Right? Like,
Speaker 2: so there's one stay, Okay, this does not look like
Speaker 2: a hedge. They're making a trade. They're taking some sort
Speaker 2: of risk that's different from the economics of the bank.
Speaker 2: Could it just be bad management.
Speaker 4: It can be, But in terms of SVB, I don't
Speaker 4: think it was. I do think it was incompetence, but
Speaker 4: not because they were incompetent in terms of being a
Speaker 4: bad risk manager as a bank or as a banker.
Speaker 4: But I think they were a very bad hedge fund manager.
Speaker 4: And again I want to go back to what they
Speaker 4: were saying about, like what they think the market is doing,
Speaker 4: which they thought is this wrong? And they thought that
Speaker 4: the swop press are too low, and they thought the
Speaker 4: swop pres they're based on the fundamental value they should
Speaker 4: be higher. And then when you look at their action,
Speaker 4: they were actually acting based on that particular belief, and
Speaker 4: I would not call that incompetence. I would call that
Speaker 4: someone in this case a banker who is actually trying
Speaker 4: to see like a hedge fund and it's trying to
Speaker 4: align his action based on that particular belief about the
Speaker 4: shape of the yield cave. And the other important difference
Speaker 4: between a hedge fund and strategy and a trade, just
Speaker 4: going back to the previous point, is that a trade
Speaker 4: is usually shorter term, but when it comes to the
Speaker 4: hedge fund of strategies, these guys are patients. At least
Speaker 4: some of these guys are very very patient, and especially
Speaker 4: in the world of fixing comarbitrash, you need to be patient,
Speaker 4: but when you are acting, you need to be very quick.
Speaker 4: And that's also one of the distinctions between just like
Speaker 4: you are entering the interest rate saw because you just
Speaker 4: want to trade a particular a derivative in this case
Speaker 4: SAB versus your intering interest rate SAB because it is
Speaker 4: part of your brother portfolio. And I do think that
Speaker 4: in the case of a SWEEB, the very interest rate
Speaker 4: SWAB because it was part of a broader portfolio, and
Speaker 4: that portfolio, the goal of that core portfolio was not
Speaker 4: to head a particular risk, in this case the interest
Speaker 4: rate risk of the those US treasuries, but rather the
Speaker 4: goal was to exploit a mispricing in the yieldcare.
Speaker 1: Talk to us about the on balance sheet activities you
Speaker 1: mentioned them earlier. So alternative credit line, subscription lines. How
Speaker 1: did those actually factor into this idea of SVB being
Speaker 1: a synthetic hedge fund.
Speaker 4: That's a very good question. And when it comes to
Speaker 4: the capital line of credit, there are so many interesting
Speaker 4: differences between this particular credit line and a typical bank
Speaker 4: credit line. I want to start by saying something which
Speaker 4: is very different from what banks do. So, as a bank,
Speaker 4: when you extend a line of credit, you extend the
Speaker 4: loan which earns interest. Your biggest incentive is to actually
Speaker 4: earn return based on the interest you are actually kind
Speaker 4: of like earning, and your biggest fear is for the
Speaker 4: guy for your counterparty not to show up. You don't
Speaker 4: want to actually be engaged in this type of credit activity.
Speaker 4: But when it comes to the capital line of credit
Speaker 4: or subscription line, is actually the opposite. When it comes
Speaker 4: to the interest rate on these lines of credit, the
Speaker 4: interest rate is actually very low. They are a structured
Speaker 4: to below. They are a structure to be too low,
Speaker 4: so that in this case, this is actually a line
Speaker 4: of credit between the bank and usually a private equity
Speaker 4: fund manager. So the interest rates are very low because
Speaker 4: you want to attract those private equity fund managers to
Speaker 4: come to you and actually postpone the capital call and
Speaker 4: in instead bring those funding gaps through this particle a
Speaker 4: line of credit.
Speaker 2: I explained that, sorry, don't understand that.
Speaker 4: Basically, like, the first thing is that these subscription lines
Speaker 4: are not a credit line between a bank and a
Speaker 4: private equity It is a credit line between a bank
Speaker 4: and a private equity fund manager. So the reason the
Speaker 4: private equity fund manager goes to the bank in order
Speaker 4: to kind of like establish this line of credit is
Speaker 4: that they want to postpone capital call from their limited partner,
Speaker 4: because that's how the private equity fund manager can actually
Speaker 4: kind of like synthetically or artificially increase the internal rate
Speaker 4: of return and therefore increases own compensation. So we know
Speaker 4: why private equity fund manager is doing so, but why
Speaker 4: the bank is involved in this type of activity. Given
Speaker 4: that the interest rate on this particular alone is not
Speaker 4: very attractive. The answer to this question is the type
Speaker 4: of collateral. The other type of credit lines where the
Speaker 4: collateral is usually let's say the physical assets or you know,
Speaker 4: another type of like financial assets. In this case, the
Speaker 4: collateral is the imployed liability of private equity limited partners,
Speaker 4: even though these limited partners may have no idea. As
Speaker 4: a matter of fact, they do not have any idea
Speaker 4: that this line of credit has been established at all.
Speaker 4: In this case, the incentive is a structure. In a
Speaker 4: very interesting way, the incentive for the bank care is
Speaker 4: a structure so that if for any reason, the private
Speaker 4: equity fund manager doesn't show up and does not clear
Speaker 4: the loan or the line of credit and it defaults,
Speaker 4: that's where the money and the profit and the attraction
Speaker 4: is going to be for the banker. So what is
Speaker 4: going to happen in this case. In this case, the
Speaker 4: banker can use what we call the power of attorney
Speaker 4: and then it becomes a synthetic limited partner in that
Speaker 4: particular private equity and the amount of loan, the amount
Speaker 4: of credit that was extended to the private equity fund
Speaker 4: manager now is going to be like as if the
Speaker 4: banker was actually one of the limited partners in that
Speaker 4: particular private equity investment, and the rate of return for
Speaker 4: the banker in this case is going to be the
Speaker 4: intelal rate of return of the private equity fund, which
Speaker 4: is considerably higher than the interest rate. In a sense,
Speaker 4: if you're a banker and if you have extended this
Speaker 4: type of line of credit, you're just like praying and
Speaker 4: like you're hoping that the fund manager doesn't show up
Speaker 4: so that you become the synthetic private equity fund manager.
Speaker 4: So in this paper, basically I am actually highlighting this
Speaker 4: activity which was actually a significant part of sweb's activity
Speaker 4: as well to say that in this case, what the
Speaker 4: banker wants to be is to become a synthetic private
Speaker 4: equity limited partner, and this particular line of credit is
Speaker 4: enabling the bank to do so. And I also want
Speaker 4: to say something about the prospect of like other banks
Speaker 4: using this This is actually a growing business. Wells Fargo
Speaker 4: now does have a whole department trying to exploit this
Speaker 4: type of line off credit. And I do think if
Speaker 4: a bank is interested in this, it is because the
Speaker 4: bank wants to become a synthetic private equity investor.
Speaker 1: Wait, talk to us more about how endemic this actually is.
Speaker 1: And I'm curious as well, like how you know that
Speaker 1: other banks are doing this? And I can think of
Speaker 1: one to posit taking institution that does this, and loads
Speaker 1: has been written about them over the years, But where
Speaker 1: are you getting the data from and how are you
Speaker 1: making that judgment?
Speaker 4: So basically like, I am connecting this research on market microstructure,
Speaker 4: and this project is called Market Microstructure Project. And because
Speaker 4: of this project, I am actually kind of like reading
Speaker 4: everything that the bankers, the fund managers are saying, like
Speaker 4: in the news, in the newspaper, in the news articles.
Speaker 4: So to answer your question, I would say that, unfortunately,
Speaker 4: as of now, I do not have access to the
Speaker 4: data set that gives me this kind of like concrete
Speaker 4: picture of like how many banks are actually using these
Speaker 4: subscription lines or extending these subscription lines. But the good
Speaker 4: news here is that I'm in touch with a few
Speaker 4: people in the fat they might extend such a data
Speaker 4: to me. So this is hopefully going to be the
Speaker 4: next project for me to formalize that and showing that
Speaker 4: in the data. But I'm collecting narratives I'm listening to
Speaker 4: the people, and also because of this market microstructure project,
Speaker 4: I'm talking to all the bankers, Like I go to
Speaker 4: this like let's say a half hours of the bank
Speaker 4: cares like the hedge fund association like parties, and I
Speaker 4: talk to these guys and I'm hearing or and or
Speaker 4: again that like the bankers are either using this in
Speaker 4: their business model as part of their business model, or
Speaker 4: they are trying to actually adopt it. So as of now,
Speaker 4: this is me as the one professor who is just
Speaker 4: trying to listen to the market. But hopefully this is
Speaker 4: soon going to be formally shown to the rest of
Speaker 4: us through the data that I will have access to.
Speaker 2: So they're like multiple things going on. There's the question
Speaker 2: of is the bank hedging or is the bank trading.
Speaker 2: There's the question of are they trying to establish collateral
Speaker 2: that's in a sort of like hedge fund or private
Speaker 2: equity structure so that they can get higher returns and
Speaker 2: so forth. If the data is available, is this the
Speaker 2: type of thing that like that you believe is detectable
Speaker 2: in advance? This bank is starting to look more like
Speaker 2: a synthetic hedge fund than what we think of as
Speaker 2: the economics of a bank, I do.
Speaker 4: Think it is, and I do think like the data
Speaker 4: is an amazing source, and I'm very glad that the central bankers,
Speaker 4: at least they do have access to so many data.
Speaker 4: At the same time, I think right now there is
Speaker 4: not that much the question of like data, but rather
Speaker 4: our framework, the lens s trivish while looking at and
Speaker 4: also the lens TRUVISI we are looking at this data.
Speaker 4: If you are looking at the same data and the
Speaker 4: only framework that you have adopted is the industrial organization
Speaker 4: of a bank, you're going to see what you want
Speaker 4: to see. That this was a bank who did a
Speaker 4: very bad and even a stupid type of like risk management,
Speaker 4: and because they just exited their interest rates opposition just
Speaker 4: before the FED started to increase the rates. So it
Speaker 4: is about the industrial organization that you adopt in order
Speaker 4: to assess the data that is being provided to you
Speaker 4: by banks. And I really think that in order for
Speaker 4: the regulators not to fail, it's not that much the
Speaker 4: question of supervision. I think banks are being supervised, but
Speaker 4: you have to supervise and assist the bank through new
Speaker 4: perspectives and understand that the banks do not want to
Speaker 4: be banks anymore, and they want to actually have some
Speaker 4: share of doors higher returns that are actually being accumulated
Speaker 4: and generated in the private market and also like in
Speaker 4: the alternative investment fund market. So once you look at
Speaker 4: what banks are doing through the business model and industrial
Speaker 4: organization of alternative investment fund, I think then you can
Speaker 4: become even a more effective bank supervisor.
Speaker 2: By the way, Tracy, I'm looking at a blog post
Speaker 2: right now from MSCI, and it doesn't look at it
Speaker 2: from the bank level, but through the fund level, you
Speaker 2: can just see the rise in charge. Whether it's looking
Speaker 2: adventure capital, buy out, various forms of private equity, the
Speaker 2: number of them using subscription lines of credit, pretty interesting
Speaker 2: charge lines going up into the right, lots.
Speaker 1: Of lines going up. So I mean, I agree with
Speaker 1: the point that supervisors should be looking at this activity.
Speaker 1: And we probably don't want banks to be synthetic hedge funds.
Speaker 1: We don't want them to do risky things because we
Speaker 1: would all like to one day get our deposits back.
Speaker 1: But in the case of SVB, I don't think I
Speaker 1: agree with the point that they were a bad synthetic
Speaker 1: hedge fund versus just a bad bank. And I guess
Speaker 1: My question is, like, is this the right thing to
Speaker 1: focus on for SVB, because even without the swap spreads,
Speaker 1: svb's bond portfolio would have had massive losses, right, And
Speaker 1: they also misjudged their deposit base. That's a pretty big
Speaker 1: failure for a bank. And by the way, I saw
Speaker 1: a presentation that was made to their Asset Liability Committee
Speaker 1: in late twenty twenty and the recommendation there from the
Speaker 1: Treasury was to buy shorter term bonds as deposits were
Speaker 1: flowing in, and the ALM committee basically decided not to
Speaker 1: do it. They said, like, if we do it, it'll
Speaker 1: cost eighteen million dollars in earnings. So they didn't want
Speaker 1: to do it because they wanted to protect their profits.
Speaker 4: But it seems to me like there are some bigger
Speaker 4: issues here, really good question. I still do believe that
Speaker 4: SVB was a good bank a very bad alternative investment fund.
Speaker 4: And also they weren't very good like in accounting, so
Speaker 4: like speaking of the US Treasury, the holding of the
Speaker 4: US Treasure is one of the other mistakes they made
Speaker 4: was that in instead of like accounting for them as
Speaker 4: health to maturity, they did do that as available for sale,
Speaker 4: and that was also one of the reasons that their
Speaker 4: balance sheet was negatively affected. So if anything, they weren't
Speaker 4: really good accountant. But in terms of like being a
Speaker 4: bank here, I do think they were decent enough bank,
Speaker 4: but they just didn't like to be that. They wanted
Speaker 4: to be something beyond that, and that where they weren't
Speaker 4: really good at. And again I'm going back to the
Speaker 4: narratives that I collected, and these are all public narratives.
Speaker 4: And when you look at why they did what they did,
Speaker 4: they really had a very very specific view of what
Speaker 4: the yield care should be and what the yield care is.
Speaker 4: They thought the swop press are going to increase and
Speaker 4: in order to actually match their fundamental value, and they
Speaker 4: thought the swop press are kind of like artificially like
Speaker 4: suppress and they wanted to take advantage of that. And
Speaker 4: they failed dramatically, and mostly because they couldn't wait long
Speaker 4: enough because they were actually constrained by regulation as well.
Speaker 4: So for me, rather than thinking that SVB was not
Speaker 4: a good bank, this is actually showing an inherent tension
Speaker 4: for any type of banks who wants to actually do
Speaker 4: something that non banks are doing, especially like alternative investment
Speaker 4: funds are doing. That even if you manipulate your models
Speaker 4: in order to synthetically replicate the trading strategies, investing strategies,
Speaker 4: or the risk and return portfolio of a hedge fund,
Speaker 4: you do not have the same flexibility to execute those
Speaker 4: type of strategies, and you do not have the same time,
Speaker 4: and you are considerably more constrained in terms of being
Speaker 4: supervised in terms of like you have to put considerably
Speaker 4: more capital. This is something that hedge funds do not
Speaker 4: need to do. And you have to respond to people
Speaker 4: who are very impatient, and those are depositors, people that
Speaker 4: as a hedge fund, you don't need to deal with.
Speaker 4: So for me, this is an inherent tension between being
Speaker 4: a bank with all the realities of being a bank,
Speaker 4: and just think that's not good enough. You want to
Speaker 4: be something better.
Speaker 2: You know, I for a long time, and I still do.
Speaker 2: Like I consider myself, like Tracy probably heard me at
Speaker 2: various times, I'm like an SVB apologist, And I've said
Speaker 2: on the podcast, I'm like, oh, they're like a good bank.
Speaker 2: They like took themselves really seriously.
Speaker 1: Everyone here has a different view. Yeah, whether they were
Speaker 1: a good bank, that's right.
Speaker 2: I think like I'm like in the middle here because
Speaker 2: I was for a long time. It's like, no, this
Speaker 2: is like what a bank should be, and they really
Speaker 2: get to know their clients and they really get to
Speaker 2: like know their industry. On the other hand, I agree
Speaker 2: with like Tracy that they just seem to have made
Speaker 2: a lot of bad mistakes and miscalculated the flightiness of
Speaker 2: its depositor base, and they probably didn't have traditional lending
Speaker 2: opportunities like most banks, so they're like, oh, I'll just
Speaker 2: put it in something safe, like Treasury is not thinking
Speaker 2: about then Treasury sometimes go down. I also home take
Speaker 2: your review that you know, like you're in Silicon Valley,
Speaker 2: you probably don't just like want to be a bank, right.
Speaker 2: You know everyone else is like getting super rich and you're.
Speaker 1: Just getting and management is dealing with tech people, right,
Speaker 1: so I imagine some of that optimism kind of rubs off
Speaker 1: on them.
Speaker 2: Yeah, So it's like everyone else is getting mega ridge
Speaker 2: and they're just getting kind of rich. So it's like
Speaker 2: you probably want to look for ways to like get
Speaker 2: something that resembles equity upside. All this being said, and
Speaker 2: this is sort of like my final question, the fact
Speaker 2: that like we're having this conversation, SDB is like a
Speaker 2: weird situation. There aren't many banks like SVB. I don't
Speaker 2: think in that one specific industry and an industry that's
Speaker 2: specific to a location, et cetera. And then there wasn't
Speaker 2: much contagion. There were a few other sort of similar
Speaker 2: banks that went down. There were some crypto related banks,
Speaker 2: but it was not contagious. In the end, it was
Speaker 2: not a big crisis of regional banks. It was not
Speaker 2: a big flight of deposits away. Regional banks DOCS have
Speaker 2: been doing very well lately and they're like basically they're
Speaker 2: a little bit above where they are when this PHB colaps.
Speaker 2: How do you think this is all along winded way
Speaker 2: to set up like the prevalence of this type of
Speaker 2: risk elsewhere. Because it feels to me that SVB intuitively
Speaker 2: feels like a unique situation.
Speaker 4: I should disagree with you, and I don't think it's
Speaker 4: about the question of like, okay, what happened immediately after
Speaker 4: I met of the claps of SVB. To me, this
Speaker 4: is a signal that where the banking is going, and
Speaker 4: this is about like the commercial banking those are like
Speaker 4: they're not too as big as Jpmerican. The City Bank
Speaker 4: or Bank of America. I do think that the biggest
Speaker 4: lesson we have to learn from this SVB is that
Speaker 4: the business model of banking system is changing, and SVB
Speaker 4: but just showing a window or opening a window towards
Speaker 4: that new world. That the banks are doing different things.
Speaker 4: They're manipulating their model in order to take advantage of
Speaker 4: some flexibility or any flexibility they might have in order
Speaker 4: to co undugged hedge fund like strategies. So to me,
Speaker 4: the collapse of SVB was very important, not because what
Speaker 4: happened immediately afterwards or the bank run on other banks,
Speaker 4: but because it is showing us that there is distension
Speaker 4: in the banking system, that banks do not want to
Speaker 4: be banked anymore, and they are looking for alternatives. And
Speaker 4: these alternatives are usually being found in the alternative investment world,
Speaker 4: and the banks are going to move towards to the
Speaker 4: direction of adopting more of that type of strategies into
Speaker 4: their traditional banking model. And it is in that regard.
Speaker 4: It is from this perspective that I think what happened
Speaker 4: to SVB is very important because it is showing us
Speaker 4: that banks are extremely uncomfortable with their identity and they
Speaker 4: want to shift their identity. Is it a bad thing
Speaker 4: or a good thing? You don't know. I think he's
Speaker 4: a very exciting thing.
Speaker 2: This is Tracy along has my approach to news. No
Speaker 2: better or good, just exciting.
Speaker 1: Yeah, although I was gonna say it was actually pretty
Speaker 1: amazing to hear you take a middle ground position on something.
Speaker 1: I don't think I've ever heard that before.
Speaker 2: I'm just a normal, moderate guy.
Speaker 1: Yeah, okay, So just on this point. One thing I
Speaker 1: remember from our discussions around SVB. I think we were
Speaker 1: talking to levmanand and he made the point that the
Speaker 1: US has basically made a conscious decision to outsource a
Speaker 1: lot of bank supervisory processes to shareholders. And shareholders, you know,
Speaker 1: they like making money, and so the incentive is typically
Speaker 1: skewed towards more risky behavior. If we decide that we
Speaker 1: don't want banks to be synthetic hedge funds, what type
Speaker 1: of regulation or limitations would you envision coming into play.
Speaker 4: I want to ask your question in a different way, like,
Speaker 4: if that's the future of banking, if the banks are
Speaker 4: actually moving towards this world of being a synthetic hatch fund,
Speaker 4: I do not think the next regulatory question is how
Speaker 4: to limit the banks, but how to create a safer
Speaker 4: environment for them, because the other lesson that we learn,
Speaker 4: at least I learned from the Oswebi's failure was that
Speaker 4: one of the reasons they failed was that at some
Speaker 4: point they realized that they do not have enough time
Speaker 4: to fully execute their strategy. Their strategy wasn't necessarily wrong,
Speaker 4: but they actually prematurely exited that as soon as they
Speaker 4: thought they might be wrong and they might actually face
Speaker 4: so many losses. I know this may sound like a
Speaker 4: revolutionary point, but I do think if the reality of
Speaker 4: the banking system is that the banks are moving towards
Speaker 4: that direction, the first regulatory task is for regulators to
Speaker 4: change their identity as well, because you cannot force banks
Speaker 4: to be banks if they do not want to be banks.
Speaker 4: At the same time, if banks are actually conducting risk
Speaker 4: care strategies, and if as a regulator you're allowing them
Speaker 4: to take on some of those risks, maybe you want
Speaker 4: to remove some of the protections. What type of protections
Speaker 4: can be removed so that you can still maintain the
Speaker 4: stability of the deposit taking world and the stability of
Speaker 4: the financial system. This is the question that I'm proactively
Speaker 4: thinking about it. I do not have the answer for
Speaker 4: but I don't think the first regulatory step is to
Speaker 4: limit what banks are doing, but rather for regulators to
Speaker 4: change their DNA and identity as well and know that
Speaker 4: they cannot be a simple, plain vanilla bank regulators anymore
Speaker 4: if banks are not banks anymore and banks want to
Speaker 4: be something else.
Speaker 2: Ohmsday, Denijah, Thank you so much for coming on Oline.
Speaker 2: We had a little three way debate therapy and there's
Speaker 2: a lot of fun things. Thank You're so much. Glad
Speaker 2: to finally have you on.
Speaker 4: Thank you so much. It was a pleasure of being
Speaker 4: here and discussing my ideas with you.
Speaker 2: Tracy. I can't believe you've said I've never taken a
Speaker 2: middle ground before. I don't take any positions.
Speaker 1: I just I just like to learn no opinion wise people.
Speaker 2: Yeah, that's me, that's me.
Speaker 1: I thought that was a really interesting discussion. I mean, broadly,
Speaker 1: what we're talking about here is reach for you behavior,
Speaker 1: and whether that comes about through synthetic leverage or something
Speaker 1: old school like just buying a bunch of long duration
Speaker 1: bonds and then not hedging the interest rate risk. It
Speaker 1: kind of amounts to the same thing right, they're still
Speaker 1: doing this to boost returns.
Speaker 2: We should do more on the rise of sublines. There's
Speaker 2: always one more thing, isn't there.
Speaker 1: Yeah. Well, and the other thing I was thinking is
Speaker 1: this feeds into that idea of banks and private credit
Speaker 1: private equity being frenemies, right, like they are objectively becoming
Speaker 1: more intertwined. Insurance companies, by the way, are also big
Speaker 1: players in private credit now, so it does feel like
Speaker 1: the trifecta of the three biggest financial industries, banks, private
Speaker 1: equity slash private credit, and insurers are becoming more intertwined totally.
Speaker 2: I mean, it's interesting and it makes total sense, right,
Speaker 2: if other entities are going to try to become banks
Speaker 2: or credit, you know, expanding entities as we've been talking
Speaker 2: about forever, it makes sense that banks are going to
Speaker 2: want to look for upside elsewhere and maybe take on
Speaker 2: positions that resemble more sort of like equity upside. I
Speaker 2: thought Aham said something kind of fascinating at the end
Speaker 2: in response to your question about regulation, which is that like,
Speaker 2: if banks don't want to be banks, like, there's kind
Speaker 2: of nothing we can do to stop them. And I
Speaker 2: think that's like an interesting principle of like financial regulation
Speaker 2: period that like you know, it is always this cat
Speaker 2: and mouse game, right and in the end, like there's
Speaker 2: sort of like entities will evolve into the new thing
Speaker 2: and at some point there's going to be a blow
Speaker 2: up and you know, hopefully regulators get ahead of the curve.
Speaker 2: But in the end, like it feels like all financial
Speaker 2: entities of any sort will like they'll evolve into what
Speaker 2: they want to evolve into.
Speaker 1: Yeah, you got to change your opinion when the facts change, right, right,
Speaker 1: Shoe Joe.
Speaker 2: Yeah, that's right.
Speaker 4: Yeah, Okay, shall we leave it there.
Speaker 2: Let's leave it there.
Speaker 1: This has been another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Alloway. You can follow me at Tracy Alloway and.
Speaker 2: I'm Joe Wisenthal. You can follow me at the Stalwart.
Speaker 2: Follow our guest Elham Say She's at el Hamsaiety and
Speaker 2: check out her recent paper banks as synthetic hedge funds.
Speaker 2: Follow our producers Kerman Rodriguez at Carman Ermann, Dash, O
Speaker 2: Bennett at dashbod and kill Brooks at Keil Brooks. More
Speaker 2: odd law content, go to bloomberg dot com slash oddlock,
Speaker 2: where transcripts a blog in a newsletter and you can
Speaker 2: chat about all of these topics twenty four to seven
Speaker 2: in our discord discord dot gg slash oddlocks.
Speaker 4: And if you enjoy add lots.
Speaker 1: If you like it when we talk about banks that
Speaker 1: don't want to be banks, then please leave us a
Speaker 1: positive review on your favorite podcast platform. And remember, if
Speaker 1: you are a Bloomberg subscriber, you can listen to all
Speaker 1: of our episodes absolutely ad free. All you need to
Speaker 1: do is find the Bloomberg channel on Apple Podcasts and
Speaker 1: follow the instructions there. Thanks for listening.