BOOTPRINTS: Moral Hazard as a Business Model | Steve Berman

What you’ve always suspected is true. Bankers lie. It’s a racket. But it’s not like “The Big Short” where deceptive bankers and greedy real estate agents and mortgage originators teamed up to load homeowners into impossible purchases of McMansions they could never afford. This is when bankers lie to each other, or when smarter bankers dupe ones who aren’t so smart.

There’s already been lots written about the technical aspects of why Silicon Valley Bank and Signature Bank failed. Our own David Thornton did a good job covering that. SVB’s management should have known that they were heading into a squeeze; that they weren’t liquid enough with underperforming bonds backing deposits concentrated in the hands of savvy investors who demand market rates for their money. And they did know, but they chose to whistle past the graveyard, believing their depositors would give them grace. Yeah, right.

Who duped SVB? Why it was the King of the Dealers—Goldman Sachs—whose boot print could be found all over the strangled neck of SVB’s corpse. As soon as I read that GS was advising SVB on their capital raise, I suspected that GS made money on the death of its client. GS makes money on everything, especially the demise of clients who listen to them.

The New York Times got someone inside GS to cough up some details.

In exchange for buying $21.4 billion of debt from Silicon Valley Bank — which the failed lender booked at a loss of $1.8 billion — Goldman could make around $100 million, said people familiar with the matter, who requested anonymity because the information was confidential. That total remained in flux.

I’ll summarize what the NYT reported and my previous take on this. The hapless graveyard whistlers at SVB got a call from Moody’s, who rate banks, warning they’re about to be downgraded on the value of their bonds. SBV called Goldman to bail them out. Goldman said “sure, we’ll buy your distressed assets” and they did. Goldman negotiated a pretty good discount to guarantee they’d make money on the deal, and arranged investment money to backfill the loss. But the structure of the deal made it impossible for SVB to hide the $1.8 billion dollar writedown before the capital hit its books.

SVB failed and GS made money on it. The dealmakers at GS likely knew that the chance of SVB surviving was near zero. The people Goldman hires are paid to know that. If someone isn’t capable of understanding how panicked rich tech investors with cash in SVB are going to react to a massive debt writedown, they are not going to be working at the director level at Goldman. The only way GS was going to structure the deal is if they made money whether SVB lived or died, knowing that the deal was going to kill the bank.

Did GS tell that to SVB management? I highly doubt it. Moral hazard is Goldman’s business model.

“The irony here is the disclosure of the loss on the bonds scared investors even more when they did not yet see new equity coming,” said John Coffee, a corporate governance professor at Columbia Law School.

I am interested in how deep the rabbit hole goes with GS, SVB, Signature Bank, and the sector in general. I mean this: does David Solomon make calls to the White House, or to Sen. Elizabeth Warren, giving some frank advice on how the government could bail out depositors and stop a worldwide panic? Maybe that advice is just what GS could use to maximize profit on its (many) hedge operations for tragedies just like this.

One thing bankers tend to play Motte and Bailey with is the fact that money is fungible. Whether we call President Biden’s deal to “make investors whole” at SVB and Signature Bank a fair use of the FDIC’s funds along with some pandemic magic, or if we call it a bailout, it’s really just semantics. Money exchanged for money doesn’t matter if it comes from the left hand or the right hand of government. Biden’s plan rewards the moral hazard while making dealmakers like GS more powerful.

In just the days following the bank closures, I’ve seen signs of the panic. Data calls from large companies asking if their supply chains will be affected by the bank failures, or do any of their suppliers have money in regional banks have gone out. Clients are getting calls from their bankers at top-tier “too big to fail” banks ensuring that everything is just peachy.

Most banks cannot survive an extended run on deposit cash. Even Credit Suisse has had to shore up its reserves with money from the Swiss National Bank to reverse a stock crash. The problem here is that regional banks that supply payroll to small businesses, who tend to keep more than $250,000 or $300,000 (the limits of FDIC insurance) in a single bank, are going to be looking to pull that money, thus ensuring those banks fail their stress test, forcing those banks to call loans and credit lines, harming small business who then can’t make payroll.

The stress underlying our inflation-wedged economy to fall into a depression is building. The fact that Biden’s administration tried to delay the reality of a recession hasn’t changed the facts, other than now the panic is hitting all at once. It’s a giant moral hazard. And one thing I can be sure of: making money on it is all the rage at companies like Goldman Sachs, whose wizards could foresee all of this, and whose dealmakers quietly whisper in the ears of the less prescient (in business, banking and government) to maximize their own profits.

There’s going to be a lot of bootprints on a lot of necks in the coming weeks.

Follow Steve on Twitter @stevengberman.

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