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What do you call a group of Black Swans?

Barchart - Wed Mar 22, 2023

In Nassim Nicholas Taleb’s book, The Black Swan, he defines a black swan as a highly improbable event with three principal characteristics - it is unpredictable, it carries a massive impact, and an explanation is created after the fact that makes it appear less random and more predictable than it actually was. 

The first black swan of my trading career was The Dot Com bubble of 2000-2002 - hopes and dreams vaulted the Nasdaq 100 to record highs before fear and panic dropped the index by 83%. Five years later, the financial crisis of 2007-2009 caught the world off guard and shortly thereafter you had bathroom attendants talking to you about liar loans and subprime lending. Last week, we experienced the banking crisis - a massive event that came out of nowhere and had significant global reaching impact. Time will tell what explanations will be created to explain it all. 

One could argue the recent banking crisis is not just one black swan event, but a group of black swans! Ironically, a group of black swans is called a Bank. Yep, it’s true. 

Black swan #1 would be the borrowing and lending practices of banks during a period of an inverted yield curve. Typically, banks borrow short term and lend long term – i.e., borrow cheap and lend it out at higher rates. With a normal yield curve, this will work fine for a bank; however, when the pandemic hit, money was pouring into banks. Silicon Valley Bank (SIVB) bought long-term government bonds and mortgage-backed securities with these deposits because they were paying a higher yield at the time. However, the Fed destroyed this investment by raising short term rates 4.75% in under 1 year. The sudden rise in short term rates caused the yield curve to invert – meaning that short term bonds have a higher yield than longer term bonds. As you can see in the illustration, the yield curve inverted back in April of 2022, where it crosses below the red line. At that point, the banks’ gameplan of “borrow short term, lend long term” became a losing strategy. When customers demanded funds, they were forced to sell assets at a loss to cover withdrawals. 

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Black Swan #2 is the shutting down of cryptocurrency onramps like ny (SI) and Signature Bank. While Silvergate had a run on the bank, they were not crippled like Silicon Valley Bank. According to the NY Department of Financial Services, Signature bank was seized because it “failed to provide reliable and consistent data, creating a significant crisis of confidence in the bank’s leadership.” It appears that both banks are being strategically swept into the hysteria and panic of the overall banking sector. This is the perfect opportunity for regulators to accelerate their all-out attack on the digital asset and cryptocurrency space. While this may seem to be a blow the cryptocurrency, it has helped fuel demand for assets like Bitcoin, Ethereum and many others as investors look for an alternative to traditional banking.

Black Swan #3 is the Federal Reserve. It is the responsibility of the Fed to establish reserve requirements for banks to ensure that a certain percentage of customer deposits remain on hand should there be a run on the bank. Even during the financial crisis of 2008, banks were required to hold 10% of customer deposits. Since the pandemic hit in 2020, the Fed lowered the reserve requirement to 0%. You read that correctly - banks are not required to hold any of the customer funds. While this was a great thing for banks, it opens the door to huge risk. Ultimately, this reckless lending and complete deployment of customer funds landed us where we are today. If Silvergate, Signature, Silicon Valley Bank, or any other bank was required to hold 10% of all deposits, it would have dampened most of the current bank runs. 

Lastly - Black Swan #4 is again the Federal Reserve. The Fed has a dual mandate: price stability and full employment. It uses every tool in its arsenal to keep inflation in check, as well as keep people working. One method to accomplish this is to expand and contract money supply to meet their goals. In this chart provided by the Federal Reserve, we are looking at M1 money supply. M1 money supply is the total amount of cash and cash equivalents available. As you can see back in 1960, we had $140 billion worth of M1. Fast forward 60 years to 2020 and that number grew to just under $4 trillion. In the next 60 days, M1 had increased to $16.2 trillion! Ultimately peaking in March of 2022 at $20.699 trillion. Are you befuddled as to why we have such high inflation? Looking to put the blame on the President (past or present) for our financial crisis and inflation? Look no further. The meteoric rise of money in circulation is the single biggest factor to our current inflationary dilemma. It’s first day college stuff - Finance 101. If you’re looking for the culprit, it’s the Federal Reserve.

A month ago, Chairman of the Federal Reserve, Jerome Powell, and Secretary of the Treasury, Janet Yellen, both reiterated the strength and security of our financial system. Yet over the past 3 weeks, we have seen what appears to be a group of black swans - the voluntary unwinding of Silvergate, the run on and closure of Silicon Valley Bank, the colossal First Republic Bank bailout, and finally, the suspicious closure of Signature Bank. 

As mentioned last week, these events create fantastic buying and selling opportunities. People will still need a place to park their cash, and for now, banks are still the primary solution. For this reason, expect changes to happen from a regulatory perspective. There is a good chance we may see a reversal of parts of the 2018 Economic Growth, Regulatory Relief and Consumer Protection Act, which exempted banks under $250 billion in assets from the Dodd-Frank Act’s banking regulations. Some banks will thrive with this new regulation, others will suffer greatly.



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On the date of publication, Merlin Rothfeld did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.