LARRY KUDLOW: This was a classic asset-liability mismatch

FOX Business host Larry Kudlow voices his concerns following the shocking collapse of the Silicon Valley Bank collapse on Monday's "Kudlow."

Right now, we can hope that the financial system is safe and stabilized by some quick government actions over the weekend. Stock markets were mostly steady today. Treasury bond rates fell. Gold and silver rallied – that’s not a fabulous sign, but, at the moment, there is no contagion catastrophe in the banking system, at this moment.

Look, like everyone, I am hoping the Silicon Valley Bank problem is contained, but as somebody who reported on two daily shows throughout the financial meltdown of 2008 to 2009, I know how difficult, indeed heartbreaking, a widespread banking meltdown can be, especially for typical families, blue-collar working folks.

Nobody wants to see another stock market crash, or a banking crash. So, like you, I hope this Silicon Valley Bank crisis is contained, but I never liked that word "contained" because that's what government authorities kept saying throughout 2007 and 2008 and they’re saying it again now.

Meanwhile, we’ll look at what’s been done. The Fed, Treasury and FDIC have guaranteed all the deposits in SVB. The Fed has rolled out a new liquidity facility that will make one-year loans to federally insured depositories, mostly collateralized by bonds that will be valued at par.

HOUSE REPUBLICANS MEETING MONDAY EVENING TO PLOT RESPONSE TO BIDEN’S HANDLING OF SVB COLLAPSE 

It includes some help for loans at the Fed's overnight interest rate and the Fed is opening the discount window wider for emergency loans. Alright. Bang, bang, bang. They took all those actions. Will this stop the hemorrhaging?

I honestly don't know. This is a known unknown. Recently, a bunch of regional bank stocks fell sharply. That’s not good. This whole story is kind of strange because SVB had a liquidity problem and they badly bungled the risk management of their securities portfolio.

They had plenty of money on deposit, but they kept using it to buy medium and long-term treasury bonds, whose value kept falling as the interest rate yields kept rising. Meanwhile, the cost of money on the liability side, including interest rates on the deposits, went up astronomically and went up fast over the past year – right from zero to 5%.

So, it was a classic asset-liability mismatch: the borrowing rate exceeded the return on assets. The yield curve was upside down and they didn't know how to deal with it. Now, they may not be alone in flunking their risk management, but they sure did flunk and I think that's the biggest problem SVB has.

Then they start selling assets, chasing lower prices. It's like catching a falling knife. You can't do it. So, their equity investors were wiped out, management was properly thrown out and now the government owns it and is running it. We’ll see how they do.

For the moment, the way these government assistance programs are structured, it’s very strange. It's both inflationary and contractionary. Economist Larry Lindsey got it right this morning: valuing the bond portfolio at par actually increases liquidity, but the smack-down of the whole bank will lead to stricter lending standards, probably a freeze on all loans.

That's an economic contraction and, to some extent, because SVB is the financial pulse of the whole Silicon Valley private equity tech world, I hope they’re still fulfilling their basic banking and payroll operations, but they’re not going to be expanding their loans and the whole tech world may suffer.

I don't know why the bank hasn't been sold yet. I don’t get that. There are rumors that one of Elizabeth Warren's radical socialist protégés from the Federal Trade Commission, now running the CFPB and a board member of the FDIC, is stopping the SVB buyout.

If that's true, it's plain stupid. Socialism strikes again, but I also have to wonder also about the quality of their loan portfolio. Let me put that on the table. Who knows? They haven’t looked into that yet.

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Maybe the final lesson here: wouldn’t it be great if the left-wing tax and spend Bidenomics program were thrown into the trash can once and for all? Because, you know what, the $5 trillion of spending that was injected in early 2021 and continued for two years created great inflationary pressures and the weak-kneed Jay Powell’s Fed helped them along and all they got was an explosion of inflation, then an interest rate explosion and then an upside-down yield curve.

That seems way too hard to handle for bank risk managers. This whole thing is a sad tale from the very beginning, two-plus years ago. Now, we have to wait on tenterhooks and hope that upside down economic policies can be prevented from another upside-down financial crisis. It’s not good. Let’s hope there is no contagion.

 This article is adapted from Larry Kudlow’s opening commentary on the March 13, 2023, edition of "Kudlow."

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