To everyone’s dismay, history repeated itself. Before we had Madoff, the subprime credit crisis, and other bank and investment officers stealing as well as losing millions of investors’ money in unauthorized trades including large, undisclosed fees. Obviously, Enron’s illegal history lingers on.
That these scams still happen clearly up to now show that some institutional and individual investors globally continue to pay only lip service to serious concerns like dubious risk management and implementing tough due diligence with counterparties.
Regulations have never stopped scam artists and probably never will. Laws and regulations don’t eliminate bad, unethical, and illegal ways of doing investments. Determined scam artists would always find a way to gain the confidence of investors to lure in more suckers to suffer more financial losses.
Both institutional and individual should really do very thorough due diligence process. As clients, don’t hesitate nor feel intimidated to ask questions if your investment manager’s strategy isn’t making any sense. Ask his investment benchmark, and ask him also to explain small but glaring discrepancies if any from the usual benchmark. Don’t rely alone on his so-called reputation or the fact that he was referred to you by his friends who, very likely, didn’t also check out these scammers either.
Investors will have a better handle of their funds if they scrutinize the investing company’s reputation, history, and integrity. For instance, if the company is saddled with bulging costs without any rising income to show, that’s a red flag warning to all. Don’t be swayed by “too good to be true” performance, if an institution or fund manager’s returns seems to be “too good to be true”, which probably are. Always remember that, sometimes, the return of your money is more important than the returns on your money.
Just recently, we again witnessed to the news of the unexpected collapse of Silicon Valley Bank in California. This bank specialized in the tech startup industry yet its major owners and management team appeared not prepared for a bank run when its major corporate depositors started making huge deposit withdrawals. Silicon’s collapse is the biggest bank failure in the US since Washington Mutual folded up in 2008.
Based in Silicon Valley, SVB had assets totalling US$209 billion at the end of 2022, according to Federal Deposit Insurance Corporation (FDIC). It provided financing for about half of all major companies in the tech sector, something some well-managed banks would not consider at all due to ongoing US Fed’s drive to keep on raising interest rates in its drive to tame US inflation.
Silicon Valley Bank invested large amount of bank deposits in long-term U.S. treasuries and other fixed-income securities. However, we all know that bonds and treasury values always fall when market interest rates start going up.
Most SVB’s clients maintained much larger accounts. Most corporate clients had deposits more than the $250,000 FDIC insured limit to return the depositors’ money.
So, when the Federal Reserve started raising interest rates in 2022 to combat inflation, the mark to market value of SVB’s bond and fixed-income portfolio started to drop. It didn’t take long for those large corporate depositors to do huge withdrawals from their SVB’s deposits, thereby causing massive drop of SVB’s cash position.
Remember this. if after one has purchased a bond and interest rate goes up, the market value of your bond will decline. This decline in the market value is not permanent because, when bond matures, it will stay pay you its full face value. However, if you want to sell your bond prior to its maturity and the yields offered by similar bonds (similar meaning bonds offered by the same type of issuer, with the same credit rating and the same maturity) are higher, you may end up selling your bond for less than you paid for it. Looking back, perhaps it would have been a different scenario if Silicon Valley Bank just held on to those bonds until their maturity dates.
Silicon Valley Bank used to lend out money in short durations. In 2021, it shifted to long-term securities such as US treasuries for more yield, but Silicon Valley Bank did not protect their liabilities with short-term investments for quick liquidations. Eventually, SVB suffered liquidity gaps for months when its fixed term investments started incurring large valuation losses, an embarrassing turn of events for SVB leading eventually to its collapse.
When negative major economic factors hit the US-based tech sector, many bank tech clients started to withdraw their large funds as
venture capital started to dry up. Unfortunately, SVB didn’t have enough cash on hand to liquidate such deposits.
By loading up on long-term bonds, SVB had taken an enormous unhedged bet on interest rate risk. SVB bet that interest rate would not continue to go up for longer period, but the US Fed ended the speculation when it kept raising the interest rate since the US Fed mandate is to tame rising US inflation.
Interest rates risk refers to the volatility of bond prices that results from changes in interest rates. If bonds are purchased and interest rates subsequently rise, then the market prices of the purchased bonds will decline. If the bondholder cannot sell the bonds at such low prices, then it is “stuck” with the purchased bonds with diminished values in the market, which clearly shows that Interest rates are always affected by many factors and are difficult to predict especially over the long term. Silicon Valley Bank definitely made the wrong bet both on interest rate risk and liquidity risk.
The lesson here is that investors should always remember that the four most dangerous words in the world of investing are “This time is different”.
Atty. Abelardo “Billy” Cortez is former FINEX national president and chairman of FINEX Foundation, former co-chairman of the Phils. Capital Markets Development Council and currently member of FINEX Ethics Committee. He is presently board director and executive committee member of the International Association of Financial Executives Institutes (IAFEI). A former independent board director at First Metro Investment Banking Corp, he is currently independent board director at other First Metro companies such as First Metro Securities Brokerage, Corp, First Metro Exchange-Traded Fund (ETF), PBC Capital Investment Corporation and First Metro Save and Learn FOCCUS Dynamic Fund (Metrobank Group).