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The banking crisis was ‘not a systemic event,’ it only affected ‘dumb and greedy institutions,’ according to famed short seller Jim Chanos
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The banking crisis was ‘not a systemic event,’ it only affected ‘dumb and greedy institutions,’ according to famed short seller Jim Chanos
Jan 18, 2024 7:44 PM

  In less than a month, three U.S. banks—Silicon Valley Bank (SVB), Signature Bank, and Silvergate Bank—have experienced failure. However, renowned short seller Jim Chanos isn't panicking, asserting that these events were not indicative of systemic risk within the banking sector. According to Chanos, who gained fame for his successful bet against Enron, the recent bank collapses stemmed from a "duration mismatch problem," affecting only a few institutions that made unwise decisions.

  Chanos, currently heading investment manager Chanos & Co. (formerly Kynikos Associates), posits that SVB and other regional lenders fell victim to a classic banking pitfall: failing to manage interest rate risks effectively. He believes this oversight was exacerbated by executives seeking larger bonuses through aggressive investment strategies.

  To grasp Chanos' perspective, it's crucial to understand how banks operate. When customers deposit funds, banks typically use those deposits to make loans or invest in relatively safe assets like U.S. treasuries, earning interest on those transactions. The system usually functions smoothly; however, issues arise when banks find themselves in a duration mismatch where their asset returns don't cover the interest due to depositors.

  Duration is a financial metric that measures the sensitivity of debt holdings to changes in interest rates. Gregory Miller, a chartered financial analyst at Colorado State University's Regional Economic Development Institute, explains that high duration means high sensitivity to interest rate fluctuations, while low duration equates to lower sensitivity.

  SVB's mistake lay in neglecting interest rate sensitivity. Amid an influx of deposits from tech startups between 2020 and 2021, SVB invested heavily in long-term treasury bonds and mortgage-backed securities, which promised higher returns but carried greater duration risk. As the Federal Reserve raised interest rates rapidly over the past year, SVB’s bond portfolio lost significant value due to the inverse relationship between bond prices and interest rates. With yields averaging under 2% and SVB needing to offer competitive interest rates on deposits, the bank faced a severe duration mismatch, resulting in substantial losses.

  These mounting losses triggered concerns among venture capitalists, leading to a bank run as they advised clients to withdraw their funds. Both Michael S. Barr, the Fed Vice Chair for Supervision, and Nobel laureate Douglas Diamond have attributed SVB's collapse to poor risk management and inadequate internal controls during a period of rapid growth.

  Despite consensus among experts that SVB's issues were isolated cases of mismanagement rather than a broader systemic threat, Chanos remains cautious about the stock market. He suggests that the SVB fiasco might foreshadow potential problems when the assumption that all will continue smoothly is shaken.

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