During their latest episode of the VALUE: After Hours Podcast, Travis, Taylor, and Carlisle discuss Fed Hikes Rates Until Something Breaks. Here’s an excerpt from the episode:
Tobias: We’ve shown what we’re going to do, haven’t we? We all know that. We know exactly what’s going to happen. The argument this whole way through has been the Fed will hike interest rates until something breaks. So, people are like, “Well, Silicon Valley Bank’s broke.”
Jake: Something broke.
Tobias: Yeah. So, therefore, they should stop. But at the same time now, you’ve got red hot inflation readings. They’re going to have to keep on raising rates to deal with that. When they cut– the market will fall over at some point and they’ll cut. The market is down on the year, down on the six-month, down on the one-month, down on the five-day, up a little bit today. Up a lot today, to be fair. I feel like we are seeing this slow-motion crash. We haven’t seen the face of the market yet. The market shows you its face every– We saw it in March 2020 at the bottom when it’s just full-on panic. When I open Twitter, you get a contact high from the fear–
Jake: Yeah, from the fear.
Tobias: That’s when you know that they were there.
Jake: Is that’s why you made Wile E. Coyote the–? [crosstalk]
Tobias: Go back and look at them. I’ve been doing a few crash test dummies, I think, last week.
Jake: Because he’s not looking down, therefore he won’t fall as long as he doesn’t look down?
Tobias: Yeah, that’s my point. What do you think, Tim?
Tim: I think last year, if you look at it, bonds have never had a year like that since they’ve been tracking the performance. So, there was a lot of carnage and that’s what’s interesting now is that the real damage was last year relative to interest rates. So, a lot of those kind of losses of what we saw last year. They don’t necessarily always have to realize it. Yeah, you could be right. I think that there’s fertile ground for more of a sell off. I also think that there’s some decent signs. Like the consumer is still relatively strong. It can be pretty hard to find employees. Unemployment is pretty low. If inflation does slow down a bit and the Fed stops raising rates, obviously that would help a lot of industries. I don’t know how realistic that is in the short-term that they could actually cut or anything like that.
If there’s a recession, I think it could be a manageable one as long as it’s based on root fundamentals. I think what I don’t like about just the current crisis is that I feel like it’s somewhat manufactured and that it’s not something that necessarily needs to occur. But if you yell “fire” in a crowded movie theater, you’re going to create a problematic situation. So, that’s I think something that should be watched out for.
Tobias: Yeah, I think it’s probably more of an accident than coordination. Obviously, I don’t know.
Jake: I like Hanlon’s razor on this one.
Tobias: What’s that?
Jake: Never attribute to malice that which can be explained by stupidity.
Tim: Yeah, it could be a combination of both. It could be a combination of both.
The bank made its share of problems. Clearly, I have no compassion for what the management strategy of that bank was by any means. But to get an actual run on the bank, it’s interesting how that came about. Just the fact that it’s VC companies and all their portfolio, that’s not normal. That’s not like how the deposits are at your local, regional bank. So, it’s an interesting dynamic. Yeah, the one thing I just– [crosstalk]
Tobias: Do you think–?
Tim: Oh, sorry, go ahead.
Jake: I was going to ask a question. The amount of money that was pulled out of Silicon Valley Bank is kind of staggering, like how fast it happened. Do you think that today’s tools, and let’s say the Fed as one of them as a big tool. Pun intended.
Tobias: I agree with that characterization.
Jake: Is that well suited for today’s world where things can happen just incredibly fast? I’m worried that they’re just going to be always fighting the last data point that came in and the world is just moving so quickly that they’re like– [crosstalk]
Tobias: Isn’t that always the case?
Jake: Yeah, but maybe more so than– A huge percentage of the deposits flew out of that in three days. That’s amazing, right?
Tim: Yeah. Look, I am not someone– If you look at who was getting bailed out, equity holders got wiped out, creditors pretty much got wiped out, the depositors definitely got bailed out without a doubt. It’s an interesting breed of depositors. It’s not the Average Joe that has 50,000 over the minimum requirements per se. So, that should understandably cause some frustration.
Jake: Tim, are taxpayers on the hook for Silicon Valley?
Tim: Only for the different.
Tobias: No, the Fed’s got it.
Tim: Well, they’ll raise the premiums on the banks. So, the banks will end up paying for it over time. But don’t forget. It’s only the excess over the assets that they’re able to realize that the taxpayer theoretically would be on the hook for. The banks normally pay for it via an insurance premium that gets collected over time. So, I think that could be worked out. But to your point, Jake, I think realistically you can’t have an implicit guarantee on just like Silicon Valley Bank and Signature Bank and then not do the same thing, because the world is different after that. It is. It’s a huge change. We saw the same thing with the GSEs. It’s just not realistic to have the status quo as it is. And so, I hope we don’t have to learn that the most painful way possible.
Tobias: Does it feel like if bonds are down– bonds had their worst year in whatever, like history or modern history over the last year, equities had a bad year, but equities have had lots of worse years than that. It seems to me like equities somehow just skated completely over the speed bump.
Jake: It’s [unintelligible 00:52:17] what have graveyard?
Tobias: Well, yeah. That’s how I feel. When we’ve seen this in the past, the Fed will keep on raising rates until something breaks. And then really, probably, what I’m talking about is the market, like individual regional banks blowing up, probably, they can rationalize that, but at some point, the market corrects. Then go back and look at what they’ve done every single time the market corrects, they lower rates. The first count of five or six rate cuts won’t do anything to the market. I don’t know. John Hussman’s theory about why the market rallied in March 2009 was they stopped having the banks having to mark to market. He says that little accounting change was the biggest–
Tim: It did. But that was because it was a stupid accounting policy in many ways, because what happened was it was a self-fulfilling prophecy, where the securities, the credit default swaps, and the RMBS were trading at such extreme levels that basically, when they had to mark to market, it showed that the banks had to keep raising capital. And then to do that, you’re issuing stock at lower and lower prices. But it was all a lot of uneconomic stuff because what happened to those RMBS securities in the following years. They were some of the best securities you could have owned. So, the prices were uneconomic.
If you want your banking system to be like a day trading environment, if you want it to be basically a day trader with everything marked to market, I understand that investment banking. Retail banking and investment banking are two different things. I think that there’s legitimate reasons for not– If you want someone to loan 30 years on a mortgage or 10 years on a business loan to a small business, you don’t necessarily want that loan marked to market to foster capital availability, in my opinion.
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