Forget a bank run – the U.S. just escaped a full-blown housing crisis.

The source of the emergency was Silicon Valley Bank (“SVB”). This tech-centric financial institution sold a struggling $21 billion bond portfolio at a $1.8 billion loss. On March 8, it told investors it needed to raise funds to fill that hole.

The announcement caused a panic – and a massive run on the bank.

Regulators shut down the bank on Friday, March 10. As little as 7% of the bank’s deposits were insured by the Federal Deposit Insurance Corporation (“FDIC”). And uninsured accounts were left hanging… until the government stepped in with a new backstop measure. Now, 100% of the bank’s deposits will be made whole.

A lot of folks have slammed the intervention. Rabobank analysts called it a “bailout of Silicon Valley venture capitalists funding Instagram filters that make cats look like dogs.”

But the government picked the best of the bad options… because if the bank run were left unchecked, American homebuyers would suffer.

Let me explain…

Silicon Valley Bank didn’t just deal in venture capital. Its balance sheets also included about $50 billion in mortgage-backed securities (“MBS”)…

If you remember the great financial crisis, that should sound familiar. MBS are tradeable bundles of home loans. They deliver periodic payments to investors who hold them – kind of like a bond. The difference is that the “coupon” – the annual interest rate – is paid by homeowners, rather than a business or government.

In the mid-2000s, MBS trading was all the rage. It was also a major contributor to the housing bubble. Back then, the problem was with how these securities were packaged…

Low-quality loans were mixed into the MBS bundles. When these “subprime” loans went into default, the institutions holding them suffered major losses.

The situation with SVB today is different… but still perilous.

The run on SVB put the bank into “receivership.” That means its deposits will be covered by another institution (in this case, the FDIC). It also means the bank’s depositors will be given first priority in getting their money back.

An obvious way to raise funds for depositors is selling the bank’s $50 billion cache of MBS. But if a regional bank run were allowed to go unchecked, here’s how quickly it could spiral…

  1. SVB sells its MBS at a distressed price to pay creditors.
  2. At the same time, a run starts on the next smallest regional bank.
  3. That bank enters receivership.
  4. That bank sells its MBS at a distressed price.

You get the gist…

This scenario would flood the market with distressed MBS. And it could explode the balance sheets of anybody holding those assets – including banks and lenders everywhere.

The Federal Reserve doesn’t want that to happen… not least because it holds more than $2.6 trillion worth of MBS on its own books.

Loan standards would tighten unreasonably, and the economy could plunge into a recession. That’s because folks need borrowing power to buy property. If banks were less willing to issue loans, housing affordability could dry up.

That would be the death knell for American homebuyers.

That’s why the government rushed in to make SVB depositors whole. It had nothing to do with Instagram filters… and everything to do with the American housing market.

Backstop or bailout, it brought the crisis under control. We don’t have to like it… But thanks to regulators, homebuyers will live to fight another day.

Good investing,

Sean Michael Cummings

Strange change at your bank [sponsor]
At least 41 major US banks have just made a drastic change to the way money in America works. It could have some major implications for you, your money and your retirement. But it's crucial you understand what's happening, before these changes get applied to your bank account. Here's everything you need to know.

Source: Daily Wealth