March 2023

Restoring Order and Calm

Dear Clients, Jefferies Employee-Partners and Friends,

We do not believe the events of last week portend a repeat of 2008, absent serious miscalculations of present circumstances.  In 2008, almost the entire financial system was overleveraged and filled with mismarked complex illiquid assets.  This is not the case today.  Our sense of the range of institutions under scrutiny is that any issues are finite and idiosyncratic – in other words, they don’t threaten the whole system and should not lead to endless contagion, as long as we remain calm, acknowledge the problems are very serious and capable of spiraling out of control, and deal proactively and aggressively in a smart, immediate and targeted manner.  From our perspective, we have witnessed nothing more or less than a conventional bank run that led to illiquidity because of a fundamental mismatch of duration in assets and liabilities.  Low yielding long-term assets and commitments were underpinned by fairly concentrated overnight funding, which had grown incredibly quickly in recent years.  When confidence was shaken and depositors became a herd heading for the doors, the bank failed.  Drawdowns on open lines of credit accelerated the process and the proposed plan to fix a credibility/liquidity issue seems to have had the opposite effect and made a terrible result quickly inevitable.  This situation in and of itself is horrible and causes incredible pain for the overwhelming majority of wonderful employees at SVB who did nothing wrong, the customers whose money is temporarily trapped (and possibly impaired), and all of the incredible growth companies who have their own real world time pressures (such as payroll).  The best solution would be a merger occurring today (and we should all be thrilled if it happens and in our dreams no past problem should haunt any rescuer), but more is needed.  Short of an outright stabilizing rescue which would border on the miraculous, there needs to be a clear process of how people beyond the $250,000 insurance threshold will have access to their cash.  When we do the math (and we acknowledge we are on the outside looking in and could be wrong), it appears realistic that any impairment of the deposits should be fairly modest.  We are not downplaying the injustice of even a penny of discount to one’s hard earned cash, but assuming the wind-down is done promptly and smartly, this event in and of itself should not cause a systemic crisis.  In the meantime, Jefferies (and hopefully others) is working actively to find practical solutions to get depositors advances on their receivables, so the very near term is workable for their respective companies.  Second, we believe these solutions should only be needed temporarily because the government and regulators must recognize these grave issues need to be addressed as soon as possible, and it is our expectation they will be.  Of course, if there was an immediate solution to make uninsured depositors whole, that would be ideal. 

 

Unfortunately, this entire situation (on the heels of Silvergate Bank going into receivership) has heightened vulnerabilities elsewhere and we could witness another handful of these in the next hours or days.  Should that happen, the ramifications become harder to contain.  We believe the best way to restore order and calm is for the U.S. bank regulatory consortium to confirm before tomorrow morning the liquidity strength of various banks, emphasize the government liquidity facilities that are already available to them, and potentially add a further facility to punctuate this and take off the table all depositor anxiety.  The depositors of those banks need to know their money is safe.  Best we see, these other banks are solvent and well-managed.  Yes, they may have some portion of their assets that are worth less given the rapid rise in interest rates, but the nature of their deposits, the ample level of buffer, and the quality of the management teams mean the future of these banks should be secure, and all that may be challenged in the near-term is their ability to generate returns on their equity comparable to historical levels.  Thus, the stock prices may adjust (perhaps they already have), but these banks can continue to thrive, and all customer deposits can be safe.  All this requires is the commitment by the government to emphasize that liquidity windows for all banks (especially the regional ones) remain open and available.  If any bank is then determined to need to be downsized or merged, it can be done in a period of calm, which is always the ideal way to solve problems.  

 

How could this have been averted?  We have opinions and perspectives but those are best saved for once the all clear sign is given.  Suffice it to say, given our experience dealing with fast moving liquidity challenges as they spiral out of control, the only way to solve them is to present the completed solution when providing transparently on the problem.  Solving a portion of the problem or looking for the public markets to be able to handle the uncertainty and price the solution will only cause everyone who can exit the scene to do so as fast as possible.  Hopefully, by all of us doing our best to provide liquidity and drive a full recovery for the non-insured deposit holders, while acting aggressively to draw a line to stop the contagion, any future problems (should they arise) will be able to be handled appropriately and in a manner that protects the innocent, penalizes those at fault and knowingly at risk, and allows the economy to continue to grow and flourish.   

 

Thank you,

Rich and Brian