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  1. #17726
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    Last rant.

    The problems with all of these companies is that they are run by the slicks who bring in the money in. The country club gigalo a, and no one cares, or pays for genuine risk management/traders/nerds who know actually what they are doing. And the customers are worse, they go where the free masters tickets are made available.

    I’d even argue they don’t, because they don’t even know what risk management is, or how to hedge risk. Since I’ve left my previous business, I’ve met people who manage ALOT of money, and they are like a deer in the headlights when I try explaining what “professional” trading desk/firms are actually doing. They aactually get offended for being so clueless.

  2. #17727
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    Quote Originally Posted by LeeLau View Post
    I dunno. How were they dumb? Their financials show they were well run. They bought conservative things ; treasuries etc and made loans ( as they should). Their spending isn't outrageous. They treated customers well.
    Part of the problem is FRC got in bed with crypto. It wasn't a big portfolio component, maybe ~10%, but enough to spark rumors. After crypto friendly Silvergate failed USDC depegged and panic selling of USDC sparked a bank run. This is an agnostic description of what happened, not an argument for or against crypto:

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    The reality is any fractional reserve bank is vulnerable to panic regardless of how they are run. At some level banking, unless we're talking about narrow banking and the like, is something of a confidence game. In 2008 the iPhone had only existed for a year and Twitter had not yet sprung into existence. We like to talk about practical things like financials but If enough people stop believing in a bank, especially if it happens very quickly, it will go bust.

  3. #17728
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    Quote Originally Posted by MultiVerse View Post
    The reality is any fractional reserve bank is vulnerable to panic regardless of how they are run. At some level banking, unless we're talking about narrow banking and the like, is something of a confidence game. In 2008 the iPhone had only existed for a year and Twitter had not yet sprung into existence. We like to talk about practical things like financials but If enough people stop believing in a bank, especially if it happens very quickly, it will go bust.
    Aye that is the ugly truth and the nature of the beast hence the existence of the Yellen, JPow and the fed put in buttressing the system.

  4. #17729
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    Quote Originally Posted by Cono Este View Post
    Interesting point about the accounting, I dunno about all that stuff.

    I do know, risk is risk. Itís quite simple to identify and manage. Buying long dated treasuries to earn a bigger spread, without hedging it, is simply naked and greedy. To add that treasuries were at a historic high when they did it, thats just plain out a stupid amount of risk. Basically a texas hedge. Long, hedged with even longer. Idiots.

    If I went unhedged for one day, the phone rang. And no matter the loss, you took it or were fired.
    I would say that in my time in the industry if I came in with an idea to originate a deal or take a position and I didn't have a clear plan for hedging risk that I'd have been shot down immediately. Bottom line is I agree. But just throwing out a devils advocate take for debate

  5. #17730
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    So if "risk is risk"...lol what is actuarial science?

  6. #17731
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    Is the stock market going to tank?

    Quote Originally Posted by Cono Este View Post
    This is not exclusives to banks. How many of us have had dumb ass partners who canít respect a business can only grow, safely, so fast? Same lack of respect for risk and what separates professionals from gun slinging morons who ruin everything for everyone.
    Asset/deposit growth is a different sorta thing. Some really interesting times where the levers to control growth all sorta stopped working. If youíre paying 0.01% (not allowed to pay zero on an interest earning account) what do you do when the money just keeps flowing in? Be mean to people? Start charging exorbitant account fees?

    And then once you have all that cash sitting in your checking account, what do you do with it? Let it earn almost nothing? Or toss it into something safe and boring like treasuries so you can add a few million bucks to earnings without taking too much risk?

    ETA: and deposit growth is more a capital concern than anything else. These guys werenít over leveraged in any traditional sense of the term: equity, resource, etc. Those deposits were at risk whether they arrived last week or had been sitting there for a decade. The chunk of treasuries would maybe have looked a little less chunky, thoughÖ Primary difference being optics.
    Last edited by Mustonen; 03-21-2023 at 01:30 PM.
    focus.

  7. #17732
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    Quote Originally Posted by highangle View Post
    So if "risk is risk"...lol what is actuarial science?
    Bear with me as I know actuaries and it's intensely boring! Actuarial science's biggest dependency is lifespan. There's other dependencies in subfields (insurance in particular but the main contingency is a statistically well-researched slowly changing variable.

    Risk in terms of financial instrument is limited only by human ingenuity in dreaming up all manner of esoteric instruments to pile risk onto risk onto risk. There are many critics of the main tool used to assess and manage risk (value at risk - I'm one of them) but it's an imperfect tool used to attempt to assess risk in a constantly changing field.

    To me; actuaries deal with mainly a single variable modified by multiple variables but constrained within a range. VaR on the other hand is infinitely multi-variable.

  8. #17733
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    Bro you're sorta way off on that, but what the hey? Maybe watch Margin Call, or thumb through a primer on financial risk management. NBD though.

    Suffice to say "risk management" is a lot more rigorous and computationally complex than you may be aware of - on par with meteorology and high energy physics.



    Source: Two of my daughters are actuaries, and they code deep.

  9. #17734
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    Quote Originally Posted by highangle View Post
    Bro you're sorta way off on that, but what the hey? Maybe watch Margin Call, or thumb through a primer on financial risk management. NBD though.

    Source: Two of my daughters are actuaries, and they deep code
    Fair point. My brother was an actuary and my friend's also one but both in pension funds. I may very well be out of touch

  10. #17735
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    Can someone explain to me how investment risk is hedged? Not as in the actual mechanism, but how does that even work to anyoneís financial advantage.

    For example, letís say an investor was making a risky $10M bet and wanted to hedge it. If the counterparty being used as a hedge was aware of the riskiness of the original investment, then theyíd be pricing it accordingly (including making it profitable for themselves) and in that case itís probably better for the initial investment not to be hedged but to just be smaller in the first place to limit downside risk?

    I kind of get the idea of hedging to smooth out returns over time, but seems different than hedging an investment bet.

  11. #17736
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    Is the stock market going to tank?

    Quote Originally Posted by J. Barron DeJong View Post
    Can someone explain to me how investment risk is hedged? Not as in the actual mechanism, but how does that even work to anyoneís financial advantage.

    For example, letís say an investor was making a risky $10M bet and wanted to hedge it. If the counterparty being used as a hedge was aware of the riskiness of the original investment, then theyíd be pricing it accordingly (including making it profitable for themselves) and in that case itís probably better for the initial investment not to be hedged but to just be smaller in the first place to limit downside risk?

    I kind of get the idea of hedging to smooth out returns over time, but seems different than hedging an investment bet.
    You hedge differently depending on the investment. Sometimes you take different sides of the same trade
    (Long S&P, short S&P at different price target), sometimes you open a correlated position (long S&P/short VIX, short S&P/long gold)

    Also, they tend to hedge with leverage/etc. If you think markets are up directionally but youíre wrong, you get a better return by buying an offsetting put on SPY than by reducing your long position.

  12. #17737
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    Quote Originally Posted by JimmyCarter View Post
    If you think markets are up directionally but youíre wrong, you get a better return by buying an offsetting put on SPY than by reducing your long position.
    I think this is the kind of example I donít understand. Seems like if the offsetting position is expected to be (consistently) more profitable, then risk is being mis-priced somewhere.

    (I donít know what Iím talking about here, so could be completely off base.)

  13. #17738
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    Quote Originally Posted by J. Barron DeJong View Post
    Can someone explain to me how investment risk is hedged? Not as in the actual mechanism, but how does that even work to anyone’s financial advantage.
    For individuals there are various “all weather” portfolios. Ray Dalio has a fund but there are also better easier versions. The All Asset No Authority (AANA) portfolio, for example, has beaten the standard 60:40 portfolio going back almost a century. It's equally balanced amounts invested in seven different asset types:

    1. U.S. large-caps
    2. U.S. small-caps
    3. 10-year Treasuries
    4. U.S. REITS
    5. International stocks
    6. Commodities
    7. Gold



    Quote Originally Posted by J. Barron DeJong View Post
    I think this is the kind of example I don’t understand. Seems like if the offsetting position is expected to be (consistently) more profitable, then risk is being mis-priced somewhere.
    It's typically not entirely offset. The way it often works is one investment performs well in one time period and another performs well in another time period. It's not necessarily binary, it's more of a ranked ordering of returns. Banks are facing mark-to-market (MTM) losses but if they're able to hold into the future even to maturity then it quite possibly becomes a different story.

  14. #17739
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    Quote Originally Posted by MultiVerse View Post
    For individuals there are various ďall weatherĒ portfolios. Ray Dalio has a fund but there are also better easier versions. The All Asset No Authority AANA portfolio, for example, has beaten the standard 60:40 portfolio going back almost a century. It's equally balanced amounts invested in seven different asset types:

    1. U.S. large-caps
    2. U.S. small-caps
    3. 10-year Treasuries
    4. U.S. REITS
    5. International stocks
    6. Commodities
    7. Gold





    It's typically not entirely offset. The way it often works is one investment performs well in one period and another performs well in another period.
    To be clear, Iím not looking at how to reduce risk in my 401k. Thatís invested in a wide variety of index funds covering US/international, large/small cap, majority stock but a small amount of bonds (still well away from retirement age).

    But when LeeLau says if he wanted to take a big position, it would be shot down if he didnít have a plan to hedge it, how does the hedging work to make the profit/risk calculation better than just taking a smaller position?

  15. #17740
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    Quote Originally Posted by J. Barron DeJong View Post

    But when LeeLau says if he wanted to take a big position, it would be shot down if he didnít have a plan to hedge it, how does the hedging work to make the profit/risk calculation better than just taking a smaller position?
    You hedge exposure to risks, not the specific security. Say you want to buy NVDA stock because you think itís going to do better than the market, but are uncertain about which direction the broader market will move. You donít reduce your investment in NVDA, you just reduce some of that market risk by buying puts on the S&P.

  16. #17741
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    Quote Originally Posted by J. Barron DeJong View Post
    how does the hedging work to make the profit/risk calculation better than just taking a smaller position?
    Jimmy provided one way of doing it. Another way is interest rate futures contracts. It's easier to show how it works with equations because you can see the math. I typed up a simple example below but it really is a toy example and might not make things any clearer. In reality, banks use a range of financial instruments, including interest rate futures contracts, to hedge against interest rate risk of U.S. Treasuries, helping them to manage their portfolios and protect against potential losses.





    In words, a bank could hedge against interest rate risk of U.S. Treasuries is by using interest rate futures contracts. Suppose the bank holds a portfolio of U.S. Treasuries and expects interest rates to rise, which would cause the value of the portfolio to decline. To hedge against this risk, the bank could enter into a futures contract where it agrees to sell Treasury bond futures at a fixed price on a specific date in the future.

    For example, if the bank holds $10 million worth of U.S. Treasuries and expects interest rates to rise, it could enter into a futures contract to sell $10 million worth of Treasury bond futures at a fixed price of 102.00. If interest rates do rise, the value of the bank's Treasury portfolio would decline, but the bank would make a profit on the futures contract because it would be able to sell the futures at a higher price than the prevailing market price. The profit on the futures contract would offset the decline in the value of the bank's Treasury portfolio, thereby reducing the bank's interest rate risk.

    So if a bank sells $10m of Treasury bond futures at a fixed price of 102.00 and if interest rates rise the futures contract would increase in value by some amount, e.g. $100,000 ($10 million x 1% x 1.02)

    The bank could then sell the futures contract at a higher price of 103.02, realizing a profit of $102,000 ($10 million x 1.02 x (103.02 - 102.00)).

    The profit on the futures contract would offset the decline in the value of the bank's Treasury portfolio due to the rise in interest rates, thereby reducing the bank's interest rate risk.

  17. #17742
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    Quote Originally Posted by J. Barron DeJong View Post
    To be clear, I’m not looking at how to reduce risk in my 401k. That’s invested in a wide variety of index funds covering US/international, large/small cap, majority stock but a small amount of bonds (still well away from retirement age).

    But when LeeLau says if he wanted to take a big position, it would be shot down if he didn’t have a plan to hedge it, how does the hedging work to make the profit/risk calculation better than just taking a smaller position?
    One example. We would lend a company a sum of money (a bond so to speak) with interest rates, payment requirements. The loan had a conversion feature so that it could convert to shares. The conversion rate depended on the company's fair market value; which we would set as a formula (stock market price at end of day; or vol weighted average price etc) but I'd always negotiate a pre-set higher limit price for conversion. We would then short the stock of the company within a certain time period so as to obtain enough proceeds to justify making the initial loan worthwhile. When I say short the stock I mean either short the listed equity on a stock market or write/sell calls. To cover the short, we could then convert the loan into stock. There's some risk but most of it is hedged. The ultimate risk is that the company refuses to convert the loan into shares so we're left short stock without the ability to cover the short. This is now often called a toxic floorless convertible.

    - If we never took a stock position; we'd get paid interest for the loan
    - If the stock goes up against the short, we'd convert at the pre-set price and be protected against unlimited losses and still make money on the loan
    - If the stock craters; we'd make money on the short and, still get paid out on the loan.

    Another example for the banks in question. Buy a set of bonds that pay out 10% interest in 3 years. Then buy credit default swaps against the bond issuer that pays out money if the issuer defaults. Keep the CDS alive for the length of the loan term

    - If the bonds pay out the bank makes 10%
    - If the bonds default, the CDS pays out the equivalent (or close to it) of the bond principal.

    Goal will be cap profit at the 10% and also cap losses at principal + close to 10%. There may be slippage based on the amount of CDS protection bought but that's the job of risk management to figure out.

    EDIT Multiverse already typed out a nice example for the banks hedging interest rate movements

  18. #17743
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    Quote Originally Posted by J. Barron DeJong View Post
    Can someone explain to me how investment risk is hedged? Not as in the actual mechanism, but how does that even work to anyone’s financial advantage.

    For example, let’s say an investor was making a risky $10M bet and wanted to hedge it. If the counterparty being used as a hedge was aware of the riskiness of the original investment, then they’d be pricing it accordingly (including making it profitable for themselves) and in that case it’s probably better for the initial investment not to be hedged but to just be smaller in the first place to limit downside risk?

    I kind of get the idea of hedging to smooth out returns over time, but seems different than hedging an investment bet.
    Professionals rarely take naked positions. 90% of volume involves somekind of arbitrage. Most of the shit you hear about from citadel etc. all hedged, all somekind of arbitrage. Otherwise, if you’re just pushing a buy/sell button, why spend millions on exchange seats and whizz kid geniuses? There is risk of course, and there is no such thing as a perfect hedge but to close out the position, but you do it the best you can with what you can. That’s why warrants all get gobbled up, they Are basically options sold at a massive discount. These firms put themselves in a position to capture that. Could be through technology, could be relationships. It’s called “theoretical edge”. It’s not scalable, but thats why the well run firms just get bigger, and don’t need other peoples money, especially retail money. The best trades are usually OTC now. Firms ripping off their own customers, then dispersing that risk (hedging) across the public mkts. I.e. Picking the rest of us off.

    You are correct though, it’s not free. Take Mark Cuban for example. I chuckle when he talks about the massive risk reversal he put on in the otc mkt, with whatever that company was that bought him. He still has no clue that the firm that took the other side of that trade only did that because it was priced so they couldn’t lose money. They sold put, bought call, shorted the stock for like a 10 dollar credit. I’m sure it was a split strike, for net zero to him, so not completely risk free but probably $10 in theo, the firm that did that probably laid off half the risk in the listed mkts, then whatever they kept, and . So long as the stock did not gap down, they made a fortune. He should have just sold the shares, but the risk reversal was probably more liquid and under the table. But hey, happy customer, even if ignorant. Probably cost him 5%.

    I’d rather make a nickel risk free than bet a dollar.
    Last edited by Cono Este; 03-22-2023 at 06:43 AM.

  19. #17744
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    Is the stock market going to tank?

    I appreciate the discussionÖ much of this is outside of my wheelhouse.

    Quote Originally Posted by MultiVerse View Post

    The profit on the futures contract would offset the decline in the value of the bank's Treasury portfolio due to the rise in interest rates, thereby reducing the bank's interest rate risk.
    I know youíre speaking generally, but what killed SVB wasnít really IRR. It was liquidity risk (exacerbated by IRR, granted). Remember the bulk of their portfolio was HTM, and treasuries HTM are still a source of liquidity with FHLB and direct with the fed, though at market, not par (BTFP flipped that to par, not market). Reading recently that they were trying their damndest to get in front of the run using this source of liquidity and missed the mark by hours, if not minutes, because nobody is apparently gonna miss happy hour just to prevent a bank failure. One of those DR type scenarios that nobody expects to actually happen.

    Hedging may have been a great idea, but I donít think it would have made any difference in this scenario. At all. Unless hedging the treasuries would have made them more liquid somehow?

    Not arguing that they did everything right by any stretch, just doggedly holding on to the notion that they werenít quite as idiotic as we all would like them to be because them being morons makes us feel better, either about ourselves or about the security of the world. And that should give you some small pause.
    focus.

  20. #17745
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    Quote Originally Posted by MultiVerse View Post
    Jimmy provided one way of doing it. Another way is interest rate futures contracts. It's easier to show how it works with equations because you can see the math. I typed up a simple example below but it really is a toy example and might not make things any clearer. In reality, banks use a range of financial instruments, including interest rate futures contracts, to hedge against interest rate risk of U.S. Treasuries, helping them to manage their portfolios and protect against potential losses.





    In words, a bank could hedge against interest rate risk of U.S. Treasuries is by using interest rate futures contracts. Suppose the bank holds a portfolio of U.S. Treasuries and expects interest rates to rise, which would cause the value of the portfolio to decline. To hedge against this risk, the bank could enter into a futures contract where it agrees to sell Treasury bond futures at a fixed price on a specific date in the future.

    For example, if the bank holds $10 million worth of U.S. Treasuries and expects interest rates to rise, it could enter into a futures contract to sell $10 million worth of Treasury bond futures at a fixed price of 102.00. If interest rates do rise, the value of the bank's Treasury portfolio would decline, but the bank would make a profit on the futures contract because it would be able to sell the futures at a higher price than the prevailing market price. The profit on the futures contract would offset the decline in the value of the bank's Treasury portfolio, thereby reducing the bank's interest rate risk.

    I find all of this really interesting as a complete moran. So clearly I'm not understanding all of this, especially when acronyms are thrown in. Thank you Google.

    Question, so the bank enters into a futures contract to sell at 102.00, who exactly is buying that and what is the benefit for the other party? How are they making a profit? Everyone is in the game to win, that's the confusing part for me. I guess the hedging all over the place is to balance out any losses is just beyond my scope.

  21. #17746
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    Quote Originally Posted by Mustonen View Post
    Hedging may have been a great idea, but I don’t think it would have made any difference in this scenario. At all. Unless hedging the treasuries would have made them more liquid somehow?
    A recurring theme here has been they were illiquid but not insolvent. That's more or less the point of post #17727 above. Hedging might have helped SVB avoid the need to raise capital, which is normal, thus avoiding Peter Theil's attention. But yeah, no bank of SVB's size is liquid enough to survive a -$42billion single day run.

    There is a solution. We could allow narrow banks for business banking. A narrow bank would invest deposits in interest-bearing reserves at the Fed and then provide business services for a small fee. A narrow bank would be safe. There would be no need for deposit insurance, for risk regulation, or for capital requirements.

    Quote Originally Posted by jackstraw View Post
    Question, so the bank enters into a futures contract to sell at 102.00, who exactly is buying that and what is the benefit for the other party? How are they making a profit? Everyone is in the game to win, that's the confusing part for me. I guess the hedging all over the place is to balance out any losses is just beyond my scope.
    The full complexity of markets, let alone how things will look in the future, is beyond anyone's comprehension. All anyone can do is use abstractions and simplifications to try an make useful predictions.

    At an elemental level you have “speculators” and “hedgers.” Speculators are trading primarily to expand opportunities or returns in the future. The hedger trades mainly to preserve existing opportunities in their portfolios. They're both making bets about the state of the world at different times. Market claims on these bets in the various states of the world are constantly being passed back and forth between and within these two groups of transactors.
    Last edited by MultiVerse; 03-22-2023 at 09:34 AM.

  22. #17747
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    Quote Originally Posted by Mustonen View Post
    I appreciate the discussion… much of this is outside of my wheelhouse.



    I know you’re speaking generally, but what killed SVB wasn’t really IRR. It was liquidity risk (exacerbated by IRR, granted). Remember the bulk of their portfolio was HTM, and treasuries HTM are still a source of liquidity with FHLB and direct with the fed, though at market, not par (BTFP flipped that to par, not market). Reading recently that they were trying their damndest to get in front of the run using this source of liquidity and missed the mark by hours, if not minutes, because nobody is apparently gonna miss happy hour just to prevent a bank failure. One of those DR type scenarios that nobody expects to actually happen.

    Hedging may have been a great idea, but I don’t think it would have made any difference in this scenario. At all. Unless hedging the treasuries would have made them more liquid somehow?

    Not arguing that they did everything right by any stretch, just doggedly holding on to the notion that they weren’t quite as idiotic as we all would like them to be because them being morons makes us feel better, either about ourselves or about the security of the world. And that should give you some small pause.

    You’re buying insurance. It’s not free, it digs into profits, but pigs get slaughtered. Like these morons.

  23. #17748
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    Quote Originally Posted by Cono Este View Post
    Professionals rarely take naked positions. 90% of volume involves somekind of arbitrage.....
    You are correct though, itís not free. Take Mark Cuban for example. I chuckle when he talks about the massive risk reversal he put on in the otc mkt, with whatever that company was that bought ........So long as the stock did not gap down, they made a fortune. He should have just sold the shares, but the risk reversal was probably more liquid and under the table. But hey, happy customer, even if ignorant. Probably cost him 5%.

    Iíd rather make a nickel risk free than bet a dollar.
    Cuban' company was broadcast.com bought by YHOO. He got YHOO shares but was locked up. His contract allowed him to hedge his YHOO position and he did. A wise move

  24. #17749
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    Quote Originally Posted by Cono Este View Post
    Youíre buying insurance. Itís not free, it digs into profits, but pigs get slaughtered. Like these morons.
    Yeah, like I said. Whatever makes you feel better.

    Neither earnings nor capital killed them - both were adequate and they could have ridden out both for quite some time.
    focus.

  25. #17750
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    Quote Originally Posted by MultiVerse View Post
    A recurring theme here has been they were illiquid but not insolvent. That's more or less the point of post #17727 above. Hedging might have helped SVB avoid the need to raise capital, which is normal, thus avoiding Peter Theil's attention. But yeah, no bank of SVB's size is liquid enough to survive a -$42billion single day run.

    There is a solution. We could allow narrow banks for business banking. A narrow bank would invest deposits in interest-bearing reserves at the Fed and then provide business services for a small fee. A narrow bank would be safe. There would be no need for deposit insurance, for risk regulation, or for capital requirements.
    I wonder what the exec team bonus structure looked like? They didnít NEED capital by any measure, and they didnít really NEED the earnings potential afforded by liquidating those investments. Itís not entirely illogical that they would do what they did, but I wonder if they were influenced by some language within their contract that caused them to act less than rationally, if they actually had any clue how tenuous their situation was?
    focus.

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