Billionaire Investor Warns of ‘Many More Problems’ After SVB Collapse
The recent collapse of Silicon Valley Bank (SVB) has raised concerns among leading analysts and investors, with hedge fund manager Ray Dalio comparing the bank’s collapse to a “canary in the coal mine” while signaling potential future problems in the venture capital sector and beyond.
Dalio wrote in an open letter earlier this week that the collapse of SVB was a classic bubble-bursting event that is part of a short-term debt cycle that typically lasts around seven years.
In this cycle, Dalio argues, tightening monetary policy leads to a self-reinforcing contraction in debt and credit, culminating in a financial crisis.
The SVB collapse signifies the beginning of the contraction phase of the current cycle, according to Dalio.
“Based on my understanding of this dynamic and what is now happening (which line up), this bank failure is a ‘canary in the coal mine’ early-sign dynamic that will have knock-on effects in the venture world and well beyond it,” he wrote.
The billionaire investor drew parallels between the current situation and the financial crisis of 2008–09, which was heavily rooted in residential real estate.
Today’s bubble, Dalio argues, lies within negative-cash-flow venture and private equity companies as well as commercial real estate firms that are unable to weather higher interest rates and tighter monetary policies.
Faced with soaring inflation that has proven far more persistent than many originally thought, the Federal Reserve has embarked on an aggressive path of rate hikes, raising interest rates at the fastest pace since the 1980s.
SVB collapsed when depositors rushed to withdraw their savings as word spread that the bank had booked huge losses on its bond portfolios, which had eroded in value due to rising interest rates. The bank took a $1.8 billion loss on a forced $21 billion bond liquidation and then announced it was looking to raise $2.25 billion in capital to fill the gap. The announcement spooked depositors, who quickly started pulling out their savings in a class bank run.
In an environment of high interest rates, in which longer-dated securities have dropped in value, many U.S. banks have unrealized losses on their bond holdings. Federal Deposit Insurance Corporation (FDIC) chair Martin Gruenberg warned recently that U.S. banks are sitting on unrealized losses on their bond holdings of around $620 billion.
“Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry,” he said, explaining that unrealized losses weaken the ability of banks to meet unexpected liquidity needs because they generate less cash when sold and because their sale often reduces the amount of regulatory capital.
Gruenberg added, however, that banks in the country are “generally in a strong financial condition and have not been forced to realize losses by selling depreciated securities.”
Dalio, in his letter, said that SVB’s collapse highlights the challenges of a high interest-rate environment in which persistently high inflation has forced central banks across the world to raise rates.
“It is likely that this bank failure will be followed by many more problems before the contraction phase of the cycle runs its course,” Dalio wrote, predicting fire sales of assets at very low prices, leading to banks booking “big losses” and pulling back on lending.
“We are approaching the turning point,” he wrote, arguing that once credit dries up and starts to hurt markets and the economy, the Fed will reverse course and start easing, while other U.S. financial authorities will provide credit and guarantees “because the problem becomes system-threatening.”
‘Much Bigger Longer-Term Problem’
Dalio believes that beyond the current challenges, there will eventually be a “much bigger longer-term problem,” which is the risk associated with large outstanding debts, central banks monetizing debt by printing more money and buying government securities, and the difficulty of maintaining real interest rates at suitable levels.
“The really big problem will come when there is too much of this money printing to provide creditors with adequate real returns, which will lead them to start selling their debt assets,” worsening the supply-demand balance, Dalio wrote.
This may result in too-high real interest rates for the markets and the economy, causing financial and economic pain.
The hedge fund manager predicts that the Federal Reserve will eventually switch from raising interest rates and selling debt (quantitative tightening) to lowering interest rates and buying debt (quantitative easing), leading to a decline in the value of money.
Dalio further believes that the financial and economic landscape over the next year or two will be “tough.”