Chit Chat Stocks - Investing Power Hour #50: Silicon Valley Bank Collapse; MSFT vs. GOOG AI War; Are Banks Investable?

Episode Date: March 19, 2023

The CCM Investing Power Hour is a live-streamed show every Thursday at 9:15 AM PST. On the show, Ryan, Brett, and a rotating list of guests have an unscripted discussion on a variety of investing topics. You can watch the show on our YouTube channel here: https://www.youtube.com/c/ChitChatMoney Follow the show on Twitter: https://twitter.com/chitchatmoney Subscribe to our newsletter: https://chitchatmoney.substack.com/ ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in, everybody. This is the Chit Chat Money Investing Power Hour. I am your host or co-host, Ryan Henderson. I'm joined by Brett Schaefer, as always. And we've got a lot of

topics. A lot of news in the financial realm this week, which is unfortunate because we chose this week to essentially take a vacation. We both took vacations, probably the complete opposite ones. Ryan went to where the most people in the world are, New York City, and I went where the least people are in the world which is the south uh patagonia chile so complete opposite vacations but yes we did take some time away from the laptop over this weekend which was i guess good because that we wanted to just been glued to our screens all day yeah and there is i mean it's probably good i think too because it maybe would have induced activity or trading some way when maybe the appropriate answer is to not do anything. But yeah, Silicon Valley Bank went into receivership.

They had essentially a bank run, and I'll talk about that. That's basically my only topic. I've received a couple of requests to kind of talk about this. I'm sure people expect us, and anyone that's a recurring listener on the Power Hour expects us to talk about this. So we'll definitely dig into that. And as Brett and I have both said, we're not banking experts, So I'm going to piece together basically a transcription of the events that – or I'll talk about the events that transpired in the words of other reporters that are smarter than me. So I'll do that, but we should talk about our sponsor before, which is Stratosphere. I don't have the script in front of me, so I'm going to speak from the heart on this one. But Stratosphere is basically our dashboard for investing.

It's our homepage. We have our watch list on there. We track all our stocks on there. If you're looking up a new business, it's got all the financials you might need. Brett's pulling it up right now if you're watching. And he's looking at First Republic Bank, which has a rough stock chart. That is a farm. But if you are interested in some of their key KPIs, look at all this stuff they got on.

Net interest income. Yeah. I mean, there's a lot of stuff with – I mean, one of the big appeals here for Stratosphere is you get company-specific metrics, so stuff that you won't get on most aggregators. so you can have total average deposits. They've got that there. You can see how it's just ballooned in the last couple of years. For companies like Airbnb, you can get the average daily rate. You can get the total nights and experiences book, that kind of stuff. And so it's really unique. It's got everything you need. It's called stratosphere.io. We use it almost, I would say on a daily basis now. And we recommend our listeners use it as well. They also have paid plans, which give you unlimited access to the company-specific metrics, which I think is probably one of the best parts of the platform. And they have a range of different paid plans. So check it

out, see if it's for you. I think it's a great alternative to some of the more costly providers. Saves us time and money. It's beautiful. It does. It definitely does. Yeah. The most important thing besides the KPIs are the 35 plus years of historical financials, Because going back more than 15, 20 years, it is very, very difficult to find that stuff. And for older companies, it is quite helpful and saves us plenty of time when looking at those. Yeah. And if you are considering a paid plan, which we get a ton of value out of it, you can use the CCM code for 15% off any of them. And so that's just code CCM.

But, and that's one more time, stratosphere.io. So look it up or we'll have it in probably any of our show notes. But without further ado, I think we should talk about Silicon Valley Bank. Yeah, you go into it. I'll maybe put myself on mute, unless you have anything you want me to add in here. You got a lot of notes on it. So I'll let you go and I'll tweet out the link here. Sure.

So I'm going to go through it. I should also say, if you're listening to this on, it would have come out on Sunday. Maybe there's more developments that have gone on here. I feel like every time we chat, there's always, at least in the last couple of weeks, there's been more news coming out the days after. So Credit Suisse is currently kind of under some turmoil right now. So potentially there's some issues there. Maybe we end up talking about that next week. But really, I know First Republic Bank is having some difficulties this morning as well.

But let's talk about Silicon Valley Bank. So like I said, a number of people have mentioned that they want me to, or they want us to talk about it. We're not experts. We're going to, or I am going to describe the events, what happened exactly, and try to get down to maybe the root of the problem, which is, you know, what went wrong? How does this, how can you kind of take this lesson if you're an investor and parlay it into any other investments you might have? But before I get into it, I'm going to quote a couple of people throughout this, Matt Levine, Mark Rubenstein, Ben Thompson, and Scuttleblurb. They all had really good reporting on it, so I recommend checking them out if you're interested. But let me start by giving a very simple explanation of what a bank is. And this is a quote from Ben Thompson, which I think encapsulates pretty well what a bank actually is. He says, banks are, at their core, facilitators. depositors lend their money to a bank for which they are paid interest and banks lend that money

out again for interest. A bank is profitable if the interest rate they charge for loans is greater than the interest they pay to depositors. Banks achieve this by leveraging time. Depositors earn a lower interest rate in exchange for being able to withdraw their money at any time. Loans earn higher interest rates, but take years to pay back. The reason this works is because a bank ideally has a diverse set of depositors whose funds come and go on an individual account basis, but on an aggregate basis are steady. This provides the stability for those long-term loans. Now, as a bank, you can either lend money directly, as it's mentioned above. So typically, you'll have your deposit customers. Maybe you have a lot of information on them. Maybe they

want to borrow money at some point. You can lend them that money. That's one solution. Or you can purchase securities with that money that earn interest. So if you don't have any people to lend to, or there just isn't enough demand for borrowing, you could purchase securities. And here's what Mark Rubenstein had to say about the purchases of securities. And this is really important. It gets slightly complex, but just you got to bear with me here. He says, when banks purchase securities, they are forced to decide upfront whether they intend to hold them to maturity. The decision dictates whether the securities are designed as held to maturity assets or HTM assets, or as available for sale, AFS assets. Held to maturity assets are not

mark-to-market. Banks can look on nonchalantly as bonds lose their value. They remain glued to balance sheets at amortized costs regardless. By contrast, available for sale assets are mark-to-market, a pure designation, but one that injects an element of volatility into a bank's capital raise. So in an environment where rates are declining, the federal funds rate is declining, it's generally better to have more of your securities as available for sale securities, because then they're worth more each quarter if rates continue to decline, and you can report higher earnings in that sense. But when rates are rising, you want, at least for reporting purposes, you want more of them inheld to maturity because then you can avoid reporting those losses or

those realized losses. They're unrealized until you sell one of them, then you have to realize those losses. So now let's address Silicon Valley Bank specifically. So first off, what is Silicon Valley Bank? From the start, they're really just set up to service tech companies and some of the tech influencers or leaders, thought leaders, whatever you want to call them. From everything I could tell, there wasn't really anything that special about the bank. They offered really standard services. They had pretty competitive interest rates, but nothing that special. It seems like basically the driver of their success was that they had the right connections in Silicon Valley and they had pretty good customer service from

what people said. And so basically, and there is sort of this network effect where if you are the bank for a lot of venture capitalists, they will recommend to their portfolio companies that they invest in to put their cash in Silicon Valley Bank. And so that's what ended up happening. They ended up servicing a lot of VC-based companies. Some were smaller, but also some were very large, like Roblox and Roku, a lot of them had more than $250,000 in cash in the bank. And so that kind of leads to part of the problem. Now, here's where it also gets kind of interesting. Since VC-backed companies usually grow through selling equity, as opposed to raising debt, Silicon Valley Bank did very little lending. So this is how Matt Levine describes it. He says,

the weird problem with focusing exclusively on crypto or startups in 2021 is that they had too much money. If you were the bank of startups, the main service that you provided to startups is that equity investors could give them a truck full of cash and they deposit it at your bank. He continues, the customers did not need loans in part because equity investors kept giving them trucks full of cash and in part because young tech startups tend not to have fixed assets or recurring cashflow that makes for good corporate borrowers. So you've got all this cash. You got essentially no one to lend to. And it isn't that they didn't do any lending. They did do some lending. They gave big, prominent VCs mortgage financing. They did a lot of vineyard financing

for Palo Alto, the nice wineries that got up there. But most of it was securities. And so this money poured in, and I mean, it really poured in, according to Mark Rubenstein, between the end of 2019 and the first quarter of 2022, the bank's deposit balances more than tripled to $198 billion. So tons of money is just flowing into Silicon Valley Bank. And so the way Silicon Valley made money is they purchased securities. However, short-term securities at the time, like treasury bills, paid out little to no interest. So instead, they tried to look for longer dated securities, things like treasury bonds, agency mortgage-backed securities. The average duration on these things were 6.2 years. They had some shorter-term

available for-sale securities as well, just less of it. So by Q1 of 2022, they had $27 billion in short-term available for-sale securities. Those are the ones where you're going to have to realize losses if rates are rising, but they're a little easier to sell. And then $99 billion of long-term held to maturity assets. Keep in mind, a lot of these, if you hold those assets to maturity, it's fine. Even in a rising rate environment, it's not great in terms of real returns, but you're still going to get the interest payments on those bonds or on those longer dated securities. It's just going to be not what you could get in the current environment. So you're taking essentially interest rate risk. But here's where things got dicey. As everyone now knows, over the last year and change, the Federal Reserve has been raising rates. This hurt the value, as I mentioned, of Silicon Valley banks, mortgage assets, and their longer-term treasury bills.

in fact, by September of 2022. So what is that? A little over maybe six months ago. They had a $16 billion unrealized loss on their health and maturity assets. But keep in mind, they don't have to realize that loss until they sell a single bond from their health and maturity assets. If they sell one, they have to mark the whole one down. So they didn't recognize those losses. That's basically the accounting practice. So theoretically, it wouldn't be that big of a deal assuming the deposit base stays strong, but therein lies the problem. I'll let Matt Levine describe it as he says. He says, there's another subtler, more dangerous exposure to interest rates. You are the bank of startups and startups are a low interest rate phenomenon. When interest

rates are higher. A dollar today is better than a dollar tomorrow. So investors want cash flows. When interest rates were low for a long time and suddenly become high, all the money that was rushing to your customers suddenly cut off. Your clients who were obtaining liquidity, I'm putting this in air quotes, obtaining liquidity through liquidity events such as IPOs, secondary offerings, SPAC fundraising, venture capital investments, acquisitions, and other fundraising activities, stop doing that. Your customers keep taking money out of the bank to pay rent and salaries, but they stopped depositing new money. Keep in mind, a lot of these VC-backed businesses are cashflow negative. They are not generating cash, which

means they're going to have to keep tapping into their bank and those deposits are going to go down instead of going up. This is exactly what was happening. From March of 2022 to December of 2022, Silicon Valley Bank's deposits fell by $25 billion. This was really the genesis of the problem because they were forced to liquidate almost all of their available for sale securities. And then they had to try and issue an equity raise. Because remember, if they sell any of those held to maturity assets, they have to mark that whole thing down. And so they can't do that. And so the goal was, we're going to try to raise some additional equity, sell some more stock. Hopefully that works out and we have the liquidity that's needed. The capital raise never ended up

happening. The day before they were about to do it, Moody's downgraded their debt rating. Silvergate Capital had similar problems to them. Silvergate was a bit of a... They were a bit messier. I think that's... Again, no banking analyst here, but I looked at Silvergate and thought that they were basically zero regardless of any decisions the management made. Silicon Valley Bank, as we'll probably discuss after this, was in less of a precarious position until the next topic you're about to get to, the withdrawals. Yeah.

And so, I mean, that was, they had a similar, like, functionally, they had a similar problem, which was deposits were coming out the door and they had long duration assets. Anyway, so Silvergate that morning, I think, right as Silicon Valley Bank was about to issue another equity raise, went into voluntary liquidation. This left basically any of the buyers of the would-be secondary offering were pretty shaky. And so they weren't able to complete the capital raise. And this started to basically have this – people caught wind of this. And I think part of what caused the scare was probably that they tried to do the secondary offering. And VCs were like, oh, shit, they need money. And so this kind of created a second

phenomenon that really hurt them. And so Matt Levine describes, he does a wonderful job of describing this part. He says, also, I'm sorry to be rude, but there is another reason that it is maybe not great to be the bank of startups, which is that nobody on earth is more of a herd animal than Silicon Valley venture capitalists. What you want as a bank is a certain amount of diversity among your depositors. If some depositors get spooked and take their money out, and other depositors evaluate your balance sheet and decide things are fine and keep their money in, and lots of more depositors keep their money in because they simply don't pay attention to banking news, then you have

a shot at muddling through your problems. That's not what happened when you're the bank of startups. Apparently, Peter Thiel was kind of the spark that really brought this thing down. He runs the Founders Fund. He recommended to his portfolio companies to pull their money out shortly after a bunch of other VCs recommended the same to their companies. That day, Silicon Valley Bank's customers initiated $42 billion of withdrawals. They had to essentially shut down all withdrawals because they couldn't sell through their health

and maturity assets in time. And even if they did, a fire sale like that, for one, they're not going to have the cash anymore because whatever they could sell those held to maturity bonds or longer dated assets at is probably less than – or definitely is less than what's quoted in terms of – than the amount of deposits. So that was the bank run. As we now know, the government has stepped in, said they will fully refund depositors. I haven't followed the shares that much, but Silicon Valley shareholders are probably – they took the risk. They're the ones that will, I guess, bear the burden. And I see some people citing that like, you know, why was there this bailout? But I think you look at this and it's probably helping depositors was probably the right

decision. People, that's not meant to be like a political take. People might have different views on that. But I love when I heard a lot of people say, well, why should they be bailed out? They're the ones that took the risk. I guarantee 99% of people don't know what the duration risk or the interest rate risk is where they currently bank. Like I have a private bank. I don't know if they have interest rate swaps or something like that. Like, I don't know if they have a book, like if you have more than

$250,000 in the bank, you don't really think of it as like taking a risk. You probably think of it as risk averse, honestly. Unless you're Giannis Antetokounmpo, who had apparently like 50 different bank accounts with $250,000 in them, which most people don't do. They use one bank. Yeah. He also has a guy doing that for him. Yeah, I'm sure. But also at that point, do you really need that much cash? Anyway, it raises a lot of questions. I've got a couple for you let's start with let's start with this one would you say this was more of a deposits problem or a security slash interest rate problem okay first just first reaction vcs they are who we thought they were but we can get into that later um it's got i mean we know it's a both problem

right the securities problem they made some choices they didn't have to make if we look at a similar company, not the exact same, but somewhat similar, Interactive Brokers. The CEO has been harping on not taking these long-term risks because they know that they could have some sort of deposit withdrawals that they need liquidity for. Again, I'm not updated on the situation and how it could be slightly different, but it was definitely... The biggest blame is on the Silicon Valley Bank, finance team, treasury team, whatever it is, whoever's managing their balance sheet, that was the biggest concern and the biggest blunder here. Because again, we've said this five times, we're not banking analysts. I read two minutes, probably. I read

an email newsletter on my phone on some ferry with terrible service. And I figured out, okay, that was dumb to have these risky deposits and then lend long or buy these long dated assets. it's just not like how are you doing that it doesn't it's just an incredible blunder and I can't believe they were able to get away with it we can maybe talk about that deregulation stuff that

came down in 2018 but that really is probably covered I don't know yeah it's covered it's covered on a lot of other shows and then on the deposit side yeah that it was definitely a deposits problem as well

because they weren't really diversified they were claimed to be diversified and maybe they thought they were because they had thousands of different companies but when the vcs control all the flows when everyone listens together when they're all talking to each other and they all make the same herd decisions when someone that's well known like peter teal decides to take things out it can cause a run on the bank much much quicker than at really any other bank, right? Yeah. Yeah. I mean, I would say this, I guess it was kind of a two-pronged problem. Obviously, they took interest rate risk. The other part here is most companies will hedge in some way. So interest rate swaps, or they will just avoid

being greedy and just use shorter term just buy things with shorter duration so I do think part of this was maybe a greed problem yeah because they wanted to hit their earnings targets earnings will go higher when they buy

those long term assets with higher yields again don't know exactly how the earnings stuff works there because we don't cover banks that well but from what I've read if you bought the shorter term stuff that would give you much better flexibility. Your earnings in the short run,

say in 2021, 2022 would look worse. But if you bought those longer ones, they look better. But obviously they took that bigger risk here. And it was, it seems pretty simple that it was very greedy. And maybe, do you think it was just 15 years of the startup world not hitting any sort of hiccup

and that they thought it was permanent? Well, I mean, they were around in the dot com era and in that time they saw deposits i think they lost like a quarter of their deposit so i would have thought like they had an idea that there's huge risk here having all depositors from the same realm similar yeah similar market environment yeah now there are yeah i think there was the aftermath or some of the characters around vc or silicon valley made themselves look like fools. Well, I got to say I'm very biased.

This has deepened my hatred for the venture capitalist community. Yeah, no doubt about it. But okay, I guess at the same time, I don't really think about my bank that much. I didn't think about the solvency potentially of my private bank that I use or whatever. I'm not really considering it. But at the same time, these are businesses with tons of cash in the bank.

Maybe you should have considered it given that how much is actually – like when you look at, let's say, Ally Bank or Ally Financial, I think like 90% of deposits are insured. Only like 10% are uninsured by the FDIC. It's a consumer bank. Yeah. Yeah. When you're a business bank or if you're banking with – if you're an actual business and you're going to a bank, you kind of have to, I think, assess maybe – maybe it is important to look at the solvency, especially if they're public. But only 10% of Silicon Valley's deposits were insured by the FDRC. So, I mean, that's part of just being a business bank. And maybe some of the rules are outdated. I saw an idea that was kind of interesting.

Matt Cochran posed it. Maybe you should be able to just buy insurance on that stuff, like insuring other things. Insurance on your deposits. Yeah. Yeah. Like the first $250,000 are free. And then if you really want to have tons more in one bank account, like you can pay for that insurance or the bank could potentially pay for that insurance. And maybe that's part of the customer value proposition. Yeah. I think that's interesting. I don't know who would want to insure that. but yeah i i kind of feel that there's a difference you know there's a separation

between these big businesses um and the uh companies that are the small businesses and individuals that have to um i don't know it's just so different where like you have the how to explain it i just think there's just should be a separation between how the big businesses are treated and then how the individual and small businesses are treated okay one second Someone's at the door. You respond and I'll listen. Yeah, that was surprising to me that they would have – that businesses are treated the same way as consumers, but it's not that big of a deal. I don't think – or I'm sorry.

It should change, I think, the risk tolerance potentially at the business. So, for example, I mean, okay, if I'm looking at this and I think, well, can you fault Silicon Valley Bank? Yeah. Beyond them just having customer concentration risk, essentially, in all of one realm, do you think they were knowingly taking this interest rate risk and it was greed? Or do you think it was genuine not knowing? Yeah. What was that like? That is your sole job. yeah well that's how you make money is by by essentially you know taking the risk with the deposits you have what's that line from the big short movie and again that's fictional where the guy says tell me the different i think it's this line tell me the difference between greed and

stupidity and i'll have my wife's brother arrested or something like that i think that's the line i think right this is a similar it's a very similar situation on the insurance side though i think they should offer i was kind of trying to think it through but i can't really get out of my mouth on the insurance side i feel like that could be a product for big companies but for small businesses and individuals i think the deposit or the insured limit should maybe be up to something like 10 million something like that that would make much more sense to me. Yeah, it is a little weird. It's too low. I feel like we should just raise it higher. What lessons do you take away from this? Banks are risky. Banks are almost

impossible to analyze. And the only thing, I mean, we just had that interview, which may have sparked the top. We had that monthly theme on financial stocks. And I just thought it was funny that we covered the financial stocks for a month and then this happened. But either way, we had the interview with John Maxfield and the big takeaway I had from that, which is a good interview for just banking in general. And he kind of threw out four or five interesting bank names that he thinks run a culture that would never get to this point. I can't remember exactly where they are, but he says the most important thing is management and not management intelligence, or maybe it's not how smart the management is,

but it's how humble, how conservative and conservative, small C conservative with their balance sheet, how risk averse they are. That's the most important thing for a winning bank over the long run or a durable banking enterprise over the long run. So I don't think it's changed.

It shouldn't grow fast. A good bank shouldn't grow its earnings quickly. Exactly. I don't think this, I guess there's lessons to take away, but from someone who has read a lot of financial history and try to cover that type of stuff, I don't think it's changed my outlook for investing in banks. It's to be really cautious to only invest in ones who have, from my perspective, have a winning niche that they go after and a really long track record of putting up good returns without, how do I say it, taking major risks that at least we know of.

And again, banks can be a little bit of a black box. But if you look at the history of that stuff, what was the... Who had the quote? I'm sure tons of people have said this, but I believe it's the long short investor, John Hempton, who said that the most dangerous thing I look at for a bank to either avoid as long or to target as a short or to research as a potential short is a fast-growing financial company, which again, is mainly a bank or bank-like entity. This is a classic case of that. So I think if you learn that, you read your financial history, this isn't a huge surprise. It's probably a surprise that it happened so quickly, just given the herd mentality of the VC community, but it's not a surprise if, again, you look at your financial history.

okay tougher question does this have ripple effects do you think there's any does this like cloud your any optimism you might have had for the market overall i don't think so seems not like the biggest deal right am i crazy am i crazy about that because I don't know what exactly has changed here, except for that niche community that this targeted, which again, some of it was crypto, which is complete. What do I say? Well, yes. Thank you, Charlie Munger. But it doesn't affect the economy outside of the people that aren't going to get their payroll from those crypto companies, which are just getting paid based on valuations and magic beans anyways.

So that was going to die in and of itself. There are these things that could get affected a little bit. The startup industry, biotech, all those early stage things. But for most people, I'm just not seeing... And this could be the coldest take in about two, three months. But I'm not seeing how this really affects things in general. I mean, what's different now for the vast majority of businesses, for the vast majority of individuals from two weeks ago, outside of the fact that actually your deposits might be more secure because the government's not going to let deposits, there's just another indication that governments aren't going to let deposits, even if they're quote unquote uninsured, go to to zero or not be a hundred percent of the dollar uh you know you're not going to be able to get the vast majority of your of your dollars back yeah um well i think

i think the government did the right thing too in terms of like preventing this from getting worse like if a lot of those companies were getting let's say 70 or 80 cents on every dollar deposited What did they, you know, you'd have a huge problem. It would potentially be a bigger issue because not only it's the, what do they call it? The whisper concern or the contagion of like fear. Like, you know, if it's not just the fact that they probably have to lay off some employees because they want to have all of the cash required to meet their payroll, some of these businesses, but it would discourage, I think a lot of other people, or maybe it would encourage

withdrawals at least for some of your money on a lot of other banks which potentially could cause further bank runs but I think this I think them stepping in and saying like we'll help depositors I think they learned with Lehman

letting Lehman fail was the wrong thing to do they didn't want to make that same mistake twice so i think they probably made the right move but i would say a credit suisse fail because we're seeing that kind of talked about now uh that is we might be talking very differently in a week here maybe maybe we're in a global banking crisis who knows the uh yeah i hate to fight the last war

because everyone's biased towards you know quote unquote the last war 2008 and by reading this Again, as no one, I do not know the banking industry very well. It feels like this is not a big deal and it's not, it's getting overstated by everyone. And a month from now, we're not going to be talking about this. However, I am also aware that there's a chance that could be an extremely cold take in a month from now, things could get ugly, but it's hard to see why I generally, I'm generally like, what would happen is Charles Schwab, like, would that be the one that's actually, you know the biggest because it seems like people are looking at that as well although they seem to

be in a much better shape than silicon valley bank but yeah the other thing reading that piece from scuttleburb again it's hard i don't understand all the numbers for that stuff but it's hard to see why charles schwab would be in the same situation they're just way better capitalized yeah and then on top of it like most for one it's the diversification of customers schwab has so many different customers we use schwab uh i have no thought of taking i have no thought of canceling my to my roth and my individual account from there no thought yeah and i don't think people would be like oh i'm gonna move the cash out but i'll keep all my stocks because most of their value in there is probably in stocks anyways for most people so here's i i know we get nervous

about investing in banks but here actually so we've noted the big the the huge problem was that the store of banks that are failing were betting that interest rates wouldn't rise that quickly and that, or they would be able to manage that. What happened is we've had stickier inflation than we thought. And the Fed has raised interest rates at the quickest pace in history, which really affects these businesses. However, we could be getting to the point where the Fed pauses, right? Who knows? Who knows? They also could be continuing to raise. this might set up a great environment going forward for the banks, for banking stocks or financial stocks, or anyone that's looking to buy financial stocks on the cheap because you have

your net interest margin is only going to get better. What I'm saying is the macro environment for these banks, we could be near the worst of it if we get flatlining interest rates from the Fed. they're able to manage through this quote-unquote really, really tough period and then come out the other side, well, you're able to make loans at much higher interest rates and just earn your net interest margin would just be much, much higher. Again, I could be missing something here, but it seems like if you're looking for some of these companies two, three years from now, could be. You look two, three years from now and say, wow, they were really cheap because the Fed wasn't going to raise at this rate

indefinitely. It's not like they're going to raise to 20% by 2024. I mean, that would just not happen. Although, who knows? I mean, that seems highly unlikely. Volcker left so many banks dead

in its wake. If rates continue to rise, I'm sure a lot of banks will die. But yeah, I've seen a lot of commentary that basically just says the Fed's unlikely to continue raising rates now after all this. I don't know. Here's another impossible or dumb question or meaningless question for us, but is important

for maybe some of these banks. Does the Fed still raise by 50 basis points next quarter as the inflation numbers have come in a little bit higher? Or not next meeting, not next quarter, next meeting. i don't know yeah it's impossible people are smarter than me say they probably won't but um the other thing here's the thing though if they don't raise and they say we're gonna um because they've been basically telegraphing they're either going to do 25 basis points or 50 basis points if they do that that indicates that they're they think everything's fine right

and then maybe that calms the contagion but or the potential contagion but if they pause that may indicate that they're worried and people might be thinking oh they're actually concerned about this becoming a problem so raising might actually be better yeah there is a giant psychological thing there's a giant psychological part of this obviously i think banking in general is built on trust the part of the uh there's two things that the ceo said the ceo of silicon Valley Bank said, which are maybe the number one and two things you don't say in the scenario, which is stay calm. Don't panic. You're just asking for people to panic. You also got to raise the money before you announce it. You have to announce that you've

raised the money. You can't announce that you're looking to raise money as a bank. if you get what i mean yes because then yeah then it indicates the problem has been solved and i don't they totally made a ton of mistakes also i want to say again i've lost the i don't know if i had any respect for these venture capitalists and again generalizing it not all of them you know maybe 80 of them i put in this bucket i've lost can we have negative respect for the venture capital community it was at zero i think i want to drop it even further because they are it's just the way they act is childish i'm saying this as someone who's 26 years old they act like children yeah it's okay whatever um nobody to single any any individual

names but it's it's it's just so wild to see them act like this yeah i mean well i don't know why so surprised to see them act in the best interest yeah but they also like yeah sure was peter they're adding value to the banking system well no they they're they're i i can't yeah there's so many things with that that's just and and they try to claim they're all libertarians and stuff and then well well you know and they're acting for a bailout is just frustrating from my view. But anything else on this? Well, the other thing I'll say is there are banks that are in really good shape.

I mean, I think I saw some stats that Bank of America saw record inflows or saw a really solid day of deposit inflows after this. Other banks, if they're structured well and they don't have some catastrophic run on their own deposits, are going to hugely benefit from this. I mean, we know a couple – we don't really have that much bank exposure in our portfolio, really. There's one, isn't it? Nelnet has a bank. And they're financial.

They also have a bunch of interest rate swaps. And so they've done a really good job. It gives me a newfound appreciation for that management team, how well they've managed or kind of positioned themselves for the interest rate cycle that we've seen. But it's going to leave some really good opportunities in financials land. That's true. I keep coming back to Ally Financial, something we've hesitated to own, something a lot of people that we know and talk to and respect as analysts and investors, they own. It seems cheap if things don't fall apart. I just get a bit nervous about something like that.

But again, they seem to be in a much different situation. And yes, that stock could be incredibly cheap looking two years. That's one of those. I'm sure there's others out there that we don't follow closely that you can think of as a listener that will look three to four years from now incredibly cheap at this moment. I'm just not sure I'm ready to take the risk on those outside of maybe one in our portfolio. All right. You got any news topics for the week? yeah i had some other ones that i think will be fun so we're seeing the continued war or i hate

using the term war the continued uh competition between google and microsoft which i have to ask do you think they had all of these products kind of in their queue and they've they've been like unloading them like it's kind of like a back and forth because there's no way they just all came up with these products in a month for these AI products that they're launching. It seems like they were waiting to launch them. What do you think? They had them sitting there and they're like, okay, when someone does something to encroach on us,

we're going to launch all these things to the public. They may have rushed the launch after seeing it. They may have been planning to launch it and then they're just like, let's expedite when we're going to do this publicly. Tighten it to the next few months, yeah.

Which maybe is for the best anyways, but yeah, I think they probably invest in, they've probably been investing in these products for 10 plus years. Yeah, okay, so here's the announcement that happened today, and actually, as we're recording this,

I saw that Microsoft, I think, announced the same thing for Office 365, but Google Workspace, which, if you don't know, is Google Docs, Drive, Gmail, all that sort of stuff that they just call it Google Workspace, which is basically the workspace documents, the competition to Microsoft Office, which has really turned into a duopoly over the last few years, or the last 10, 15 years.

They unleashed some new products that get, I would describe it as an AI enhancement for Google Workspace. So you have, I don't know if it's the same sort of barred tool, but you have this kind of search bar at the top of your document where you can say, add in some sort of... And I think an example they had was a resume. Build a resume for X coder, like an engineer. And then they put out a template for you or their AI will put out a template for you

and then you can edit it further. So it takes out a lot of the busy work. You can also do it. They had an example of with emails. You can say, okay, say for example, you're on a vacation for a week. You had these work emails. There's probably maybe a thread of one topic

and someone went back 50 times, you could ask the AI, can you summarize the key points from these topics and then write a response? And obviously it doesn't send the response until you edit it, but it can also help with that as well. As it says like, hey, here are the key points.

Here's what, who brought up, you know, this X person brought it up. And I think Microsoft just launched the same ones here. Any thoughts on these? Because it seems like both these companies are the clear leaders in this stuff, at least from who's launching what. Amazon doesn't seem to be doing much.

And I guess they don't have any really consumer products in this regard, although I'm kind of thinking them from a cloud competition perspective. Apple doesn't seem to be doing much. I mean, it feels like these are it's kind of going to turn into another duopoly, and this is going to further strengthen the Google workspace and Office 365 modes. Yeah, I agree. I would be surprised if either of – I mean, if they're both announcing some of these new features and some of the new products like the OpenAI versus Google's that they just rolled out, they don't seem hugely different. I would be surprised if it led to either company really gobbling up market share from each other. Also, the products are so interchangeable, in my opinion. you're basically just going to take whatever you work on currently or whatever your company is

choosing to work on and probably just continue doing that for a long time. So I would be surprised if there was that much margin or market share fluctuation. The other thing with all the Bing stuff, we can officially say how overblown that was. Google grew search share in February and everyone thought google was going to apparently implode i think they shaved off more than 200 billion dollars in their market cap because of fears that they would lose share and they gain share so um yeah i think we can now maybe look back and say that google does have a solid note potentially yes i i want to say that i also think that the i would classify by, let's see, these banking issues that happened

or really the collapse of Silicon Valley Banking, Signature Bank, potentially First Republic and Credit Suisse as maybe more consequential than the Microsoft AI push. But a few months from now, we're going to look at it into a similar light where it's important that it happened, right? And it has effects where all these AI tools are going to be really probably the most important thing

from a consumer surplus perspective where it's just going to help people eliminate so much busy work. However, I also think it was a bit overblown where it became the thing of the moment. I mean, I had someone on some kayak trip in the middle of nowhere talk to me about Silicon Valley Bank where I said, yeah, one of our employers said that they were at Silicon Valley Bank, things are going to be fine, but they just wanted to update us that there could be some hiccups with payroll as everyone's been talking about. And they were guys, two guys, obviously. I was like, do you guys work in the investing world at all? I was just wondering because how they knew about that. They're like, oh, no, I just was following the stuff. I was

like, yeah, it seems like everything's fine. The government backstopped it and probably someone will end up buying them eventually for really cheap, kind of like what happened with the UK division with HSBC. They're like, well, when did they say that? Did they say that today or two days ago i was like guys like we're in the middle of though it just seems like i get it that's an example of how this sort of i think this news story just got totally overblown where people are talking to me in the middle of nowhere about silicon valley bank like guys it was a small bank and when people talk about it being the second biggest bank failure in history can we please adjust for inflation please i can't stand that the nominal deposits i cannot stand

No. Yeah. Just do it in terms of relative comparisons. It was one of the 19th largest or something like that in the US. So I'm sure there have been, maybe I'm wrong, but I would assume that maybe there's been one that's relatively larger in history that's failed. Lehman was probably, I mean, Lehman, I guess was, I want to call him a pure bank, but would you call him a pure bank? I don't know. What's your definition of a pure bank? Lehman, they're an investment bank. It's a bank, right? Yeah, I guess. Anyway, we do have some comments. X Marks says, Google is also ripping today.

Yeah, I did see that. I find it weird. Yeah, QQQ is ripping for some reason. Don't know why. Don't know why. I got to say, I don't know. I get worried when I don't know why something is ripping or why the market is going higher,

but sometimes you just got to embrace it and say, look it's gonna happen i i've seen what amazon and google i think are both up four percent today that it's a bit wild yeah um i'm gonna talk about a second comment here in a second but you raised something that's interesting to me which is people and i was in new york for this bank run and it reminded me of a quote that i want to say it was chanos who said it um who, I could be wrong on this, but it might be Klarman, but basically he said like people today are too active because they haven't been around long enough or they haven't been investing long enough or maybe they're too young in their careers that they think any move is like the

most important move that they think like any event that's happening is like they're sitting there working all day on new in new investments potentially that they want things to be bigger events than they are and they want to feel like they have to trade around it when you when it's way better to kind of zoom out and if you just like okay i took this week off essentially not i mean i like read about it because yeah we took a few days off right yeah yeah and i think i was better for it like if you owned any financials you just decided to sell like instantly because of fear you may have uh you may be looking back on that and largely regretting that so it's i think people want especially if you work in finance you want every day to be like

maybe you're just so bored that you just want it to be a bigger news they want every day to be like uh the next big short that gets turned into a movie or a tv they think they're in the movie margin call yeah yes exactly although we do know an analyst at silicon valley bank that could have been the i won't name names obviously catechism confidential that could have been the guy that comes up and made the model with him uh and said it could have that exact same moment where they said uh yeah where they say if this model were to occur the losses would be greater than the entire market capitalization of this firm and that was correct silicon valley bank was similar to margin called but i think the um your base case should be that you are not going to get turned into a movie

and most things are less of a big deal than the media the financial especially the financial media which cnbc and all those people and all on twitter as well their incentive is to make you think it's a bigger deal than it is because their business model is not to make money off of investing their business model is to make money by people watching so it's honestly It was honestly a pretty lame bank run. I was looking at this, looking through, and I started to realize this was pretty predictable eight months ago. And now I didn't predict it, so whatever, it's easy to say. If you follow the company closely, I mean, look at the short seller, John Hempton said that he, who I mentioned earlier, who knows his financials well, and really is good at targeting these financial companies as potential shorts.

He said, I have three shorts in my financial book. One was Signature Bank. One was Silicon Valley Bank. The third one is still can't disclose because he doesn't want to cause, you know, not ethical, I think, to disclose that. But he has a third one that's still active that he thinks is in a similar situation. if you're someone that knows that industry well you probably could have seen this coming there was a ton of people that did and it's just if you looked under the right rocks and knew the

right information yeah it wasn't like it wasn't an ftx situation or something where like there's just like pure like malice on the other side it was like if the trends that have persisted over the last year continued the bank would have gone under it just happened quicker because people saw it but like they were getting redemption like they were getting withdrawals uh they they banked with uh unprofitable businesses like yeah that part is also important they're going to lose deposits um so yes i think the base case again just any recommendation first off you're listening to two people that are under the age of 30 but i think what has helped us not to overstate things as we're not very experienced you know not very experienced at all

within the industry is to read up on financial history even if it's just the basics of the last 100 years of american financial history it can be very helpful to see that most things that happen have happened before or most of the things that are happening within markets within whatever just whether you call it disruption risk whether you call it financial contagion risk has happened before and and will happen again x marks 97 also says loved the nail net podcast fellas that seems to have been a fan favorite um we did that what last week two weeks ago two weeks ago yeah it's a it's fun it's fun yeah it's fun to cover it's interesting again just as a disclosure it's one we did that one as a company that we own within our uh arch capital investors fund limited

partnership and yeah we try to cover it with you know we admit that we have some bias there but we try to cover it not as say a recommendation we don't send any price targets but just to Analyze the business, why we like them, why we like the management team, stuff like that. That's another one where I would say, and obviously my bias is going to come out here, but they sold off slightly on this news. I think everything in the financial section basically sold off slightly on the bank run, but they're almost inversely correlated really to Silicon Valley Bank, which is they have interest rate swaps in place. they have benefited in some ways from higher rates. They've been really well positioned throughout all this. Perfect time to start a bank. You didn't make bad mortgage MBS purchases and treasury purchases back in 2020 because the bank didn't exist yet. Yeah. Part of that was,

I think, just fortunate timing, but it's one where I think it's a good example of it selling off without a whole lot of reason. Like, you know, you can, if this is an 08 scenario, there were a lot of businesses that sold off without good reason. So, you know, maybe this is bargain hunting time. You had another comment there.

I'm sorry, I'm not looking at it just because my internet's slow. I don't want to have another thing loaded up. Do you, you had another comment there you said you wanted to address, Ryan? No, it was just a Nelnet pod. and Google ripping. But any other news?

We got four minutes left. Okay. Let me save potentially the executive insider trading from other companies, which I thought was an interesting piece. We can save that maybe for next week if there's something

we can't find enough things to talk about. But there was an interesting, and I think this is important for covering the fintech sector, which I wouldn't, they're not, the fintech isn't really financial. is kind of, if you're not taking that balance sheet risk, if you're not a lender, I wouldn't call you a financials company. That's why the separation is quite important. But I think the

big overview is, again, I saw, and it's still in soft launch, I guess, or hasn't actually launched yet, but the Federal Reserve is accelerating the launch of what they're calling FedNow, which are instant transfers from bank accounts. So instead of the old process, as we know, is that it's extremely frustrating for sending money between bank accounts. They're going to launch this. And they were originally thinking, if I'm remembering this article I read correctly, of launching it in 2024. But now we're going to do it this summer.

And it doesn't seem like that big of a deal, I guess. But my thought is, are there any people, not people, companies that could get hurt by this? who are, I don't know, benefiting from the old system. And my only thought is that someone like Venmo and Cash App would get hurt because they earn some of the money off of taking a small fee if you get instant deposits or instant transfers from your digital wallet to your bank account. But if FedNow allows everyone to do instant transfers across bank accounts, then that

the value proposition there goes to zero. Yeah, I think PayPal would be hurt maybe through its core transfers business, but also through Venmo. But I also have very little belief that the Fed can produce a really good consumer product. That's right. Yeah, that's another.

I think it's a big TBD, but it's something to watch out for, I think, if you're in the payments. Not necessarily payments because they're not going after Visa and MasterCard, at least I don't think yet. with this product. I only read a few short paragraphs on it, but- I mean, Zelle would be in trouble.

No, Zelle is within... Now, there's a little bit of nuance with Zelle, where Zelle is the only, I believe, and again, I can't remember the exact name, the only bank payment system set up on top of something the Fed is already doing or something, and maybe not exactly what the Fed is doing. And that's why all the big banks have launched onto them and are doing instant transfers through Zelle through your bank account. So that would technically disrupt Zelle, but it really I don't think anyone would be

upset because Zelle is not technically a company that, or I don't know, the value there, you kind of get what I'm saying there, where the value for the banks would not really change. They would just tap on the Fed now. Maybe it hurts wire fees and some of the fees that banks earn. And that's great

for people. If they could come up with a real good solution to wire in this money, it would be so nice because it is such a pain to do like big bank-to-bank transfers. And eliminating those fees,

small businesses like us would be, we would thank the Fed. I would become a bigger, even a bigger Fed apologist. Yeah, I'd become a Fed truther. It's about time. I think we started this one minute early, so it's been an hour,

but appreciate everyone for tuning in. Sorry if we got anything wrong on the banking side, but I think I did my best in terms of describing the events. So hopefully you have a clearer understanding of what exactly happened. Well, you offset your risk to third parties by quoting other people, right? True. Their fault if anything was false. Anyway, that's going to do it. Appreciate everyone for tuning in. We should throw a disclosure on this. Brett and I are not financial advisors. Anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. We are, however, general

partners at Arch Capital. So clients may have positions in the securities discussed in this podcast. Thank you all for listening. Thank you for turning in, maybe viewing if you're on YouTube and we'll see you all next time.