Eighteen months ago, I wrote that there is a good case to be made that the tech cycle is more economically significant than the credit cycle. By way of example, customer-facing tech and corporate collaboration technology contributed far more to robust S&P 500 earnings during the pandemic than the Fed’s bond buying and money supply expansion. Having access to capital is great; it doesn’t do a bit of good unless it can be productively channeled.
Twelve months ago, I wrote a piece titled The Credit Cycle Strikes Back. This time last year, rising interest rates and inflation reminiscent of the 1970s cast a pall over the tech sector, most obviously with tech firms laying off tens of thousands. Arguably, it cast a pall over the tech cycle in its entirety, from households forced to consolidate their streaming service subscriptions to employers increasingly requiring their workforce to return to office. Winter had come to tech, courtesy the credit cycle.
Silicon Valley Bank collapsed last month. The balance sheet, risk management, and regulatory reasons for its collapse are well documented. The Fed responded to SVB’s collapse by providing unprecedented liquidity in the form of 100% guarantees on money deposited at SVB. The headline rationale for unlimited deposit insurance - economic policy, political exigence - are also well documented elsewhere. Still, it is an economic event worth looking into.
An interesting aspect to the collapse of SVB is the role that social media played in the run on the bank. A recent paper presents prima facie evidence that the run on SVB was exacerbated by Twitter users. In a pre-social media era, SVB’s capital call to plug a risk management lapse may very well have been a business as usual event; that is, at least, what it appears SVB’s investment banking advisors anticipated. Instead, that capital call was a spark that ignited catastrophic capital flight.
If the link between Tweets and capital flight from SVB is real, the Fed’s decision looks less like a backstop for bank failures caused by poor risk management decisions, and more a pledge to contain the impact of a technology cycle phenomenon on the financial system. As the WSJ put it this week, “… Twitter’s role in the saga of Silicon Valley Bank reiterated that the dynamics of financial contagion have been forever changed by social media.” Most banks had paid attention to the fact that Treasurys had declined in value and took appropriate hedge positions to protect their core business of maturity transformation. Based on fundamentals it wasn’t immediately obvious there was a systemic crisis at hand. Yet the rapidity with which SVB had collapsed was unprecedented. The Fed’s response to that rapidity was equivalent to Mario Draghi’s “whatever it takes” moment.
Social media-fueled events aren’t new in the financial system; by way of example: meme stock inflation. And assuming SVB’s collapse truly was a social media phenomenon, the threat was still at human scale: even if those messengers had a more powerful megaphone than the newspaper reporter of yore observing a queue of people outside a bank branch, it was a message propagated, consumed and acted upon by humans. Thing is, the next (or more accurately, the next after the next) threat will be AI driven, the modern equivalent to program trading that contributed to Black Monday in 1987. Imagine a deepfake providing the spark fueling adjustments by like-minded algorithms spanning every asset class imaginable.
As tech has become an increasingly potent economic force, it represents a bigger and bigger challenge to the financial system. To wit: eventually there will be a machine scale threat to the financial system, and human regulators don’t have machine scale. As the saying goes, regulation exists to protect us from the last crisis - as in, regulations are codified well after the fact; the scale mismatch we’re likely to face implies a low tolerance for delay. The last line of defense are kill switches, and given the tightly coupled, interconnected, and digital nature of the modern financial system, orchestrating kill switches presents a machine scale problem itself. The Fed, the Department of the Treasury, the OCC, the FDIC, the European Central Bank, and all the rest need new tools.
Let’s hope they don't build HAL.
