People keep talking about how 'this is a solvency crisis because if SVB had to sell everything today, they wouldn't cover liabilities' when that is the definition of a liquidity crisis.
EDIT: To be clear, think of it this way. I have a piece of paper saying you'll give me $100 in 1 year plus 1% interest that I bought for $98.
No-one buys that piece of paper for $98 today, because they can get the same deal with better interest. But that doesn't change the fact that I will get $100 for it.
If deposits hadn't shrunk, $100 would go to SVB in 1 year and everything would be fine, it's the fact that they have to sell it so far ahead of maturity that's the problem, we just didn't notice this phenomenon in the past few decades b/c rates fell and prices went up.
This is not because SVB has a particularly risky book (we're talking treasuries here), it's because they didn't account for declining deposits (itself a very stupid, but unique bad decision unrelated to their risk tolerance).
> People keep talking about how 'this is a solvency crisis because if SVB had to sell everything today, they wouldn't cover liabilities'
This is not accurate, and the inaccuracy is the difference between solvency and liquidity.
If svb had longer (ie weeks), they still wouldn't be able to cover their debts. Its not a matter of needing time to arrange buyers for their assets; their inability to pay isn't related to liquidity today or tomorrow, it's related to their asset's value. If they snapped their fingers and marked to market all their assets, they would be in debt because they're insolvent.
Not really. Insolvency is by definition time independent. If you owe more than you have, you're insolvent. It doesn't really matter if you might make enough to cover the difference in the future.
In practice, you might get away with it if no one forces the issue upon you, but that doesn't change the math of whether or not you could pay your debts.
Liquidity is different. It is time dependent by definition. Some things take time to structure, deal, and sell. You can also get away with this in practice.
They can both have similar effects when they happen, but their causes are sharply different. I have a house I can sell to cover my mortgage, but couldn't sell it in less than a couple weeks or maybe even months. Illiquid but solvent.
> Insolvency is a state of financial distress in which a business or person is unable to pay their bills.
This isn't true. If you eat at a restaurant but forget your wallet, you can't pay your bill but you're still solvent. You have assets to cover your debts. "Can't pay your bill" is too broad a statement to be meaningful. There are many complicated financial instruments and needing time to make a payment doesn't automatically make you insolvent.
> People keep talking about how 'this is a solvency crisis because if SVB had to sell everything today, they wouldn't cover liabilities' when that is the definition of a liquidity crisis.
I don't think that's right. It would be a liquidity crisis if the market value of everything they own is higher than their liabilities but they can't find a buyer at this time. You are saying that a liquidity crisis is when they can find a buyer but everything they have is worth less than their liabilities. That's not the case.
yep, it's a solvency issue. The minute they tried to offload the bonds at a price lower than they paid for them (which seemed like the right thing to do to fix the liquidity issue), they were effectively in a hole and even if they waited 10 years later, would not have been able to cover the deposits.
You need to realize that essentially bond pricing reflects the present value of all cash flows you expect from the bond. For long term bonds especially, this makes it a particularly risky book, because you are very sensitive to interest rate changes.
If the interest rate goes up while you are holding your low interest bonds, that means that your future cash flow from the bond (the repayment) is literally worth less than what it was. Your bond payments have a lower real value due to the higher interest rate of the surrounding environment and the increasing price levels, despite being the same nominal amount. That's why the bond's price plummets in the market, which is why this is a solvency crisis: because the assets really are not good for the liabilities at present value, which is the only kind of valuation that makes sense here.
EDIT: To be clear, think of it this way. I have a piece of paper saying you'll give me $100 in 1 year plus 1% interest that I bought for $98.
No-one buys that piece of paper for $98 today, because they can get the same deal with better interest. But that doesn't change the fact that I will get $100 for it.
If deposits hadn't shrunk, $100 would go to SVB in 1 year and everything would be fine, it's the fact that they have to sell it so far ahead of maturity that's the problem, we just didn't notice this phenomenon in the past few decades b/c rates fell and prices went up.
This is not because SVB has a particularly risky book (we're talking treasuries here), it's because they didn't account for declining deposits (itself a very stupid, but unique bad decision unrelated to their risk tolerance).