Update on scenarios after SVB failure

Ok, we now know what the player next in turn did: The regulators and government officials decided to take out the bazooka right away without hesitation. As I said yesterday, "this time around this would come much sooner than it did in 2007-2008 – the action during pandemic showed that with large financial crisis in recent memory, the point when political establishment acts is significantly earlier than otherwise.". This is especially so given that Yellen is sitting at the Treasury.

This changes the likehood of the scenarios quite a bit:

Nothing happens: 20-25% >>> 30-35%

Tremors without casualties: 25-30% >>> 30-35%

Some casualties, but situation remains contained: 25-30% >>> 10-15%

Contagion which is eventually contained: 10-15% >>> 5-10%

Nothing happens: 2-5% >>> 2-5%

Effectively, with forceful action from the government providing backstop to the uninsured depositors the middle of the probability distribution has hollowed out: It is much more likely that this will end as soon as it started. However, this does not mean that adverse outcomes are ruled out. It is just that now they would require other mechanisms to occur, which is less likely. This even applies to the middle outcomes: I dont think we have a good model of depositor's beliefs formation, and it is still likely that at least some of them will act out of caution despite the government guarantee. It is just that now it is rather unlikely this will reach a critical mass. 

Rather than the depositors, the behavior to watch now is of bond holders, sources wholesale funding and stockholders. Bond and stock holders were wiped out in SVB, something that officials did only in rare occasions in 2008 out of fear. It remains plausible that they will pull out in more meaningful fashion. And there is still possibility that there are vulnerabilities we do not know about. Therefore, the probability of truly adverse outcomes has not decreased much.

Addendum: Looking at my probabilities, I realized that the wording of "without casualties" is not aligned with the exact idea in my head. I really mean no meaningful casualties. E.g. few small banks failing still qualifies as "no casualties". By no casualties I mean no banks in the size range of SVB or larger fail.