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After a relatively mild start to 2023, it was starting to seem that all the talking heads predictions of an imminent recession were way overblown.
Until Friday, that is. That’s when this happened.
Silicon Valley Bank collapsed Friday morning after a stunning 48 hours in which a bank run and a capital crisis led to the second-largest failure of a financial institution in US history.
California regulators closed down the tech lender and put it under the control of the US Federal Deposit Insurance Corporation. The FDIC is acting as a receiver, which typically means it will liquidate the bank’s assets to pay back its customers, including depositors and creditors.Silicon Valley Bank collapses after failing to raise capital, CNN
I gotta say, in the world of finance, nothing is quite as pants-shittingly terrifying quite like a bank collapse. A war breaks out? Fine. A terrorist attack? Yawn. But a bank failure is something that perks up everyone’s ears because the failure of Lehman Brothers in 2008 was what turned the sub-prime mortgage lending problem into a full blown economic crisis.
SVB is, ahem, was started in 1983 in San Jose, California, home of many big tech company, including the one that used to write my paycheques when I worked as a computer employer. They specialized in providing financial services to those tech companies, lending them money, facilitating funding from venture capitalist firms, and managing the wealth of tech millionaires and billionaires.
It was also big.
In it’s heyday (i.e. last week), their clients included nearly half of all venture-capital backed tech and health care startups in the US, with total assets over $200 BILLION dollars. That makes it the 2nd largest bank to fail since Washington Mutual in the middle of the 2008 market crash.
What happened has been the subject of considerable debate. Initial reporting on Friday laid the blame on rising interest rates. During the pandemic when interest rates were near zero, SVB took the money it received in customer deposits and loaded up their balance sheets with low-interest bonds, and when interest rates rose, the value of their bond holdings fell. When depositors caught wind that the bank was sitting on these falling assts, they panicked and tried to pull out all their money at once.
However, this oversimplified explanation doesn’t quite pass the smell test. Yes interest rates rose, and yes that caused bond prices to fall, but lots of other banks owned government bonds. Why didn’t they also collapse?
The reason is that those banks fell under regulations passed in the aftermath of 2008, called the Dodd-Frank act. Among other things, the Dodd-Frank act forced “systemically important banks” to keep a certain amount of liquidity in their reserves, as well as regularly conduct stress tests to make sure that if a run on the bank occurred, the bank would be OK. A systemically important bank was defined by the Dodd-Frank Act as a bank with assets over $50 billion. And since SVB had assets of $200 billion, this catastrophe shouldn’t have happened.
So why did it?
Because the CEO of SVB, Greg Becker, personally lobbied the government to exempt his bank from these rules.
Eight years before the second-largest bank failure in American history occurred this week, the bank’s president personally pressed Congress to reduce scrutiny of his financial institution, citing the “low risk profile of our activities and business model”, according to federal records.Silicon Valley Bank chief pressed Congress to weaken risk regulations, TheGuardian
In a 2015 statement to the Senate Banking Committee that has aged super well, you guys, he stated that because of “SVB’s deep understanding of the markets it serves, our strong risk management practices,” the definition of a systemically important bank should be changed from $50B to $250B, thereby letting SVB off the hook from enhanced scrutiny and regulation.
In response, the government created the Economic Growth, Regulatory Relief and Consumer Protection Act which weakened the financial oversight of banks like SVB, and on May 24, 2018, the act was signed into law.
Now, if you’re reading this, chances are you don’t have an account with SVB. Their main clientele was not end consumers but tech startups. And even if you did have an account with them, SVB was FDIC-insured, meaning your deposits up to $250,000 were guaranteed by the federal government. When the bank opens again on Monday, you will be able to get your money out.
The problem, of course, is that if you’re not an individual but a start-up, $250,000 is a drop in the bucket compared to what your actual balance was. Those guys are in a world of hurt.
So the big question is, is this the start of a new Great Financial Crisis? Is this the beginnings of a financial contagion that will sweep the rest of the economy?
My humble opinion is no.
While it’s true that rising interest rates affected everybody, banks generally make more money in a rising interest rate environment, not less. As I’m sure anyone with a variable rate mortgage has noticed, holders of debt get screwed, but the issuers come out ahead. That’s why when banks reported their Q4 2022 profits at the beginning of this year, the announcement sounded like this…
America’s biggest banks will report another quarter of bumper profits from lending this week, a windfall investors fear will near its peak this year as the US Federal Reserve’s rate rise cycle draws closer to its end.
The Fed’s effort to combat inflation by tightening monetary policy has been a boon for banks, which have been able to charge borrowers more for loans without raising the interest rates they pay depositors by as much.US banks set for bumper lending profits but face end of rate rise cycle, Financial Times
But remember, SVB is a specialty bank that caters to start-ups and not the general public. They don’t lend money to home-owners in the form of mortgages like a regular bank, nor do they issue credit cards, car loans, personal lines of credit, or any of the other products that allowed the rest of the financial industry to make a killing.
In short, they got all the downside of rising rates, but none of the upside.
And don’t forget the US jobs report, which was released literally the same day but got buried amongst the avalanche of news about SVB.
The US economy added 311,000 jobs in February, according to the latest monthly employment snapshot from the Bureau of Labor Statistics released Friday.
That’s a pullback from the blockbuster January jobs report, when a revised 504,000 positions were added, but shows the labor market is still emitting plenty of heat.The US economy added 311,000 jobs in February, outpacing expectations, CNN
Add it all up and it reveals the SVB collapse for what it really is: A failure for the tech industry, but not a sign of wider economic collapse.
Regulators Are Stepping In
This story has really evolved quickly over the weekend, and that’s because they’re up against a ticking clock. Most employers operate on a bi-monthly pay cycle, and by sheer bad luck, this morning is when paycheques are supposed to go out. If Monday rolled around and depositors didn’t have clarity on the status of their funds, this would have triggered a wave of layoffs.
On Friday, SVB collapsed. On Saturday, the FDIC stepped in and was trying to find investors who were willing the step in and rescue the bank (interested parties included, of all people, Elon Musk). And by Sunday evening, the Biden administration announced they were stepping in to backstop the depositors and prevent a total financial collapse.
In an extraordinary action to restore confidence in America’s banking system, the Biden administration on Sunday guaranteed that customers of the failed Silicon Valley Bank will have access to all their money starting Monday.US regulators say SVB customers will be made whole as second bank fails, CNN
It’s important to note that while this sounds like a 2008-style taxpayer-funded bailout, it’s actually not. Instead of handing them sackfuls of cash that will probably disappear into the CEO’s bonus checks, the Federal Reserve is providing liquidity in the form of cash payments in exchange for the bank putting up bonds as collateral. That means that SVB no longer needs to sell their lower-valued bonds at a loss, and can instead exchange them for cash at par value in order to meet their liquidity needs. Since the Federal Reserve can afford to wait for those bonds to mature, they’ll get their money back without requiring taxpayer funding.
This is exactly why the banking sector needs more regulation, not less. I don’t know why we keep having to learn the same lessons over and over again, but the banking industry is way too important to just leave to finance bros to take care of. SVB isn’t out of the woods yet, and may still go bankrupt (arguably deservedly so), but this debacle came perilously close to causing a wave of failures in other companies that did nothing wrong.
This week will likely continue to feature volatility in the stock markets as traders digest the flood of news that happened over the weekend, but for now at least, crisis appears to have been averted.
What do you think? Is the SVB collapse a harbinger of further bank failures to come, or are we going to be OK? Let’s hear it in the comments below!
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