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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.
Le sigh.
Possible Contagion?
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.
Conclusion
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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Good grief. What a clickbait title. Is this what you’ve saved all those years to do?
Poor you had to actually read… ;(
What about New York’s Signature Bank which also closed?
It’s a little early to think the damage is done. Next we will find out who else is vulnerable. A crisis like this always turns up surprises.
“It’s only when the tide goes out that you learn who’s been swimming naked.” ― Warren E. Buffett
On the plus side, stocks may be put on the clearance racks, and every women knows what to do. Poke through the marked downs and maybe get a once in a generation find.
I haven’t sold anything but this is why I’ve put all my new cash since last year into BIL, money market ETF and GIC/CD. Can’t beat 5% and knowing my money is safe.
Thanks for the nice summary! I don’t have cable, and I avoid mainstream media. What will be the impact on the U.S. tech sector?
The central bank will ALWAYS bailout banking crisis. We’re still screwed, but on the serious way UP, in the form of much higher inflation (potentially heading to hyperinflation) in addition to much higher interest rate. This is possible because higher interest rate now translate to higher unrealized loss of banks, which will translate to further bailout from the central bank, which in turn lead to even higher inflation, which will force even higher interest rate, and on and on in an “infinite” loop until Weimar republic repeats.
Why the US can hike interest rates but not Japan and China? It’s because Japan and China have almost double the government debts vs the US. With the US rate hike, money is flowing out of Japan and China to US, thus forcing Japan and China to print more and cut rates. All major economies (including Japan, China, UK, and US) will eventually have such crazy debt level that they cannot hike rates or else everything will blow up but at the same time inflation will continue to go much higher.
Eventually hyperinflation will erupt and force the central banks to hike rates. For a very short time (maybe just a few months), life on earth may probably be far more unbearable than hell as there will be rampant crimes around and almost everyone will lose their properties. Back in Argentina, its last hyperinflation resulted in a lot of homeowners and landlords losing everything because property tax was damn high and owners cannot find paying tenants and they end up losing everything, including their houses because they cannot pay for the crazy high taxes.
As Klaus Schwab of WEF said, “You will own nothing…” but I really don’t think you will be happy.
Fear is spreading. We bank at a regional bank and I moved a few thousand dollars to Chase a Fidelity. I need to be able to pay the bills.
I think there will be more problems, especially with banks that have a lot of money in crypto companies. Who knows what will happen next? Recession, here we come!
We know you are bearish on bonds and it is obvious based on the SVB story.
Have you blogged about the LDI (Liability Driven Investment) situation in London? The central bank had to intervene in that one too!
Can you also let readers know what to expect with their workplace pensions which are typically 60/40?
I can’t say that I have a firm enough grasp to project what will it won’t happen. In general, I think the fed is applying a demand side solution to inflation that is currently being driven by supply side issues. In other words I don’t expect rate hikes to work. To the extent that this collapse was caused by rising interest rates – and I have some doubts there – the policy needs to be re-examined. As far as the rest goes, I’m in my 50s and people have been proclaiming that the economic end is nigh since I was in college. We are still here and growing folks
The banks need less regulation not more! There are lots of rules already in place to prevent this kind of debacles. They don’t work now so how will more regulations help in the future?
The free markets would sort this out and separate the wheat from chaff and not make politicians rich.
I’d like to see the banks fail and from it a better system might rise out of the ashes.
The fact is — we don’t know how many other SVB’s are ticking time bombs out there. Their debt was rated investment grade right up until they collapsed. Good going rating agencies! With the demise of Signature bank over the weekend (which served mostly law firms and the real estate industry) I would say this is far from contained to tech. The common thread as of now appears to be the heavy bets these banks placed on crypto. Plus, SVB’s stupidity in going long on long-term Treasuries in an increasing interest rate environment, falsely assuming the Fed would pivot back to lower rates this year. Best to prepare for a bumpy ride ahead.
I think it’s odd that the regulators felt the need to make sure depositors got all of their money back, over and above $250,000. What’s the point of having the limit in the first place then, if the regulators just come in and pacify the situation by telling everyone they will get all their money back?
I understand they want to avoid a run on the banks and panic, however irrational people panic about this. If you follow the guidelines on the limits of FDIC coverage, there is no reason to be concerned. And where would you put all the money you take out anyway? In another bank that is more “safe”?
They say it’s not going to cost taxpayers to fully insure the deposits of these customers, but it will come from a special assessment from member banks. But guess where the member banks get their money from? Tax-paying customers…
@Financial-Fives, the wealthy always get a bailout. This is how it was done in 2008 as well.
SVB is unimportant. What’s important is what happens March 15, 2023 8pm ET. This is where you’ll be wowed and amazed by…sponsored advertising. Don’t forget, free t-shirts made in some 3rd world factory.
I live for that.
ok, I give up, what happens Mar15 at 8pm?
SVB CEO Greg Becker should be in jail along with most of the CEOs of the companies dealing with the Crypto fraud like FTX and others.
Now this is really a click bait post
Greed starts and ends at banks.
They need less regulation?
LOL. Are you dense?
This might enlighten you:
https://www.forbes.com/sites/mayrarodriguezvalladares/2023/03/12/how-trumps-deregulation-sowed-the-seeds-for-silicon-valley-banks-demise/
.
Your are SO right. Thank you for this response.
What money market ETF are you buying and why?
I’m in Canada so I’m trying to find a Canadian equivalent?
Thanks in advance and I agree with you 100%.
I buy CASH.TO in Questrade
There are already lots of regulations in place to keep the banks disciplined.
However, they are never enforced!
What good does more rules do it the bankers ignore the rules that are already in place?
P.S.
Just like here there are rules about insulting people and calling people dense but you chose to ignore it and it’s not inforced.
Thanks for proving my point dumb ass!
Well, well, if it isn’t another greedy banker NOT headed for jail though he should be…Mr. Greg Becker!!
P.S. Isn’t everyone glad we shut down the economy to save 0.0002% of the population!! Let’s do it again! It only takes about 10 years to get things back to “normal”!
Wanderer – thank you for a really good explanation
Thanks, your explanation on how this bail out is different is really helpful. It is still SICKENING that banks are not more strongly regulated and that something like this can still happen. Here in NZ / AU banks are recording record profits, meanwhile the average person is suffering under the weight of enormous housing and living costs. In the words of an excellent journalist we have here, Bernard Hickey: “The more we see the arms of state being used to socialise the losses from financial disasters and privatise the profits of financial stability, the more we see the west’s social cohesion erode and its political fragility increase.” 100% Agree. The SVB directors keep their huge piles of gold and just move to a different bank, there is no accountability.
Well, well, well…we don’t really keep up with the news because who wants to add more stress and negativity to their lives, am I right? But guess what? Our dear family members advised us to take out all our money from the bank account and boy, did that throw us on a crazy rollercoaster ride! We had to hit the internet to find out what was going on, and let me tell you, it was a wild weekend.
Luckily, things ended up pretty much back where they were, and we were reminded of the importance of FDIC insurance when having a bank account in the USA (at least that is pretty good to have).
Now we are back to our regular nomadic life, currently living it up in Cambodia and checking out all these amazing temples. Maybe we’ll have to start following the news just for the sheer entertainment value! What do you guys suggest?
Did nothing wrong? Anyone depositing more than $250,000 and exceeding the explicit fdic maximum took a blatant and unnecessary risk, which should have consequences. The government essentially promised to backstop all uninsured deposits, which is tantamount to writing checks to poor risk management.
Regardless of Dodd-Frank, the bank reported its situation and the fed inspectors failed to notice all was not well (despite the bank reporting it’s actual situation). D-F doesn’t matter if the government ignores the bad stuff.
Source on what was reported that govt regulators ignored?
They’ve reported a CET1 ratio of 12% as of Dec 2022, almost twice above the regulatory requirement of 7%, while being already insolvent at that date after considering the unrealized losses of $15,152M on held-to-maturity securities …
Hi
This is part and parcel of life. It makes sense for one to diversify the investment portfolio into various baskets (such as shares, bond and cash accounts etc). This gives one the peace of mind.
WTK