[Updated March 17 to correct an error. SVB was, in fact, a Fed member bank. Click here for my March 17 update.]
On Friday, March 10, Silicon Valley Bank (SVB) was closed by the Federal Deposit Insurance Corporation (FDIC). The proximate cause was the bank’s decision to hold long duration U.S. government securities. That, essentially, was a bet on interest rates remaining low. SVB lost that beta, interest rates rose, and the market price of those securities fell. But up to that point there’s no damage. The losses were all book losses from an accounting perspective. (From an economic perspective, opportunity costs are the real costs. The bank’s market value would have been higher if they had not bet on those securities.)
This piece began as a deep dive into SVB’s collapse. But as I dug deeper, I discovered layers of nuance. I hope I can give an overview here with follow-up articles later. Among the many issues are regulatory failure, the status of SVB’s charter and Federal Reserve membership, and whether, in fact, this is the fourth largest bailout in history.
Contrary to what the Biden administration (especially Treasury Secretary Janet Yellen who should return her Yale economics Ph.D.) this was a bailout in the conventional sense of the term. Credit Irvine Sprague for popularizing the term in his 1986 book “Bailout.” This book is still available as a Kindle edition! “Bailout” is required reading for anyone who wants to know the details of how banks get into trouble and the various ways in which the depositors are helped out. Click here to visit the Amazon page for this book.
A bailout means the $250,000 cap on insured deposits is lifted. All depositors’ account balances are paid in full from the FDIC’s insurance fund. Stockholders are wiped out – the market price of the stock is zero. Lenders with secured debt will be paid according to bankruptcy laws. FDIC is tasked with using the method that costs the government the least. That usually means stripping out the nonperforming assets and selling what’s left to another bank. Sadly, the Biden administration is staunchly opposed to any and all bank mergers. That will reduce the demand for SVB’s “good” assets, lowering the prices, and increasing the cost to the government.
What Went Wrong at SVB?
All banks in a fractional reserve banking system are illiquid by definition. Since they only need to keep a fraction of their deposits as reserves, they never have enough cash on hand to survive a bank run. When a bank experiences a run, it has several options available. The bank can sell assets to raise cash. If it is a member of the Federal Reserve, it can ask for a loan. The Fed will decide whether to approve the loan based on the bank’s financial condition. The principle is that banks in good financial shape should get loans to get them through the liquidity crisis. (Today almost all banks are insured by FDIC. That is not an issue in most cases.)
SVB had two problems. First they were chartered by the state of California, not the Federal Reserve. Second, as far as I can tell they were not members of the Federal Reserve system. [March 17: SVB was, in fact, a Fed member bank. Click here for more information.] California was the main regulator via the California Department of Financial Protection and Innovation (DFPI). This agency is unlikely to have the competency and expertise of the FDIC, the Fed, or the Comptroller of the Currency (the agency that issues federal bank charters). While the Fed can regulate banks with over $50 billion in deposits, they apparently failed in this case. Making matters worse, only Fed member banks have access to the lending facility. As far as I know there is no similar state program in California. That left the bank with these options:
- Sell assets,
- Borrow from another bank, and/or
- Issue more stock.
SVB’s most liquid assets were short-term Treasury securities. They ran out of those in a hurry because SVB management had tried to increase profits by buying longer-term securities. Those carried higher yields but also were subject to duration risk. If interest rates rose, the market price of those securities would drop. SVB had not hedged against rising interest rates. When the Fed started tightening monetary policy, interest rates rose and the market value of SVB’s Treasury portfolio sank. But the bank needed liquidity.
They lost about $1.8 billion on those security sales. In brief, they had converted an ugly balance sheet into actual cash losses. They might have been able to arrange a loan from another bank before this. But now their only hope was to float an equity issue and hope there were enough suckers out there to buy the stock.
Before that got off the ground, DFPI stepped in, closed the bank and summoned the FDIC to handle the details. Note that this was caused by incompetent management, not the Biden administration, FDIC, the minor Trump administration loosening of regulations, or any other external factor. SVB didn’t seem much interested in banking. Their CEO Greg Becker has a B.S. in Business from the Kelley School at the University of Indiana. His LinkedIn profile is exceptionally brief for a CEO.
I’ll just add that for six months in 2022 SVB had no senior risk management officer. They simply did not take banking seriously.
SVB also failed to diversify their customer base. They were exposed to tech risk. If Silicon Valley firms got in trouble, SVB would also be in trouble. This is just another form of industry risk. According to Genevieve Roch-Decter (@GRDecter),
Tracy (@ChiGrl) added this (emphasis added):
The triggering event was the recent upheaval in Silicon Valley companies. There have been well-documented layoffs at
- Twitter (5,000 employees, 67% of workforce)
- Meta (Facebook) (11,000 workers, 13% of workforce)
- Google (12,000 employees, 6% of workforce)
- Microsoft (10,000 employees, 5% of workforce)
- Zoom (1,300 employees, 15% of workforce)
Those five companies laid off 8% of their workers (39,300 out of 500,782). Note who’s missing from that list: Apple, apparently one of the few companies that figured out that the COVID economy was only a temporary change.
Now normally when a business shrinks, their deposits decrease, their bank’s required reserves fall, and the bank is fine. The problem was SVB’s balance sheet was bleeding red with book losses on their Treasury assets. On Thursday, Silvergate Bank announced it would wind down operations. They were mainly lenders to the cryptocurrency market with significant exposure to FTX. Friday was a bloodbath for Silvergate’s liquidity as depositors staged a classic bank run. The market value of Silvergate’s crypto loans had fallen considerably. But the bank was forced to sell those assets to maintain liquidity. Essentially, the bank ran out of cash in a liquidity crunch. (Coindesk.com has a very good explainer on the relationship between Silvergate and SVB.)
Sadly for SVB, they also had some exposure to crypto lending. The deposits began exiting. Like Silvergate, SVB had a liquidity problem. A lot of their asset portfolio had depreciated when interest rates rose. They were forced to sell those assets at a loss, turning book losses into cash losses. FDIC stepped in after the California Department of Financial Protection and Innovation (DFPI) seized the bank. DFPI was the regulator because SVP was a state-chartered bank. That should have set off alarms for anyone who knows the first thing about banking. State chartered banks are regulated by the state in which they are chartered. Let’s just say that Federal regulation in this market is likely to be driven by actual knowledge of how banking works. And remember, SVB was not a member of the Federal Reserve system. That’s’ a second big red flag to any customer (depositor, borrower, or stockholder).
Next, I want to see where SVB stacks up against other bank bailouts. That’s not quite as simple as you might think. Why? Wait until next week!
- A bank run occurs when many customers try to withdraw their deposits at the same time. This quickly depletes the bank’s cash on hand and sometimes leads to an outright failure. ↑