This blog was written from episode 57 of Business by the Numbers. Click here to listen to the episode!
There have been 3 massive bank failures in March, most notably Silicone Valley Bank. Why did this happen? The follow up questions of anyone would and should be: “Is my money safe?”
SVB is Silicon Valley Bank. This crash happened very quickly (and seemingly out of the blue). Silicon Valley Bank went belly up and asked the Federal Reserve, FDIC, and just about anyone who would listen for help. This is a very complicated issue, but what happened in March took 1 week for several events to transpire.
- On Monday, Moody’s (an agency that rates credit worthiness, click here to learn more) contacted SVB with concerns about their financials.
- On Wednesday, the financial arm of SVB announced they were going to be raising capital.
- Also on Wednesday, SVB sold $21 billion of government securities with an overall accounting loss of $2 billion.
- At the end of Wednesday, Moody’s announced they were downgrading the credit worthiness for SVB. This made people who had money with this bank transfer it out of SVB.
- Thursday, $42 billion was attempted to be withdrawn from the bank.
- By Friday morning, SVB threw in the towel and crashed.
This all happened from March 6th to March 10th. Since then, SVB has a new CEO and announced that it was back. While the government did eventually step in, the damage to anyone with money in SVB had already happened. SVB wasn’t the only bank that failed. The direct ripple effect was 4 bank failures the following week. SVB was the second largest bank failure in the history of the US. Click here for a current list from the FDIC of failed banks since October 1st 2000.
Bank failures do happen, but usually they are very small banks and don’t hit the news cycles. In 2008, Washington Mutual (another large bank) failed, but because there was so much going on financially that year, it didn’t make the news. What makes this current event newsworthy is the size of SVB and the ripple effect it has and may continue to have on the economy.
Why did this happen?
To understand the current situation, it is necessary to understand how banks handle money deposited with them. If someone deposits money with a bank, the banks invest that money and leverage other people’s interest to pay that person. In deposit accounts, people don’t typically take money out, which is why this works. The investments the banks make with deposits are usually in low-risk securities. SVB invested in long-term treasury bills. The upside to long term treasury bills is that if you leave them for the long term, they are typically a pretty good investment. Back when SVB did this, this was probably the case (2%, 3%, or even 4% interest). The downside to long-term investments is if money is taken out early, not only is there no interest, but usually there’s a penalty for doing so.
Where the trouble started; 18 months ago, when the Federal Reserve started raising interest rates, SVB’s long term treasury bills were starting to look not so great as investments. This was because short term treasury bills were paying 6%, 7%, 8% or even 9%. To get into shorter term investments, SVB cut their losses and sold the treasury bills for $21 billion that were projected to be worth $23 billion (Remember I said that if pulled out early, there’s no interest and a penalty for doing so?). The SVB selling their treasury early accrued a loss of $1.8 billion. If they had held the treasury bills to their full extent, they would have been worth $23 billion.
Client Concentration and lack of diversity
Another factor is client concentration. SVB was almost exclusively the lender to VC firms and tech startups without a lot of diversity in clientele. For the past twelve months, this market has had a massive decrease in revenue with layoffs in Facebook, Twitter, Instagram, etc… because of revenue decreases. Wall Street has gotten more specific and aggressive about evaluating companies since they’re not only unprofitable, but they are burning through money. This caused deposits to fall because tech companies were having a harder time getting funded.
Deposit Drops From Economic Hardship
Another factor that isn’t specific to SVB is that 2020-2021, there was quite a bit of money getting pumped into the economy, but generally going to banks (EIDL, PPP, etc…). So, banks saw a lot of deposits. The same companies that put these deposits in have been hurting, causing deposits to decrease significantly.
The Perfect Storm
Re-summarizing many factors that went into this situation, (client concentration, deposit drops, interest rates, VC Firms and tech startup markets crashing) it’s safe to say that a perfect storm was created. The balance sheet of SVB didn’t look that bad. If they liquidated all their assets, they probably could have recouped 98% of their losses. Unfortunately, their assets weren’t liquid, so they needed more time, thus leading them to ask for help. To add to everything else, there was certainly some level of criminal activity and other bad investments, and the government didn’t offer much accountability in this regard. This is a large-scale situation that unfortunately didn’t come out of nowhere.
Looking a little deeper into the situation, there were internal players at SVB that knew things weren’t good. The chief administrator of SVB investments used to be the CEO of Layman Brothers, a company that went under in 2007. Barney Frank was on the board of directors of Signature Bank (another failed bank). Who is Barney Frank and why is he important? Barney Frank is a long-time politician who served as a ranking member of House Financial Services committee and was a key player during the 2008 financial crisis. Barney Frank helped pass the Dodd-Frank Act, a bill meant to safeguard consumers from bank mismanagement and financial risk associated with banks (https://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm). While the entire Signature Bank failure can’t entirely rest on the shoulders of Barney Frank, his life’s work certainly centered around protecting consumers from bank mismanagement. He didn’t seem to be able to protect the bank that he was a board member of. This situation really leaves a big question mark regarding the banking industry’s overall credibility.
Bank Runs and FDIC
Bank Runs refers to the widespread fear that consumers’ money isn’t safe in a small or mid-sized bank – they need a bigger, more secured, larger capitalized bank. FDIC is insurance that guarantees that deposits up to $250,000 are protected (per bank). This theoretically should make small and mid-sized banks secure as well.
What people were hoping would happen when SVB came out and asked for help from the government, was that the government would tell people all their deposits were safe. The opposite happened. The government had waited too long to act as a backstop and the ripple effect had started of deals not happening, payrolls not happening, and people moving money to bigger banks. The long-term toll on startup and tech companies will be difficulty in getting financing going forward. If you’re a startup company and you need a personal mortgage, you could have gotten it from SVB, but a large bank like Wells Fargo doesn’t have the knowledge of the industry to help people in this position.
What will the future look like?
The public is so concerned about the banking crisis that they’re pulling money from small and mid-sized banks. Inevitably, we’ll see more of these banks fail. The government has come up with a few ideas. They’ve guaranteed the money in SVB, Signature, and Silvergate. Unfortunately, convincing the individual consumer to not move their money to the big banks will be difficult. The larger banks could take over (and are likely anticipating doing so). Losing smaller community regional banking is not good for the individual consumer. The general consumer needs small and mid-sized banks. If someone makes a deposit or asks for a loan from one of the larger banks (JP Morgan, CitiBank, Wells Fargo, Bank of America), they often don’t really want to deal with small business or an individual. The government’s goal was to slow the economy down with interest rate hikes. They knew this would affect the lending arm of the economy, but it could send the economy into an absolute free fall. Best case scenario, this is the tail end event of the financial impacts of the global pandemic. Worst case scenario, this is the first domino in a very steep downturn for small and midsized banks.
The current situation has begun to develop into a liquidity crisis in the housing market. The rest remains to be seen. Stay tuned with our various resources to stay up to date and get a chance to ask your own questions!
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