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What Does the Silicon Valley Bank Failure Mean to Us?

I had another topic planned for this week, but the Silicon Valley Bank (SVB) failure burst onto the scene and I wanted to use this week’s article to talk about this possible banking crisis.

As a former banker, I’m sensitive to cracks in the banking system and I know that there are some misconceptions about banking and Federal insurance programs like the FDIC.

Full disclosure: while I have many individual companies’ stocks in my retirement investment portfolio, I do not have any banking institutions.  This is by design as I learned from a bad (but not devastating) experience when the 2008 financial crisis occurred.  In my mind there is a potential for the 2008 scenario to be repeated, if not now, then perhaps some time in the future.  So, I’ll stick with healthcare, utilities and energy, thank you very much!

What Was SVB?

Silicon Valley Bank provided banking services to nearly half the country’s venture capital-backed technology and life-science companies, according to its website, and to more than 2,500 venture capital firms. 

SVB took deposits from companies who went public and had large amounts of fresh cash for future investments, payroll, etc.  Many of these companies retained their relationship with SVB long after going public.

What Happened?

Of course, the primary function of any bank is to lend deposit money out and charge more interest on their loans than they pay depositors in interest.

SVB took in huge amounts of deposit money.  So much so that they could not lend the cash out fast enough.  SVB’s natural reaction to these large amounts was to invest in Treasury securities.  Sounds prudent, right?

Well, not the way that SVB invested.  Treasury securities are a safe investment if held to maturity but their value day-to-day changes as market interest rates change.  As interest rates rise, the value of any bond decreases.  (Click here for an explanation of this behavior.) 

SVB invested their excess cash in Treasury securities when interest rates were low.  As the Federal Reserve raised interest rates, the value of SVB’s securities dropped.  This drop in value eventually ate up all of the bank’s equity.   In fact, SVB’s equity was negative as long ago as September 2022.

What SVB did wrong was they didn’t “hedge” their investments by buying options that would go up in value if interest rates rose.  These gains would have offset the drop in value of their Treasuries and protected them from loss.

Investors saw this precarious condition as early as January 2023 and began withdrawing funds from the bank.  Last week, in a few hours, $42 billion was withdrawn.  SVB needed to sell some of their treasury securities at a loss to generate cash to pay depositors forcing the bank into insolvency.

This was the classic “run on the bank.”  See “It’s a Wonderful Life.”

What Will Happen to Depositors?

Normally, when the FDIC takes over a bank it frees up deposits under $250,000, thereby protecting small depositors.  Customer accounts with amounts over the $250,000 are frozen until the FDIC can resolve a bank’s outstanding assets and liabilities.  Effectively, large depositors are creditors of the bank and their deposits are repaid on a prorated basis upon the disposition of a bank’s assets.

In SVB’s case, initially, the Federal Deposit Insurance Corp. (FDIC) said that it would protect the first $250,000 of depositor’s funds as provided by insurance.  Large depositors’ accounts were frozen.  In fact, 89% of SVB’s deposits were uninsured.  This negatively impacted many of SVB’s corporate customers like Etsy, Pinterest and Shopify.  These customers would be unable to make their payrolls and pay their vendors who often are small businesspeople.

Responding to this crisis, and to prevent a snowballing effect of the failure, the FDIC and the Treasury announced that customer deposits in excess of $250,000 would be protected.

What Does it Mean to Us?

Well, if you have more than $250,000 in a single bank (lucky you!) you should consider moving the excess amount to another bank.

But for the rest of us, there’s no reason to worry about your money if your bank experiences difficulties.

The larger risk to all of us is that the Federal government has effectively guaranteed all the deposits at SVB.  Now that they’ve set this precedent, banks know that they don’t have to worry as much about protecting their customers’ money and may take extra risk in the loans and investments they make.  This effect could cause future bank failures and, taken to extreme, could tank the banking system.

If you feel a bit nervous, you may consider keeping a bit more cash under your mattress at home.  Otherwise, barring a sudden loss of cabin pressure, we shouldn’t worry too much.

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“Liberty is meaningless where the right to utter one's thoughts and opinions has ceased to exist. That, of all rights, is the dread of tyrants. It is the right which they first of all strike down.”

-          Frederick Douglass

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It’s Almost Tax Time!

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