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If you haven’t been following the second-largest bank failure in history, you may want to start. To recap, Silicon Valley Bank (SVB) located in California was the 16th largest bank in the United States, with $209 billion in assets. Just a few weeks ago, it failed. Shockingly, the Silicon Valley Bank failure happened in just 48 hours. As it turned out, this was simply an old-fashioned 1930’s style run on the bank. Why is this important to you? Simply put, fear causes contagion, and if SVB could fail that fast, your bank might be in trouble, too.
Certainly, nobody wants another Great Financial Crisis like we had in 2008-2009. However, there are major differences between these two crises. The SVB problem wasn’t a credit crisis, as in subprime mortgages. It was a liquidity crisis, as in depositors took their money out so quickly that SVB management could not raise capital fast enough by selling more shares in the bank or their fixed-income assets. At the end of the day, the Silicon Valley Bank failure happened because SVB didn’t manage its interest rate risk. This caused what is known as a Black Swan event, defined by the Corporate Finance Institute as “an extremely negative event or occurrence that is impossibly difficult to predict.”
Silicon Valley Bank Failure: The Primary Cause
During the pandemic, there was just too much money going into banks at a time when the economy was shut down and nobody needed loans. Instead of this cash earning nothing, SVB bought longer-dated (duration) treasury bonds and mortgage-backed securities with very low yields and, as it turned out, at very high prices.
Last year, when the Federal Reserve raised short-term interest rates rapidly to almost 5%, the older bonds that SVB purchased back in 2020 were immediately underwater and showing massive losses. This was a real problem because it made their balance sheet look weaker and this alerted the credit agencies. SVB wasn’t the only bank to do this. This unrealized loss on the balance sheet for SVB shouldn’t have been a problem under normal circumstances. All SVB had to do was hold these bonds to maturity and they would get their money back and not have to take any losses. However, when depositors wanted their money back so quickly, SVB had no choice but to sell some of these bonds at a loss to raise the cash.
The other issue SVB faced was over 90% of the deposits in the bank were uninsured. The Federal Deposit Insurance Corporation (“FDIC”) covers up to $250,000 per depositor, but in this instance, most of the customers at SVB were start-up technology companies with much more cash in the bank than was FDIC insured. For example, the digital media player company ROKU had almost $500 million of cash deposited in SVB. As rumors spread that a Silicon Valley Bank failure was increasingly evident, venture capital firms urged their technology clients on social media to move their deposits out of SVB as soon as possible. When they did that, SVB ran out of cash and had to close their doors.
Government Reaction
To stem the panic and a similar run on the smaller regional banks around the country, the Treasury Department, the Federal Reserve, and the FDIC guaranteed all the depositors in SVB would get their money back regardless of the amount. Another move the Fed made, according to Politico, was “the Fed also announced that it would offer cash loans of up to a year for any bank putting up safe collateral — an action that, in theory, would allow banks to handle deposit withdrawal of any amount. The goal: to reassure people that they don’t need to take their money out at all.”
Unlike 2008, shareholders in SVB lost their entire investment. As President Biden and Secretary of the Treasury Janet Yellen have made it perfectly clear, taxpayers will not bail out SVB shareholders. The FDIC was covering the uninsured depositors in SVB with a dedicated fund to be used for situations such as these. Fees paid by banks cover this. Another idea under consideration by the FDIC is they would guarantee all loans, regardless of the amount, for the next two years. If they do this, then depositors wouldn’t have to move their money to one of the ‘too big to fail’ banks: JP Morgan, Bank of America, Citicorp, or Wells Fargo. Today it isn’t clear whether deposits above $250,000 would be covered in the event of another bank default, which is probably why bank stocks keep going down.
The Fed
It wasn’t too long ago that some economists were thinking the Federal Reserve would raise interest rates 50 basis points at their next meeting. Now odds favor only 25 basis point moves going forward. This is important because the Fed’s inflation fight might take a back seat to resolving the banking crisis first. There is also the possibility this latest crisis throws the U.S. economy into a recession which would help bring down inflation on its own. Perhaps that could be the silver lining to all this; however, no one could have predicted that just a few weeks ago.
READ: Finding the Silver Lining Amidst Rising Interest and Inflation Rates
Foreign Problems
As if the Silicon Valley Bank failure, alongside similar failures of U.S. banks including Signature and Silvergate, weren’t enough this month, Europe has had its problems, too. Credit Suisse Bank in Switzerland has just been rescued by UBS Bank. Credit Suisse has been in trouble for years now, but the banking issues in the United States triggered worries about the solvency of this Swiss banking giant. At the 11th hour, UBS Bank took over Credit Suisse and hopefully stopped other European banks from going under.
What Is Next
While it may be too early to know if the rapid responses by the Fed, the Treasury, the FDIC, and UBS will be successful in calming markets here and abroad, at some point, fear will turn into greed and there should be some bargains in the banking sector. If investors can find value in battered regional bank shares, the hedge funds who have made a fortune shorting these banks will have to cover to realize any profits. If they start to do that, these stocks should recover. Only time will tell. The other side effect emanating from the demise of SVB will most likely be tighter government regulations of smaller banks with regard to interest rate risk on their balance sheets. Maybe next time banks won’t be so quick to buy treasury bonds and mortgage-backed securities thinking they were risk-free.
Fred Taylor is a Partner, Managing Director at Beacon Pointe Advisors, LLC. The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed. Past performance is not a guarantee of future results. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified or attested to the accuracy or authenticity of the information. The discussions, outlook, and viewpoints featured are not intended to be investment advice and do not consider specific investment objectives or risk tolerance you may have. All investments involve risks, including the loss of principal. Consult your financial professional for guidance specific to your circumstances.