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What Happened to Silicon Valley Bank
Everyone’s talking about it. What actually happened?
If you’ve been under a rock the last two weeks, Silicon Valley Bank (SVB) collapsed and was taken over by the government on March 10. It was the 16th largest bank in the US and the biggest bank collapse since the Great Recession. This article will be the first in a two-part series looking at the collapse. The first is factual; what happened. The second, which will be published next week, will discuss how to think about SVB and what should be done going forward.
The first thing to know about banks is that, unlike Scrooge McDuck, they do not keep all their money in a vault.
That would be silly – how would the bank make any money by just keeping the money in a room? Instead, they put a depositor's funds to use. The most common way they put depositors' money to use is by lending it out. People buy homes, businesses need loans, etc. Of course, a bank doesn't lend money to people and companies out of kindness, they do so to make money, so they charge interest on the loans. The risk here is that some loans go bad. If too many do, then the bank won’t have enough money to cover all the depositors it owes money to.
Because loans have some risk, banks also invest in securities. Again, keeping money in a vault is a waste, and lending money out has risks, so they buy things like treasury bonds from the US government. The government then pays the bank interest on those bonds and pays the bank the face value of the bond at the maturity date.
Now banking is generally pretty safe because even if a bunch of loans goes bad, most people aren't going to want to their money out of the bank at the same time. People and businesses will keep most of their deposits in their bank accounts for years at a time. Additionally, normal people don't have to worry about their bank failing. Even if it does, the government guarantees up to $250,000 in a bank account will be reimbursed through a program run by the FDIC. So if a person has $50,000 in their checking account and their bank fails, the government will pay back the individual.
This is where Silicon Valley Bank is unique.
As the name suggests, SVB caters mainly to businesses in Silicon Valley, which are disproportionately tech companies. This is risky for two reasons. First, businesses often have more than $250,000 in their accounts. A lot more. If you're a start-up that just secured $100 million in funding and are planning to spend that $100 million in the next six months, you park it in your bank until it is needed. If you have $100 million in your account and the bank fails… you are only guaranteed to get $250,000, and you may have just lost the other $99,750,000. Bummer. In SVB’s case, 93.8% of their deposits were not insured by the FDIC. That is higher than any other bank with at least $50 billion in assets. Signature Bank, which also failed, was 89.3%. Other banks have very high uninsured deposits, but SVB is unique, likely singular, in its high concentration of firms in the tech field.
SVB is also unique in another way. According to their year-end report, SVB had $210 billion in assets – mainly loans and securities. In fact, $120 billion in securities, or 57% of all assets. The typical asset breakdown of big banks is far different, where only 31% of their assets are securities (percentages calculated from Table 6 on this page). I’m a bit over my skis here, as I’m not 100% confident I’m making an apples-to-apples comparison, but it appears that SVB has a substantially larger portion of its assets as securities rather than loans compared to the typical large bank. Also, SVB decided to buy a lot of long-term government securities, like 10-year and 20-year bonds.
These two facts – that SVB depositors were disproportionately tech companies and that SVB had a lot of long-term government bonds, combined in a novel way to spell their doom. As it began clear that inflation was not transitory but permanent in 2022, the Fed began to raise interest rates at a dramatic pace, from 0.5% to 4.75%. This is bad news for companies that rely on loans and capital to grow, such as the tech industry. Thus, SVB’s clients started losing money and needed to withdraw funds.
To cover those withdrawals, SVB had to sell some of its securities or loans. For reasons that are not fully clear, SVB decided the best way to raise the funds they needed to cover these withdrawals was to sell $21 billion worth of long-term government bonds. But because interest rates had increased so much, nobody wants old government bonds that pay 1.0% interest when new government bonds pay 3.5% interest. SVB was forced to sell those bonds below their face value and take a $2 billion loss. Various financial entities noticed this and urged their clients to withdraw all their funds. Those clients listened, and withdrew their funds en masse, resulting in a classic bank run.
No bank can survive a bank run. If every client decides they want their money, then the bank will be unable to pay. It sounds like a house of cards, but the reality is that modern banking is a pillar of our society and a key reason we aren’t still living in the Middle Ages.
Fortunately, the government figured out a solution that means all SVB depositors will get all their money back. Even firms that had $100 million just sitting in a checking account. Money will come from an insurance pool that banks participate in, and no taxpayer money will be used. This was done mainly to prevent bank runs on other, healthy banks, as any bank run becomes a self-fulfilling prophecy.
To recap: Silicon Valley Bank had a lot of clients in tech and bought a lot of long-term government bonds. When interest rates increased, two things happened at the same time. First, their clients wanted some of their money out. Second, to pay their clients SVB had to sell their government bonds for a loss. People noticed this and urged their clients to withdraw all their funds less SVB collapse and those deposits disappear. Which of course caused SVB to collapse and those deposits to disappear. However, the government came up with a solution that will result in all depositors being reimbursed, and this money is not coming from the taxpayer.
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