Silicon Valley Bank has closed down in the largest bank failure in 15 years. Let’s figure out why they failed, why the bank run happened, why it’s similar to 2008 and how you can protect yourself.
We know why it happened but it’s definitely NOT because their Chief Administrative Officer Joseph Gentile was the former CFO of Lehman brothers.
But why did it happen?
Of course the banks don’t hold 100% of their clients’ deposits.
They work on fractional reserves meaning they have about 10% of the money. Which means they can lend 90% to someone else who lends 90% of that to someone else and everyone makes more money.
But that’s until something interesting happens like the Fed starts raising interest rates.
First, SVB is no ordinary bank. It was the go-to bank for Silicon Valley startups.
1) SVB also invested in debt like long U.S. Treasuries and mortgage-backed securities.
2) They were also buying corporate bonds of technology companies.
Higher interest rates negatively affect bond prices.
Tech companies suffered the most in this recession and SVB was seeing continued material outflows of client funds.
So the bank saw more unrealized losses until one day these losses became larger than the bank's capital.
Many of their bonds were yielding an average of only 1.79 percent at a time when interest rates had risen drastically. So clearly they didn’t expect the rates to go up this quickly.
This is the risk of investing in risk-free assets.
To cover up the losses the bank’s management chose to sell $21 billion of bonds at a $1.8 billion loss.
Plus they chose to raise new equity from the venture capital firm General Atlantic and also to sell a convertible bond to the public.
Some venture-capital investors got liquidity concerns — which basically means the bank doesn’t have enough cash — and advised startups to pull their money out of the bank.
The failure of SVB was caused by a run on the bank on Thursday. The bank had 17 billion in cash, which is normally a substantial amount for the bank. But not when everyone is panicking.
Especially when everyone is panicking on Twitter.
One of the reasons for the disaster is actually the portrait of their client - fast, smart and tech-savvy person, who reacts to twitter notifications faster than to their alarm clock.
So as these people started to withdraw funds, the figure rose to $42 billion on Thursday.
When the bank got negative capital, The California regulators had to step in and close it and FDIC took it over.
First they said they would cover insured deposits up to $250 thousand. But the thing is 97% of all the deposits are over $250 so they were not insured.
A considerable sum for an individual but it’s almost nothing for a business. Companies like Roku, Circle and Roblox, held several billion dollars at SVB.
Later the government announced 100% of the deposits will be available by Monday 13th of March.
But you get the picture of what could have happened if the government hadn’t made that statement, approving an extraordinary intervention aimed at averting a crisis in the financial markets.
The government says it’s not a bailout, maybe not for SVB but it is a bailout for the economy.
However on Monday Biden said the money won’t come from the taxpayers, it will come from the fees that banks pay into the deposit insurance.
But what if this kind of thing continues to happen?
On Thursday the four biggest banks – JPMorgan, Bank of America, Wells Fargo, and Morgan Stanley – lost $55 billion in combined market value.
The KBW Bank Index – which tracks the leading publicly-traded banks in the US – plunged 7.7% for its worst day in almost three years.
The ripple effect has been spreading. Regulators also closed down Signature Bank of New York on Sunday.
And they are extending protection to their depositors as well.
But how many banks can they save?
Clearly this is a warning for the Fed.
Powell is fighting inflation by slowing down the blood system of the economy — banks.
A thread breaks at its weakest point.
The Fed cannot continue to raise interest rates otherwise the banking system will suffer.
If we don’t want the banks to fail like in 2008 they should stop rising rates.
The tech sector is the weakest here, they rely on credit money the most. So if the Fed keeps raising rates, there will be more SVBs and tech closures.
But if they don’t, inflation will continue to grow.
They’re likely to avoid steep tightening because the risks of collapsing the banking system are too high.
You can survive inflation, but not another Lehman brothers.
So far they haven’t beaten inflation, but there is nowhere to increase the rate further, because then the banking system will collapse.
The inflation might keep rising, while the economic growth is slow. This leads to stagflation.
So instead of a soft landing, we get stagflation.
So what can you do about it?
If we get stagflation the assets that grow the most are commodities: oil, gas, metals, food, and construction materials.
Don’t forget about diversification not only in your investment portfolio but also with you bank accounts.
But if you have over $250 thousand you’re probably thinking the same. It’s probably best to stick to the big banks to keep your money.
And let’s hope 2008 doesn’t happen again.
All the best and see you soon!
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