Over the weekend, we learned that Silicon Valley Bank and two other banks failed and were taken over by the Federal Deposit Insurance Corporation (FDIC). These are the first bank failures since 2020 and three of the 563 that have taken place since 2001 (https://www.fdic.gov/bank/historical/bank/). This caused a fear over the weekend that we might see a repeat of 2007-2009. As the week has gone on, fear has spread to larger regional banks such as First Republic in California and international banks such as Credit Suisse.
This explainer will lay out what happened, what the response was and why this is not like 2007-2009.
What happened at Silicon Valley Bank (and the other banks that failed):
An old-fashioned bank run!
(I’m partial to the bank run in It’s a Wonderful Life https://www.youtube.com/watch?v=iPkJH6BT7dM)
Since the events depicted in It’s a Wonderful Life, the government and banks have established a number of programs to minimize the chances of bank runs. The Federal Deposit Insurance Corporation guarantees deposits for up to $250,000 and ensures the orderly winding down of banks that face this sort of situation. This insurance covers most individual depositors. At most banks nearly half of their deposits come from people with less than $250,000 in their account at one time.
The unique thing about Silicon Valley Bank is that despite its size it was not very diversified. Over 90% of its deposits came from large depositors who had more than $250,000 in their accounts. Early last week, Silicon Valley Bank needed to write down (or take a loss) on selling some extremely safe assets (longer-term treasury bonds and mortgage backed securities) that had lost value with rising interest rates (remember bonds go down when interest rates go up) to meet increased demand from their depositors (in this case startups), who were withdrawing money because the start up industry is struggling to find new investors and the rate at which they are losing money is increasing. (For more information on the technical problems with how Silicon Valley Bank managed their interest rate risk– the risk of bonds going down when interest rates go up- and risk broadly, see here). We also wrote a less technical blog post on bond duration you can read here.
This spooked the rather small, close knit community of venture capital (VC) and start-up Founders in Silicon Valley and like the citizens in the small, close knit community of Bedford Falls (some trace the run to a single chat group that linked about 200 founders), they ran to the bank because they realized they were holding a lot of uninsured cash above the FDIC limits and if the bank failed, they wouldn’t be protected– and remember 90% of the deposits are uninsured at Silicon Valley versus a much, much higher percentage of insured assets at large banks and community banks (for a more detailed view of the uniqueness of Silicon Valley Bank, click here).
When this run started, Silicon Valley Bank (and the two other banks that failed), put into play plans to raise capital beyond selling these assets. Think of this as Mary Bailey reaching into her purse and pulling out the wedding gift money. Unfortunately, unlike Mary and George, Silicon Valley Bank (and the two other banks which were taken over by the FDIC) couldn’t access this capital as quickly. The run continued and Silicon Valley didn’t have the money on hand to pay off its depositors– it closed its doors and the FDIC came in.
What’s gone on from there?
The threat of rising interest rates is not unique to Silicon Valley Bank (indeed, the great Savings and Loan Crisis was caused by the rising interest rates that tamed the inflation of the 1970s compounded by some corruption and malfeasance), so investors are now scouring the balance sheets of a variety of other banks to see if they face the same sort of risks as Silicon Valley Bank. In the United States, attention has turned to “super regional” banks that are roughly the same size as Silicon Valley and unlike the super-sized banks aren’t subject to regular stress testing from the Federal Reserve and may have less diversified balance sheets. Most of these banks appear to not face the threats that doomed Silicon Valley Bank due to very few having the profile of owning many long-dated treasuries and lots of uninsured depositors, but when the markets panic, the markets sometimes tend to panic indiscriminately.
On Wednesday of this week, Credit Suisse’s largest investor (Saudi National Bank) basically said, “Don’t come to us looking for a handout” which spooked European markets about the possibility of the failure of European banks. That led to a rollercoaster of a day on Wednesday and then the Swiss regulators coming to the rescue of the beleaguered bank.
What was the Government Response? Is this a “bailout”?
What usually happens in these cases is that the Federal Deposit Insurance Corporation comes in on Friday afternoon and takes over the banks. They try to find a buyer over the weekend and barring that they sell off the individual assets. This is usually a very successful practice: indeed, since the 2008-2009 crisis, depositors (even the uninsured depositors) haven’t lost deposits in the case of a bank failure. In this case, worried that the (mis?)information about the Silicon Valley Bank failure could spread rapidly (via say Twitter or Facebook, two former Silicon Valley startups), the FDIC (with the backing of the treasury) basically said they would insure all deposits for the time being including those above the limit. This quelled the initial bank run, but there is still a lot of fear about bank balance sheets and their interest rate risk going forward as the Federal Reserve and central banks may need to continue to raise interest rate risks to continue to combat inflation.
This is a bailout of depositors, but not of holders of bank stocks or bonds, so it’s not how we traditionally understand a bailout, which we view as a bailing out of the investors in financial institutions and of banks themselves. It is basically a backstop to ensure that we don’t see any more bank runs. It has been consistent with how the Federal Reserve usually winds down bank failures (depositors get all of their money back), but the explicit guarantee has troubled some commentators.
Is this like 2007-2009?
In our view, no.
First, the major problem in 2007-2009 was largely at an institution to institution level: for a variety of reasons, banks lend things and money to other banks and brokerages (either to meet short term liquidity needs or because they have credits from a bank and are waiting for assets to move). In order to protect themselves against the fact that they wouldn’t get their money back from their trading partners, they had also taken out insurance on these banks/counterparties to make sure they weren’t holding the bag should these institutions or the various loans they issued fail. Unfortunately, when Lehman went out of business their insurers had sold so much insurance on the bank and a variety of bonds it issued (and repackaged these products into such a variety of ways) that the insurers couldn’t pay the insurance on the assets or the banks and the surviving banks and financial institutions couldn’t get their money back on the insurance they bought.
The fear that other banks, trading institutions, etc. would fail and they would be left holding the bag meant they didn’t trust their partners and wouldn’t lend money even overnight! If institutions won’t lend overnight (think pay on delivery versus pay and get it delivered!) the movement of money grounds to a halt and that causes serious problems.
Unable to borrow institutions still needed money to meet the daily flow of business (withdrawals, etc). Unfortunately, banks held many of these items on their books as “assets” that they could sell should they need liquidity and as the panic set in, liquidity couldn’t be found as no one could value these assets they were trying to sell or the price on offer would be ruinous to the seller. “Mark to market” accounting may have also contributed to this as well, though some would dispute this point (inside Walkner Condon we have very polarized views on this).
This is where the TARP “bailout” came in 2008: in this case, the US Treasury bought up these assets that banks were holding on their balance sheets until the market could normalize.
Unlike 2007-2009, Silicon Valley Bank was not holding risky loans or assets– they were holding safe assets (treasury bonds and safe mortgage securities) that lost value because interest rates went up. As I noted above, they were not protected very well against interest rate risk nor were they well diversified as a bank. The assets most banks hold are now highly liquid (United States treasury bonds)
Second, in 2007-2009, banks were less liquid and less well-capitalized than they were now. That is to say requirements and regulation have led banks to hold more assets on hand.
Third, these banks that make loans to other banks and institutions (that is to say the biggest banks, the one’s called systemically important) are required to subject their balance sheets to stress tests to see if the variety of their assets lose money and if they are able to handle liquidity needs safely if these items happen. As a large regional bank, Silicon Valley Bank didn’t do the sort of flow of money lending to other banks and institutions that many of the large New York Banks and Financial Institutions did and do. While they had a lot of assets, they were largely confined to Silicon Valley/Bedford Falls.
Should I panic?
No.
Your US deposits less than $250,000 are still fine and safe and insured, and you also have $500,000 in coverage if you hold joint accounts (cited right from the FDIC).
It may increase the risk of a recession, but we’ve been waiting for a recession (like Godot according to the Wall Street Journal) and as a leading indicator, the stock market tends to go up when the recession finally arrives.
The past doesn’t predict the future, but lots of people panicked when this happened in early January 1991:
U.S. is Taking Over a Group of Banks to Head Off a Run
Does anyone other than bank historians remember it?
The Walkner Condon Team
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