Silicon Valley: Bust
It ain't what you don't know that gets you in trouble. It's what you know for sure that just ain't so.
Although Mark Twain’s quote holds up to the SVB collapse as it did in 2007 and to an extent the recent failure of Credit Suisse, a Swiss investment bank -, don’t be so sure that we are going to experience another rerun of ‘The Big Short’ - yet. The S&P 500 is up 6.4% since the failure of the bank and current moods are high. However, what does this mean for the average person in the US or UK and where did this instability in the banking sector start?
To answer these questions we have to go back to the Obama administration in 2010. When President Obama signed the Dodd-Frank Act, a reform that would subject nearly all banks to stricter regulation as an attempt to reduce poor business practices and overly-risky lending that caused the 2008 recession. However, some of these reforms were rolled back by the Trump Administration in 2018 - for smaller banks with assets of $250bn or less. This crucially included Silicon Valley Bank and these looser rules allowed SVB to partake in riskier business practices. The bank experienced a huge wave of deposits during the 2020 pandemic - to the tune of a total of $189bn: triple that of before COVID. They put this money into what seemed to be safe assets, long-term US treasury bonds, and government-backed mortgages. However, early into 2022, the Federal Reserve, responsible for dictating US monetary policy, raised interest rates to reduce inflation in the economy. This caused those bonds to fall greatly in value - the bonds that were really bought with depositors' money. Very quickly, SVB began to lose money on these assets, specifically $17bn. Although, they weren’t in trouble yet as long as depositors didn’t withdraw too much of their savings. However, customers were already scared as most of SVB’s accounts contained more than what was insured by the government if the bank went under. Combining this with announcements by Silicon Valley stating they were selling their undervalued assets to maintain a cash supply began to make depositors lose their confidence. The stock fell significantly as a result and customers were not happy. What started as a small trickle in withdrawals grew exponentially to become a run on the bank. The spiraling situation caused the stock to fall further and by 10 March, Silicon Valley Bank ran out of cash. The US gov. seized the bank later that day. To avoid runs on other banks, the FDIC (Federal Deposit Insurance Corporation) announced that all depositors would be paid back in full, using an insurance fund that all banks pay into - so don’t pull out your pitchforks just yet as this is different from a 2008 bailout. Nevertheless, a New York bank also went under - as well as Credit Suisse being bought out by UBS a few weeks later.
Ok - maybe that was a bit of an information overload - but what does it mean for everyone other than bankers? Well, SVB specialized in start-ups in the tech and life-sciences industries, so the accounts that were affected were business clients. Although the affair was and still is very destabilizing for Silicon Valley - SVB held accounts with nearly 50% of venture capital start-ups in the US - for most people there won’t be a whole lot changing in terms of their relationship with their bank. President Biden is currently with Congress to roll back the changes that the Trump Administration made back in 2018, tightening the rules for the banks again to try and stop another bankruptcy from happening in the future. Over the other side of the Atlantic, HSBC bought the UK division of Silicon Valley Bank for a grand total of £1, hoping to extract some equity from SVB’s carcass.
So, a happy ending - Depositors got back the money they were owed and the crisis was contained… Well, not for all. Credit Suisse, a Swiss investment bank went under during the commotion. They were already weak at the time; their stock had been falling consistently since early 2021 and they were overleveraged (had too many loans), especially on tech stocks - that were impacted by SVB. Their portfolio plummeted and investors decided Credit Suisse didn’t have much of a future, so they pulled their money. UBS, another Swiss investment firm, scooped up Credit Suisse for $3.2bn and they are in the process of gutting the dead bank.
One major reason why the fall of SVB didn’t domino into the next financial crash was probably the speedy reaction of the US government - they promised to return all of the depositor's money to SVB and Signature Bank (another bank that failed during the crisis) meaning depositors had no reason to pull their money out of other banks. It meant the crisis was contained - investors saw that another recession was unlikely and ‘bought the dip’ in financial services stocks, influencing the wider market. This is why we are seeing rises in both the US and UK markets so quickly after the crisis.
It’s important to realize however this was a close call, and if the FDIC had been slow to react, it’s very possible runs on other banks would have ensued. There’s always a lesson to be learned from these situations, and this time it's a reminder of the inherent risk that comes with the entire banking system. All it takes for the financial machine to come crashing down is one loose gear - and the establishment almost never learns from its mistakes.
by Finn W. Burgess
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