Silicon Valley Bank imploded last Friday and was seized by a U.S. government agency. Cue the hysterics over one fatal bank run triggering a wave of others, California’s tech sector melting down and America losing its world-beating competitive edge in everything from smartphones to flying taxis.
Less than a week later, the prophesied calamities didn’t happen, even if investors’ nerves had been rattled. On Tuesday, regional banking shares recovered much of their lost ground, and even Bitcoin soared. SVB’s contagion seemed largely boxed in, in good part because Uncle Sam insured all of the bank’s deposits.
The new banking crisis was across the Atlantic, where a capital-raising and liquidity nightmare at Credit Suisse, a long-time basket case, triggered a broad sell-off of big-bank shares in Europe and elsewhere. But CS’s woes do not appear to reflect interest-rate problems that the wider banking system can’t handle. Still, the herd mentality prevailed Wednesday.
If little else, the collapse of SVB stands out for sheer entertainment value. It exposed the hypocrisy of the tech bros, many of whom called for a full bank bailout, blowing a hole in their libertarian mantra. And it exposed the epically bad management and risk-taking skills of the bros who ran the bank – into the ground.
Silicon Valley Bank collapse: What’s next for banks and investors?
SVB was launched in 1983 to focus on tech startups in the San Francisco Bay area. It was a good idea, since mainstream banks had little expertise in tech and naturally avoided small companies with little or no revenue stream, zero profits and scant collateral to back loans. In effect, SVB became the captive bank of Silicon Valley and thrived, boasting clients such as Cisco Systems and Bay Networks.
It survived the 2007-08 financial crisis with a little help from the U.S. government and went on to become the tech bros’ plaything, picking up clients in life sciences, venture capital, private equity, even the premium wine market. It supplied mortgages to rich Silicon Valley entrepreneurs and expanded overseas to fund the hot tech markets in India, Israel and Britain. Europe really had no equivalent, though in a sense Italy’s Mediobanca, the investment bank that exploited connections and influence to build an empire linking many of the country’s top businesses, came close, conceptually speaking,
Profits and return on equity soared. What could go wrong?
The answer was a funding model whose fatal flaw was revealed when interest rates rose, hitting the bank like a precision bomb. SVB had been taking in gushers of cash as its clients raised a lot of money in a tech-worshipping environment through initial public offerings, venture-capital investments and the like. As Megan Greene, chief economist for the Kroll Institute, pointed out, SVB could have ploughed the deposits into Treasury bills. But those short-term securities paid almost nothing in a zero-interest-rate market. So SVB opted instead for longer-dated Treasury bonds and mortgage-backed securities.
The formula worked well until central banks jacked up interest rates to fight high inflation. When they did, the cash flowing into startups slowed, so they had to withdraw their deposits from SVB to pay their operating expenses. SVB’s deposit base shrank massively last year and, to cover the outflow, the bank had to sell its fixed-rate securities at a loss – when interest rates rise, the prices of fixed-rate bonds fall.
When SVB clients learned through social media that their beloved bank was shovelling cash out the door, they panicked. Bank runs are notoriously hard to stop. Within a few days, customers yanked more than US$40-billion from SVB.
No bank is free of risk, but it didn’t take a genius to figure out that SVB was riskier than most. Its business was centred in a volatile sector whose fortunes were headed south as interest rates headed north. Its fixed-rate securities accounted for 56 per cent of its assets, about double that of many of the big banks.
It turned out that the smartest guys in banking were anything but. Did management subject its funding operations to regular stress tests? Did they take precautions as their tech clients fell from grace? Apparently not. The bank’s risk management failed miserably, which triggered schadenfreude among the non-techies who were weary of the bros’ often pretentious and arrogant attitudes.
The non-believers were also amused by the bros’ pleas for a full bank bailout, especially since the same crowd had a history of whining about the evils of regulation and state intervention. As SVB was doing its imitation of the Titanic, prominent venture capitalist David Sacks tweeted, “Where is [Federal Reserve chairman Jerome] Powell? Where is [Treasury Secretary Janet] Yellen? Stop this crisis NOW.” Garry Tan, the boss of Y Combinator, called SVB’s collapse an “extinction level event” for startups.
It wasn’t, of course, all the more so since the bros’ yelping worked somewhat. While SVB’s bond and equity holders were wiped out, all depositors were made whole. The bank is suddenly billing itself as rock solid, at least for deposits. In a statement to clients that, incredibly, attempts to turn a failure into an opportunity, the bank said federal deposit insurance “means that deposits held with SVB are among the safest of any bank institution in the country.”
All more amusing than harmful. This is not a repeat of the 2007-08 financial crisis – far from it.