The Silicon Valley Bank Failure Explained

My name is Morris Pearl. I am the Chair of the Patriotic Millionaires and a former managing director at BlackRock.

We usually write this newsletter in the collective voice of our entire membership. This week though, I’d like to take the reins and give you my perspective on the Silicon Valley Bank (SVB) failure that has been dominating the news over the last few days. (Two other regional banks – Silvergate Bank and Signature Bank – also collapsed, but I will focus on SVB as it is the largest of the three.)

I know a thing or two about bank failures. I was part of the team at BlackRock hired by the Federal Reserve, Treasury, and Federal Deposit Insurance Corporation (FDIC) to structure and assess the cost of the Citibank bailout during the 2008 financial crisis. I then worked on similar projects in the UK, Greece, and Ireland before agreeing to work full-time as the Chair of the Patriotic Millionaires. I will try to use my experience and expertise to explain 1) what happened with the SVB crash 2) why it happened and 3) what lawmakers can do to right the ship and stave off further damage.

What just happened

Last Friday, the FDIC announced that it would take over SVB, a 40-year-old regional bank based in Santa Clara, California, after it failed to find a buyer.

According to its website, SVB provided banking services to roughly half of the venture capital-backed technology and life-science companies in the US. It handled more than $209 billion in total assets and $175 billion in total deposits, which made it the 16th largest bank in the country. Its downfall represents the largest bank crash since the 2008 financial crisis.

The reverberations of SVB’s collapse have been felt far and wide. Yesterday, stock at other regional banks – particularly First Republic Bank and Western Alliance – nosedived as panicked customers and investors, worried that their bank was also in jeopardy of closing its doors, rushed to remove deposits and dump stock.

President Biden took to the airwaves to assure Americans that the country’s banking system is safe. Federal regulators also announced the activation of emergency measures that would ensure that all SVB depositors would receive their money – even those with deposits above $250,000, the FDIC’s standard deposit insurance limit. This was welcome news to the nonprofits and businesses – including well-known names like Roblox, Etsy, and Pinterest – whose employee payroll was tied up at the bank. Also, it’s important to note that this is very distinct from previous bailouts: the only people made whole were the bank’s depositors, not the bank’s investors or its management.

Why it happened

Banking and finance are complicated, and the story behind SVB’s collapse is no exception. That said, I’ll try my best to explain some of the primary culprits behind the SVB disaster to help you better understand things.

SVB was unique in that most of its business was concentrated in a relatively small group of technology companies with big deposits. This put SVB in a vulnerable and risky position, as any weakness or turmoil in the tech industry could subsequently destabilize the bank.

The tech industry has definitely experienced turmoil lately. In its fight against inflation, the Federal Reserve has raised interest rates several times over the last year; at its meeting last month, the agency raised rates to 4.5% and indicated that it would continue to raise rates for as long as it deemed necessary. Tech start-ups did well during the pandemic but now have struggled to attract funders because it’s increasingly expensive for people to borrow money for investment purposes. As a result, to cover their expenses and stay afloat, these start-ups have needed to make more and bigger withdrawals from SVB.

Unfortunately, SVB was not managed well enough to weather this kind of storm. It kept a portion of its deposits in cash and then used a lot of the rest to invest in government-guaranteed residential mortgages. When SVB bought bonds during their pandemic boom, interest rates were very low. Now, however, interest rates are very high because of the Fed’s action. Older bonds with low interest rates can only be sold at much lower prices than new bonds with high interest rates. And mortgages, like those that SVB invested in, are even more sensitive because when interest rates go up, people tend not to pay off their mortgages early (by refinancing).

What ended up happening was that SVB was forced to meet their clients’ increasingly hefty withdrawal requests by selling the low-interest bonds they bought at steeply discounted prices, which put them at a financial loss. Eventually, things got so bad that SVB couldn’t pay all of its depositors and was forced to shut its doors last Friday.

Unfortunately, regulators didn’t do anything to help the situation until it was too late. Back in 2018, Congress passed and former President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act. This bill rolled back key portions of the 2010 Dodd-Frank Act, the famous banking regulation bill that was passed in the aftermath of the 2008 financial crisis. Among other things, the 2018 bill changed which banks would be considered “systemically important” to federal regulators; only the largest banks with over $250 billion in assets would be subject to strict oversight and regulation, including requirements that banks keep a certain amount of cash on hand to protect against losses and submit to regular stress testing which help determine whether banks are strong enough to withstand losses. This exempted SVB, leaving it free from some of these critical regulations that might have prevented last week’s crisis.

Back in 2015, Greg Becker, the CEO of SVB, actually personally lobbied Congress to raise the threshold for “systemically important” banks so that small and mid-sized banks such as his would be exempt from federal regulations. He also spent $500,000 in lobbying efforts to pass the 2018 law, and even hired two former staffers of now House Speaker Kevin McCarthy to do his bidding. He got his wish, but his bank is now paying the ultimate price. We’ll never know what would have happened if the 2018 law had not been passed, but it’s undoubtable that stricter oversight could have mitigated the scale of disaster now unfolding at SVB’s doors.

What lawmakers should do

Disasters like the one unfolding at SVB can and should be prevented at all costs. Thankfully, stocks at regional banks around the country began to rebound this morning, but with the Fed continuing to increase rates, we might not be far away from another disaster.

I suggest several courses of action:

1. The Fed should stop raising interest rates. This is not the correct course for solving the type of inflation we’re currently facing, and it ends up hurting the poor and vulnerable. It also makes us susceptible to crises like this.

2. Regulators should have the authority, and the will, to actually regulate banks. Banks have this enormous special privilege, through the FDIC, that other businesses do not have — they can get money from their depositors and invest it to make money. The FDIC needs to make sure that banks manage their business with the priority of avoiding losses like this (not making profits for shareholders). Lawmakers need to say that these banks are “systemically important” and must be regulated accordingly. That involves repealing many of the changes from the 2018 law, and going even further.

Bankers always say that the best way to prevent banks from losing people’s money is to help them make huge profits by loosening regulations, but we’re seeing yet again where that leads us – to socialized losses and privatized profits. It seems that lawmakers and regulators forgot the lessons of 2008 after just a decade. Let’s hope that this reminder is all it takes to put in place appropriate legislation before we experience another, much more serious, crisis.

Working Americans are already burdened by enough financial woes. They should not be expected to worry about the reckless behavior of a few executives at their banks too.

Related Posts