By now we have all heard about Silicon Valley Bank’s (SVB) sudden collapse and we are wondering whether we are on the precipice of a 2008 scale meltdown. After all it is the second largest bank failure in U.S. history. Even more concerning is the recent rattling at Credit Suisse. In this post we'll explore, some key takeaways from the pundits and publishers out there.
Examining the Connection Between Silvergate Bank’s Collapse and SVB’s Bank Run
A few weeks ago, the well-known cryptocurrency bank, Silvergate, suffered a sudden collapse. As a prominent institution within the world of crypto, Silvergate served as a crucial entry and exit point for individuals looking to convert their cryptocurrency into fiat currency. It also maintained substantial exposure to both Alameda Research and FTX.
In contrast, Silicon Valley Bank (SVB) maintains no direct connections with the cryptocurrency sector or Silvergate Bank. However, the dramatic downfall of Silvergate likely instilled enough fear among SVB depositors, prompting them to trigger a panic. For a more in-depth exploration of the Silvergate collapse, check out Wall Street Millennial’s take on the situation:
Unveiling Risk Management Flaws: What did Warren Buffett say about low tides?
Warren Buffett once said, “You don’t find out who’s been swimming naked until the tide goes out.” This sentiment rings true for SVB, which suffered from a maturity mismatch between its depositors' on-demand withdrawals and the long-term debt it held. The bank was exposed to interest rate risks but took no action, leaving it vulnerable.
How did things go so wrong?
When looking at what happened at SVB, we need to go back in time an examine the impact of the zero interest rate policy that's been in place for decades. It resulted in “the search for yield”. This search for yield funded everything from mortgage-backed securities, cryptocurrencies, investments in emerging markets as well as risky investments in the oil sector. And this is what likely prompted the executive management at SVB to lock in their money in long term debt. Specifically, SVB owned over $80bn of mortgage-backed securities with 97% of them being 10+ year duration at a weighted average yield of 1.56% (link).
Interestingly, SVB contemplated managing this risk but decided against it. As noted on Bloomberg:
“In late 2020, the firm’s asset-liability committee received an internal recommendation to buy shorter-term bonds as more deposits flowed in, according to documents viewed by Bloomberg. That shift would reduce the risk of sizable losses if interest rates quickly rose. But it would have a cost: an estimated $18 million reduction in earnings, with a $36 million hit going forward from there”
Then inflation struck. This caused the Fed to aggressively reverse its zero-interest rate policy. The swift increase in interest rates led to a significant decline in the value of SVB’s debt holdings, as the value of debt falls when interest rates rise.
To deal with this widening hole in their balance sheet, management failed to raise $2.25 billion. This left SVB unable to cover the unexpected withdrawal of $42 billion in deposits (that occurred in 1 day!), as the value of the debt they held had severely diminished and could not cover the outflows. For more on the numbers, check out Patrick Boyle’s take:
Furthermore, the absence of a risk officer from April 2022 to January 2023 compounded these issues. Moreover, the CAO was none other than the former CFO of Lehman! For more on this check out Cold Fusion’s take:
The Race to escape the Sinking Ship: Who will be left holding the bag?
Venture capitalists, known for their interconnectedness through WhatsApp groups, began to realize the bank's shortcomings. They themselves were quite vulnerable as 90% of SVB's deposits were uninsured, in contrast to the industry average of 52% (link). As noted in this Bloomberg Odd Lots podcast, SVB was not actually dealing with a diverse set of clients. Instead, they were dealing with a handful of VCs. Consequently, the clients pulled out their funds in unison as a response to the request from their respective investors.
The Ripple Effect: Contagion Risks Loomed
The inability of Silicon Valley to access cash for payroll could have spelled disaster for numerous startups. This cash flow issue would have also generated incentives for customers to avoid smaller banks, potentially triggering bank runs on other vulnerable institutions. It would also lead to consolidation of customers around the “too big to fail” banks, as people will not trust banks that are the same size or smaller than SVB.
Questionable Timing: Bonuses and Stock Sales
The timing of bonus payouts and stock sales raised eyebrows, with bonuses ranging from $12,000 for associates to $140,000 for managing directors issued the day FDIC took over the bank. (link) Silicon Valley Bank CEO Greg Becker's stock sales, totaling nearly $30 million over two years, also drew scrutiny. Most notably, Becker sold $3.6 million worth of shares just days before the bank disclosed a substantial loss that led to its stock plunge and eventual collapse. (link)
Capitalism on the way up, Socialism on the way down?
The US Treasury jumped into shore up ALL deposits. The new "Bank Term Funding Program" will offer loans of up to one year to lenders that pledge collateral, which will be valued at par. Management and shareholders, however, will not be bailed out.
The Biden administration and other government officials have emphasized that the FDIC intervention is not a bailout, seemingly more concerned about potential backlash than addressing investors' needs. Their apprehension likely stems from the possibility of sparking a new Occupy Wall Street or Tea Party movement, as Uncle Sam's aid tends to favor those deemed "too big to fail" rather than offering support to smaller, struggling entities.
And the Biden Administration has good reason to be aware of this perception.
As reported in the Washington Post, prominent venture capitalists and tech executives, including LinkedIn founder Reid Hoffman and investor Ron Conway, leveraged their connections and influence to lobby Democratic lawmakers and administration officials for intervention in the bank crisis. As prolific donors to Democrats, including Biden, they worked with Pelosi and Gov. Newsom to pressure the White House and Treasury Department. Over 600 tech industry executives joined a call with Rep. Ro Khanna, who then emerged as a vocal advocate for the Biden administration to support the bank's depositors and prevent broader financial repercussions. Washington Post summarized the situation as follows:
“The lobbying blitz reflected a broader sea change in the normally libertarian tech industry — one that typically tries to ward off federal intervention. Now, many of those same voices were calling on the Biden administration to act and protect an ecosystem in which they had a large stake.”
Ironically, it was none other than the CEO of SVB, Greg Becker, who lobbied back in 2015 to evade the Dodd frank regulatory constraints and thereby get lighter scrutiny. Here is an excerpt from this article:
“Touting “SVB’s deep understanding of the markets it serves, our strong risk management practices,” Becker argued that his bank would soon reach $50 billion in assets, which under the law would trigger “enhanced prudential standards,” including more stringent regulations, stress tests, and capital requirements for his and other similarly sized banks…Becker insisted that $250 billion was a more appropriate threshold…“Without such changes, SVB likely will need to divert significant resources from providing financing to job-creating companies in the innovation economy to complying with enhanced prudential standards and other requirements,” wrote Becker…”
Commenting on the contradiction between this attitude and the SVB bailout demanded by the 600 tech execs, Scott Galloway, a prof at NYU’s Stern School of Business, offers a succinct and insightful summary of the underlying dynamics (see here and here):
"We have capitalism on the way up and socialism on the way down."
Sure, this protected the depositors. And yes, it was not for the shareholders or management. However, one cannot deny that it was the special access to the powerbrokers that brought in the FDIC to save the day. In the absence of such privileged access, the account holders would have likely met the same fate as mortgage holders who were left stranded in the 2008 crisis.
Author: Malik Datardina, CPA, CA, CISA. Malik works at Auvenir as a GRC Strategist that is working to transform the engagement experience for accounting firms and their clients. The opinions expressed here do not necessarily represent UWCISA, UW, Auvenir (or its affiliates), CPA Canada or anyone else. This post was written with the assistance of an AI language model. The model provided suggestions and completions to help me write, but the final content and opinions are my own.
