Silicon Valley Bank and All That

https://www.youtube.com/watch?v=GQGBD4zCMAg

Where is Powell? Where is Yellen? Stop this crisis NOW. Announce that all depositors will be safe. — David Sacks, PayPal co-founder and Silicon Valley libertarian commentator, 3/10/2023

OK. We can all enjoy some schadenfreude as the Silicon Valley techno-libertarians discover that maybe there is a role for government, after all. Especially when their money in Silicon Valley Bank (SVB) might vanish. Of course, it didn’t. It didn’t because those burdensome government agencies decided to make them whole, 100 cents on the dollar, including the more than 90% of deposits that were above the $250,000 Federal Deposit Insurance Corporation insurance limit.

How Did SVB Get Into This Mess? 

In 2015, Greg Becker, then and now the CEO of SVB, appeared before Congress and argued that failure to “relax” the capital requirement of the 2010 Dodd-Frank Act (which aimed to ensure that banks would have enough capital on hand to meet obligations)  would “stifle our ability to extend credit to our clients.” Three years later, in 2018, under the Trump administration, Congress complied. New legislation raised the level of exemption from the “stress tests” applied to “systemically important banks” such as JP Morgan Chase, Bank of America, etc., from $50 billion in assets to $250 billion. In a stress test, the assets and liabilities of a bank are run through extreme but possible scenarios, such as what would the bank’s situation look like if interest rates were to double or triple in a short time period. Such a test should have raised flags about SVB, but we don’t know how much attention the results would have received. In the following three years, SVB assets increased more than 250% to just under the new threshold, an increase largely driven by deposits from an aggressive campaign to get new tech startups to use SVB to park their cash and to take out loans. 

So What Is the SVB (and Signature Bank) Story?

In essence what happened to SVB and later Signature Bank in New York is an old-fashioned bank run. Modern banking is based on faith — that your money will be there whenever you want it. This faith allows banks to profit using a very traditional banking model of paying lower interest to depositors and lending at higher rates to businesses, households, etc.

But this run-of-the-mill bank run occurred at a very unusual bank (Signature Bank, much smaller than SVB, shared some but not all of SVB’s traits. Like SVB, most of the deposits in Signature were above the $250,000 FDIC insured level. The customer base was also concentrated, in this case law and real estate firms.  Signature also had a significant percentage of deposits from the crypto sector.)

The business model of SVB worked well — until it didn’t. SVB took in large amounts of deposits from a narrow customer base of tech start-ups and tech entrepreneurs and loaned, by the bank’s account, to almost half of all venture-capital-backed technology and life-science companies in the United States. 

Some tech innovators and their companies kept their deposits at SVB because the condition for a loan included the requirement for depositing working cash in the bank. Some just liked the creative startup vibe from CEO Becker, described on the SVB web site as a champion of the innovation economy. And Becker also had influence and power outside the world of Silicon Valley tech entrepreneurs, serving since 2019 as a Class A director of the San Francisco Federal Reserve Bank. His picture was removed from the Bank’s website and his seat declared vacant on March 10, the day SVB collapsed.

The Financial Environment Changed

Thirteen years of very low interest rates following the 2008 financial crisis meant a low cost of capital for the exciting world of Silicon Valley startups, encouraging more and more such ventures and fueling the growth of SVB when other, larger banks were reluctant to loan to these companies. However, the sharp downturn in the tech sector in 2022, the crypto-crash, and the Federal Reserve Bank’s (the Fed’s) obsession with fighting inflation created a very different financial environment. The tech sector was hit particularly hard by the rapid series of interest-rate hikes engineered by the Fed, chaired by Jerome Powell. Companies in the Valley could no longer get the low-cost capital they needed to operate. The only money they could get were their deposits in SVB. As the draw on SVB’s deposits grew, so did worries about the bank’s financial situation. 

Meanwhile, Powell assured Congress — on March 6,, four days before the FDIC seized SVB — that the Fed’s interest rate hikes posed no risk to the financial sector. Moody’s and S&P continued to give SVB an investment grade rating.

CEO Becker was a little smarter than Powell or the rating agencies. Two weeks prior to the collapse, he sold $3.6 million of SVB stock. Several executives also made strategically smart stock sales in the weeks leading up to the collapse. The Department of Justice has announced an investigation into these trades.

Contagion – Or Maybe Not

But of course, what we really want to know is the question of “financial contagion.” Are SVB and Signature Bank only the first dominoes to fall, the Lehman and Bear Sterns of a new financial crisis? This is a harder question than the simple description of what happened.

On the one hand, they are relatively small banks. Yes, I know, everyone is saying SVB is the biggest bank failure since 2008. But SVB, at about $250 billion in assets, is less than a tenth of the size of the largest bank, JP Morgan-Chase. However, SVB is of sectoral importance, which is probably the reason that Treasury Secretary Janet Yellen invoked the “systemic risk exception” in bailing out the bank. 

But, beyond the issue of size, there is another very important difference between SVB and Bear, Lehman, and AIG, etc., in 2008. SVB apparently has no derivative or other transactions with the larger banking community. Thus, containing the risk should be rather straightforward, and the decision to make all depositors whole is a big step in that direction. Will this be sufficient? That is yet to be seen. Many other FDIC-covered banks are sitting on large unrealized bond losses, estimated at more than $600 billion at year-end 2022.

But there is a larger question for progressives to think about and to try to insert into the realm of political discourse. If we, the citizenry at large, are going to bail out the tech innovation sector when it makes bad financial decisions, shouldn’t we get some of the upside when one of the “unicorns” succeeds? It may be that technological innovation is too important to leave to bankers and Silicon Valley libertarians, that we begin to think about the socialization of investment.

The finger pointing has only begun. But to paraphrase the old adage that “there are no atheists in a foxhole,” it is clear that there are no libertarians in a financial crisis.