Silicon Valley Bank's three fatal flaws
SYLVIE DOUGLIS, BYLINE: NPR.
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DARIAN WOODS, HOST:
We have been watching these huge waves rock the banking world over the last weekend. The 16th-largest bank in the country failed on Friday. Then, on Sunday, the government said it was taking over another big bank.
ADRIAN MA, HOST:
President Biden was up on the podium this morning, trying to project calm.
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PRESIDENT JOE BIDEN: Look, the bottom line is this - Americans can rest assured that our banking system is safe. Your deposits are safe.
MA: The government is moving to protect customers' deposits because everyone is worried about contagion - one bank failure leading to the next bank failure, which could cripple businesses and households all over the country, and we could be plunged into some pretty dark economic waters if that were to happen.
Today, we're almost at this quiet in the storm, hoping the biggest bank failures since 2008 have been contained.
This is THE INDICATOR FROM PLANET MONEY. I'm Adrian Ma.
WOODS: And I'm Darian Woods. Today on the show - what happened with the big bank where this all started - Silicon Valley Bank?
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WOODS: Howard Lerman is the founder of a virtual office company called Roam. And on Thursday morning, he started to get some panicked texts from people and other companies about Silicon Valley Bank, or SVB.
HOWARD LERMAN: And so I started to look at what was going on, and it was clear there was an absolute, all-out run on Silicon Valley Bank happening.
MA: Bank runs are when a lot of bank customers try to withdraw their money at the same time. But because banks lend out their customers' money, they can't meet everyone's withdrawals at the same time, and that panic spurs further withdrawals. And in a single day, that was what was happening at SVB.
LERMAN: It was kind of stunning to just see a bank that for 40 years had partnered with the whole venture capital and startup ecosystem collapse.
WOODS: SVB became the bank for thousands of startups and tech companies in the San Francisco Bay Area starting in 1983. Over the decades, the bank was steadily growing and expanding. It was opening offices around the country and overseas. And then, starting in 2020, around the time of the pandemic, its deposits shot up like a rocket.
Anat Admati is a finance and economics professor at Stanford University.
ANAT ADMATI: They really exploded, in terms of there was just a lot of action in Silicon Valley - all kinds of startups - so the bank grew a lot.
MA: Silicon Valley Bank would lend to startups and startup founders like Howard, and those startups would park their cash at SVB. And remember, starting in 2020, tech companies were booming. More venture capital was sloshing around the world. And as a result, SVB was getting a lot of that money in the form of deposits. It had to figure out what it was going to do with it. We spoke with somebody who worked at SVB, who remembers there were some conversations internally about this growth in deposits actually being an increased risk for the bank, which is kind of funny because you might think that having a lot of deposits is a nice situation to be in.
WOODS: Yeah, you would. And to be clear, having more cash in itself is fine. But then you got to do something with it - maybe earn a bit of interest. And if you make the wrong decision, that is a worry.
MA: Right. SVB put a lot of those extra billions into what would normally be very safe investments, like Treasury bonds - lending to the government. These are very safe assets, and it's what a lot of other banks do. But SVB had three vulnerabilities that fed into each other, causing the eventual collapse.
WOODS: Vulnerability No. 1 - the Treasury bonds and other similar assets had long maturities. That meant they cashed out way into the future. And Anat Admati says that means more risk.
ADMATI: The longer the maturity, the more sensitive it is - the more it changes in value when interest rates change.
WOODS: And now, with the Fed jacking up interest rates to fight inflation, bond values are going down. That's what happens when interest rates go up.
ADMATI: Basically, it's a piece of paper - the bond - that promised to pay you 2%, and interest rates now are, say, 4%. So what happens is that thing that is paying 2% is now worth less.
MA: A lot of banks do invest in these kinds of bonds, but SVB did it a lot more. More than half their assets were in these bonds or similar investments, compared to about a quarter for the average bank. And on top of that, SVB did not do any major hedging to balance out the risk of interest rates going up.
WOODS: SVB's second vulnerability was that its business was concentrated in the tech sector, and the tech sector is really sensitive to interest rates, too. In some ways, they are like those bonds - like, a startup hopes to pay big profits way out into the future. And when interest rates are very low, all those potential profits way out into the future are worth a lot. You could see that in the high stock prices for tech companies like Tesla and Slack - these companies that might become very profitable in the future.
MA: But when interest rates are higher, investors become more impatient. They want profits now - not 30 years from now.
ADMATI: Right now, you have turmoil in the valley.
WOODS: A lot of layoffs in the tech sector companies...
ADMATI: Layoffs and no new money - just a slowdown.
WOODS: That makes Silicon Valley Bank almost doubly vulnerable to interest rate hikes because...
ADMATI: Right - because it's not like there are more depositors walking in the door all the time.
MA: Fewer deposits meant less revenue for Silicon Valley Bank.
WOODS: SVB's third vulnerability was panicked customers who weren't covered by normal federal deposit insurance. The government explicitly insures bank deposits up to $250,000. But if you're like the founder Howard Lerman, your company does not have $250,000 in the bank. It's got $4 million in the bank - or even more in a lot of cases. And that means that less than 10% of the value of SVB's deposits were covered by the government's regular insurance, which is pretty unusual. The average bank has half its deposits covered by federal deposit insurance.
MA: So those were the three key vulnerabilities facing Silicon Valley Bank - a lot of long-term bonds, concentrated business in the tech sector and panicked customers without deposit insurance. And it was that first vulnerability that sort of started this snowball rolling.
So about a week and a half ago, SVB heard from Moody's - this rating agency - that they might get downgraded because it was holding onto all these bonds that were going to become less valuable because of rising interest rates. So to avoid a big downgrade, SVB worked out this plan to sell a bunch of its bonds, take a loss and, to make up for that loss, it would get some new outside investment.
WOODS: By last Wednesday, SVB had done part of this. It had sold its bonds. But the second part of the plan - the outside investment - that was taking a bit more time. And SVB's plan was now in full view, and investors were getting worried. On Thursday, SVB's stock price collapsed. The venture capital firm Founders Fund told its startups to withdraw all their money from SVB. It was then when Howard Lerman from Roam started getting those panicked texts, and Howard tried to get out his company's $4 million.
LERMAN: We tried to move the $4 million out on Thursday at 2 p.m., and it just didn't work. It got caught.
MA: SVB saw $42 billion withdrawn in a single day. That is more than a fifth of all of the deposits SVB had. And no bank can really sustain that kind of run that fast.
WOODS: On Friday morning, SVB employees were told the bank had been taken over by the FDIC and that the authorities were shopping around for a buyer.
MA: And two days later - i.e., yesterday - the government announced depositors like Howard would get all their money back - even the amounts over a quarter million.
WOODS: Anat Admati thinks that banks should have been given tougher regulations so that this wouldn't happen in the first place. She thinks the U.S. banking system is inherently fragile.
ADMATI: People are not trusting that that system is safe, and that's actually right. The system is not safe. That's the reality we have to face.
MA: That is a glass-half-empty view, to say the least.
WOODS: It really is. Anat is known for her withering critiques of the banking system, and she's been talking about the need for banks to have more cash on hand for a long time. But, you know, not every economist is that pessimistic. And, taking a step back, the financial world is this balancing act between regulation and banks taking responsibility for their own business. And now, with the government stepping in and protecting depositors, that raises the question once more - have we taken on board the right lessons from the last big crisis in 2008?
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MA: This episode was produced by Noah Glick, with engineering from Katherine Silva. Sierra Juarez checked the facts. Viet Le is our senior producer. Kate Concannon edits the show, and THE INDICATOR is a production of NPR.
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