ABUNDANCE BEGETS FAILURE

The Downfall of Silicon Valley Bank

A system dependent solely on the public confidence should itself exhibit confidence. Any doubt thrown upon one member must excite doubt in regard to them all. This was signally proved yesterday. The instant that the discrediting of the Bank of Pennsylvania was made public, the run upon the other banks commenced. Instead of arresting the difficulty, the distrust of that bank was only transferred to the others. After the bankers showed their want of confidence in one bank, the public at once declared their want of confidence in them all.

The Philadelphia Daily Evening Bulletin, September 28, 1857

If you happened upon Silicon Valley Bank’s webpage on the evening of Friday, March 10, you may have come across a section at the top of its newsroom tab showcasing “notable announcements and reports.” The most prominent announcement reads, “SVB named one of America’s Best Banks in 2022 by Forbes.” This is standard fair in the banking industry. But there’s one problem. Hours earlier, SVB had been declared insolvent and placed into FDIC receivership.

SVB failed fast. Two days earlier, after telling analysts for months that it didn’t need to sell assets, SVB jettisoned most of its available-for-sale securities and locked in a $1.8 billion loss. With that went any semblance of confidence in the bank. By the end of the next day, depositors had withdrawn $42 billion and sealed the bank’s fate.

With $212 billion in assets, SVB ranks behind only Washington Mutual on a list of the biggest bank failures in American history. But while WaMu had a larger balance sheet, SVB presents more complex questions. The most important of these is whether the evaporation of confidence in SVB will spread to other banks with similar balance sheets.

SVB was a tinder box of liquidity waiting to catch fire. Less than 5 percent of its deposits were insured by the FDIC, leaving more than 95 percent without protection.

This funding structure worked for years, providing SVB with a steady source of non-interest-bearing deposits with which to finance its assets. But it began to unravel a little over a year ago.

You can trace the earliest hint of trouble to the first quarter of 2022. That’s when SVB’s deposit mix began to shift. Only a third of its deposits at the time were classified as interest-bearing. But by the end of the year, the share had climbed to more than half, as customers sought to benefit from rising rates.

Since the end of 2019, moreover, SVB has seen its deposits grow by 300 percent, or nearly $130 billion. It isn’t just that SVB was paying higher rates on deposits, in other words, it was doing so on a larger share of a larger base of deposits.

“Business conditions and methods may change with the times but sound banking practice cannot depart from its fundamentals: careful judgment, conservatism and steadiness.”

Toy National Bank, Sioux City Journal, September 29, 1940

It was SVB’s efforts to defray its rising deposit costs that snookered its fate.

The bank parlayed $100 billion worth of deposits into investment securities between 2019-2021, with the majority allocated to mortgage-backed securities. It echoed First Pennsylvania Bank’s decision to load up on long-term government bonds in the 1960s. Both banks were effectively betting that rates would stay lower for longer — which, of course, they did not.

The Federal Reserve sent SVB into a death spiral by raising interest rates in early 2022. Never before in the United States have rates risen so far so fast — not even in the early 1980s under Paul Volcker. This presented a conundrum. At the same time that SVB’s securities were losing value due to rising rates, its need to sell those securities grew increasingly acute, as its customers, largely start-up companies fattened with easy money over the previous two years, began liquidating their account balances.

SVB was left with a Hobson’s choice. It could address its liquidity issues, but only by selling securities that had declined in value and thereby impairing its solvency. Or it could maintain an illusion of solvency, but only by retaining its securities and rolling the dice on liquidity.

It’s like choosing between the firing squad and the electric chair. Both are likely to kill you, but the possibility of bad aim offers at least a slender reed of hope.

Making matters worse was the fact that only a slim minority of SVB’s deposits (6 percent) were covered by FDIC deposit insurance. The vast majority (94 percent or $175 billion) were funds in excess of the $250,000 deposit cap. This acted in effect, though unbeknownst to SVB, as a performance-enhancing serum that improved the accuracy of the sharpshooters.

The die was cast. That SVB chose the firing squad made no difference.

It’s worth considering the broader implications of SVB’s failure. Will the reverberations be contained like they were in the failures of Grant & Ward in 1884 and the Knickerbocker Trust Co. in 1907? In both instances, incipient panics were smothered at birth. Or will it spark a raging conflagration like that of Jay Cooke & Co. in 1873 and the Bank of United States in 1930?

At one point on Friday, shares of First Republic Bank, which, with 80 percent of its deposits exceeding the FDIC cap, is similarly in the bottom quartile of banks when measured by the percent of insured deposits, had lost more than half their value. Meanwhile, shares of Signature Bank, at which 94 percent of deposits are uninsured, bounced between $60 and $90 per share, as it’s considered to be the most susceptible to contagion from SVB.

As we’ve seen in past crises, the depth and length of economic turmoil will be dictated by the government’s response. Thus far, it hasn’t been reassuring.

In a press release on Friday, the FDIC said that uninsured SVB depositors will receive an advance dividend within the next week followed by a “receivership certificate” for the remaining amount of their uninsured funds. The absence of specificity is at once understandable and lamentable — the former given the speed of SVB’s collapse, but the latter given the amplifying effect of uncertainty on confidence, the thing most needed right now. Suffice it to say, an aggressive response that in some way reassures uninsured depositors in banks like First Republic and Signature is probably the most effective way to smolder the coals left by SVB.

As to the question about what an individual bank or banker should do in response to SVB’s failure, the answer is as clear as some may deem unsatisfactory. I refer you to a contemporary account of the managers of the Ohio Life Insurance & Trust Company, the failure of which ignited the Panic of 1857. “The nature and extent of the difficulties are wholly unknown to the managers here, upon whom the sudden announcement fell like a thunderbolt, and who, in the absence of full information, are at great loss as to what to do. In such cases there is always greater fear of doing too much than too little.”

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