Here’s my view of what happened at Silicon Valley Bank. I’ve limited it to only this bank for easier explanation. So why do I know something about this? I was a banker for more than 30 years. I also spent two years getting the equivalent of a masters degree from Pacific Coast Banking School. What I learned is that no one ignores the kinds of problems that brought down this bank. Bottom line: I think management looked out for themselves more than they looked out for their bank.
Let’s greatly simplify what happened. Deposits at Silicon Valley, or at any bank, can be pulled out at any moment. So what happens when the depositor says I want my money back, and their money is being used for a loan that won’t be paid for several years? How does SVB or any other bank pay back the depositor? They have to go out and find more deposits. Sound something like a Ponzi scheme to you? But this one is legal. What if no one wants to give large amounts of cash to the bank because there is a rumor that it’s failing? The bank has to get someone else to loan money to them so they can use that money to pay back the depositors. If not, its accounting books are under water and the regulators close them down. Virtually all banks have at least some of this risk. Add in how fast information flows and look at Silicon Valley. Its depositors pulled out $40 billion overnight. No way they can borrow that much money or get equivalent deposits in 24 hours.
The risk is even greater because many of their clients kept big deposits. The FDIC only insures deposits up to $250K. What if you have $10 million at the bank like some depositors did? Those people are running to safety because the FDIC might only pay them $250K out of the $10 million. Even if there isn’t a run on deposits, what happens if another bank offers to pay 1/2% more for that money than Silicon Valley? Again, the depositors might run to that other big bank. The one they say they’ve always hated but now need.
So there is a time imbalance between the term banks lend their money and the term others deposit the same money with the bank. What do banks do? Well, they could avoid loaning those deposits to companies and instead invest them for very short terms. But those investments pay terribly. What about U.S. Treasury bonds? These can be bought for terms of 1 to 20 years. The bonds are absolutely safe and can be sold in an instant. So Silicon Valley loaded up on those. Especially long-term bonds because those paid the best interest rates. But there was another problem, and it wasn’t as if their management couldn’t have foreseen it.
Long-term treasury bonds are sold at a discount. That means you buy a bond for say, $900K today, and the U.S. government pays you $1 million in 20 years. If interest rates go up, the bank holding the bond—read, Silicon Valley Bank—can only sell that bond at a loss. With long-term government bonds, these losses can be huge. Silicon Valley had an enormous portfolio of government bonds. Selling those bonds at a loss would wipe out its capital and make the bank go, yes, bankrupt.
So did the owners of Silicon Valley know about this risk? Of course they did. But here’s how I think they looked out for themselves. A bank doesn’t have to declare a loss unless they sell those long-term bonds before they mature. No sale means no loss. If they hold them for 20 years no loss is reported. As long as they don’t sell them early, income keeps coming in. And why would they delay those sales for as long as they could?
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