For those unaware, Silicon Valley Bank became the first bank to fail since 2020 and the largest bank to fail since the Global Financial Crisis in 2008-2009. Is our current situation an echo of the last financial crisis, or is it a one-off? While the circumstances surrounding their failure are mostly unique to them, it is important to look at the implications for the rest of the banking industry.
To truly understand this story, we first need to look at the preceding 10+ years of low interest rates and how the seeds were sown for the situation we are in today. A low interest rate environment allowed money to flow freely into companies that had big dreams about their future potential but were short on current profits. A lot of these companies are concentrated in Silicon Valley in California, which is where our story picks up.
Given this backdrop, the foundation for this failure was in place – the pandemic was the catalyst to set it into motion. We all remember the COVID economic environment: stimulus checks and soaring stock prices. This created a mountain of cash, especially in Silicon Valley, that needed somewhere to go, and personal and corporate checking and savings accounts at SVB saw a large influx of cash.
When you deposit money at a bank, that money becomes a liability for the bank because they need to be prepared to give that back to you on demand. Simplistically, banks need to offset those liabilities from deposits with assets in the form of loans to customers or investments held by the bank. The appetite for loans was not enough to offset the growing deposit base, so SVB chose to invest this excess money in high-quality bonds. The problem with these bonds is that they were exposed to the risk of rising interest rates, which manifested itself last year as interest rates rose, driving the prices of these bonds down. Executives at SVB did not take enough action to hedge this interest rate risk, so they were vulnerable to needing to meet any large-scale withdrawal of money from checking and savings accounts.
The Federal Reserve’s actions to quell inflation have primarily focused on raising the rates on short-term bonds. This had a dual-pronged effect on SVB’s balance sheet. First, higher interest rates slowed the growth prospects for many of its customers’ businesses, which led to these companies withdrawing some of this cash to pay for continuing operations. Second, there became an opportunity cost for holding cash in a checking account, paying close to 0% interest. People started withdrawing cash to buy things like Treasury Bills. These withdrawals left SVB in an unenviable position of selling some of their bond holdings that were at a loss, which raised some red flags, and caused account holders to try to withdraw their money at once. Just like that, a 40-year-old institution was forced to close up shop.
The banking system is built on trust, and things can get messy once that trust erodes. The government has taken steps to alleviate concerns about other similar banks, but nobody truly knows how this will play out, which can be unsettling. However, this is nothing like 2008 which saw our largest financial institutions with truckloads of bad loans on their books from making questionable lending decisions. This is not the first time something like this has happened, and it won’t be the last.
David Rath, CMT, CFA, is the Chief Investment Officer at Continuum Wealth Advisors in Saratoga Springs. Continuum Wealth Advisors, LLC is a Registered Investment Advisor registered through the Securities and Exchange Commission. For more information, visit contwealth.com.
