A deep dive into the events that led to the second-largest bank failure in US history and an analysis of the parties responsible for its downfall.

March 10^th 2023, a regular Friday started as a positive day in the world of finance and economics. A surprisingly positive job report showed the addition of 311,000 jobs in the US, had markets somewhat optimistic about the feasibility of a “soft landing” and saw the Dow Jones (DJI) up 0.50% by 11:30 and the FTSE 100 (^FTSE) holding steady. Within 72 hours the second and third largest bank failures in US history transpired and by Monday morning the Fed and the Bank of England had followed through on plans to bail out depositors. How did we get here? 

What is Silicon Valley Bank?

Silicon Valley Bank (SVB) was launched in the spring of 1983. The product of two former managers of the Bank of America, SVB specialized in the technology and life sciences sector. By 2015, SVB claimed to serve 65% of all US startups. By focusing on startups primarily fueled by venture capital, SVB steadily climbed to become the 16^th largest bank in the US and the go-to destination for startup founders, venture capitalists, and private equity firms. In 2010 SVB had begun banking in the UK catering to the British tech industry in a very similar way. By the time SVB and SVB UK collapsed they were controlling $209 billion and £6.7 billion respectively.  

On the surface, SVB ran just as any other leading financial institution. Depositors’ funds were used to fund billions in loans and to purchase billions in fixed-income securities and government bonds, while only a proportion of funds were kept as cash. This fractional reserve banking system was a standard practice followed by almost every bank in developed nations. The investment of bank funds in bonds and securities has always been considered safe and effective as these investments are not highly volatile and generally very liquid, meaning easy to convert back into cash. 

How did SVB crash?

Generally, bond prices are inversely related to bond yields, meaning amid rising inflation the prices of bonds purchased before the rise decrease. What this meant for SVB was that the bonds they had purchased with customer deposits were now worth over $17 billion less than what they purchased them for. If SVB had picked its time to sell these bonds, then it is likely they could have avoided most or all the losses as inflation rates decreased, and the market returned to “normal”. However, this wasn’t a possibility for SVB. Coinciding with the drop in bond prices, a decrease in funds spent on venture capital and private equity meant that SVB’s main customers (tech startups) were struggling to find capital to do essential business functions, like pay rent and payroll. This caused a massive increase in requests to withdraw funds. Recognizing a looming liquidity issue, SVB attempted to sell off $21 billion in securities at a loss of $1.8 billion to meet the demand for withdrawals. To fund the same, they attempted to sell more shares of their stock. In a perfect world, this would’ve worked, but clearly our world is far from perfect. Investors lashed out at this plan; tanking SVB’s stock by 60%. This further decreased depositor confidence starting a run on the bank. On Thursday the 9^th March 2023, over $40 billion was requested to be withdrawn. This turned a liquidity issue into a fatal liquidity crisis for SVB. To put it simply: they ran out of money. 

SVB did take some steps to avoid total bank failure. They reached out to the FDIC (US) and FCSC (UK) which insure a portion of depositors’ funds, $250,000 in the US and £85,000 in the UK. However, over 90% of deposits were uninsured as they surpassed these thresholds. They also attempted a flash sale of SVB which failed in the US but the UK branch was purchased by HSBC for £1. The solution ended up with the US government stepping in and taking control of SVB. The Fed and US Treasury then formulated a plan to provide access to all funds at SVB to depositors (and also to Signature Bank which was the 3^rd largest bank failure in US history that occurred on Sunday the 12^th) funded by an auction of SVB assets and payments by banks to FDIC, this meant that no taxpayer money would be used. While some have called this a bailout, this has key differences from 2008-style bailouts as losses will be realized by bank shareholders and executives. 

Let’s Play the Blame Game 

The question of ‘Who to blame?’ is tricky in this case. So, let’s break it down into the three main suspects: SVB itself, the US Government, and the depositors and their backers. 

SVB must bear at least a portion of the blame. Clearly, they did not manage risk well enough, particularly real interest rate risk and concentration risk (the majority of their deposits coming from one industry), and failed to act quickly enough to stop the liquidity issue before it became a crisis. Investigations will surely unearth some pressing issues that were ignored and unveil possible insider trading. SVB CEO Greg Becker sold off more than $3.6 million in SVB shares just days before the bank failed and it has been alleged that SVB employees received bonuses on Friday as the bank was collapsing before their eyes. While technically SVB was not acting out of the laws or norms for financial institutions, there was clearly more at play here.

The US Government may also be somewhat responsible here. Over the past year the Fed and BOE have dramatically raised interest rates with the aim of curbing inflation. This created a capital crunch that caused banks across the world to see losses on security investments. It seems the central banks may have miscalculated the possibility of liquidity crises while increasing rates. Additionally, the US Government moved to reduce regulation of the banking industry in recent years. Keith Fitz-Gerald principal of the Fitz-Gerald Group called federal and state banking regulators “complicit” and “having a hand in designing this mess” when speaking to CNBC. 

Perhaps it’s the tech industry, venture capitalists, and private equity investors who should take most of the blame. The system created in Silicon Valley rewarded VCs for doing the most deals possible regardless of the success of the companies they backed. VCs were willing to have 50 losers for the chance at a single “unicorn” company that reaches $1 billion in valuation. Legendary investor Michael Burry derided this system in a tweet blaming “people full of hubris and greed taking stupid risks and failing”. When the economic tide started to shift VCs and bad startups realized their mistakes and all attempted to save as much capital as possible rather than letting bad companies fail. Spencer Greene, a partner at TSVC argued that there “was no liquidity issue until a couple of VCs called it” creating a “self-fulfilling prophecy”. Ryan Falvey an investor at Restive Ventures shared a very similar view; “This was a hysteria-induced bank run caused by VCs, this is going down as one of the ultimate cases of an industry cutting its nose off to spite its face.” VCs were far too loose and fast with money and ultimately willingly or not manufactured a bank run of 1929 proportion that leaves the rest of the world to clean it up.  

Mark Naslund

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