Americans were unexpectedly thrown into the world of banking and finance when Silicon Valley Bank (SVB) had to shut its doors in early march. The fear and uncertainty of what would happen to deposits rolled across the country leaving no house without questions of some kind. Our own home was even at risk as my wife's employer used SVB. How did this happen? WHat is the FDIC? Investments, getting paid, individual accounts, business accounts, loans, the list went on and on. Ultimately the Federal Government, the Treasury of the United States, and the Federal Depositors Insurance Corporation (FDIC) passed emergency policy to ensure that the estimated $175 billion in deposits with SVB would not be lost.
The 3 Federal entities previously mentioned believed that essentially the closure of the bank was not fair to depositors. There's no way they could've seen this coming. The FDIC already insures bank deposits up to $250,000. For SVB, there were many accounts that had balances greater than this. SVB in particular specialized in banking for start up companies. They had been operating successfully for nearly 40 years and were vital in supporting much of the technological explosion that has come since the internet became mainstream. Because of SVBs targeted clientele, there were risks they took on many traditional banks did not. Start ups are considered a risky and volatile investment. Usually start ups are operating in new, unexplored sectors. Just for example, 5 years ago if you went to your traditional bank down the road and asked for a loan to start a VR company, they would have laughed at you. Even with the best business plan; determining the total market size, what share of that you expect to capture, average VR business life expectancy, revenue generation, and competition are only a few of the risks difficult to quantify for the sector. But SVB filled this niche.
An important aspect of the “how” behind what happened to SVB, which it's almost impossible to believe they didn't know, is the volatility of start ups. A big risk that is inherent to baking with start ups is the speed in which a business can flip. A startup can run revenues to the moon one year, and be asking for change on the corner the next. They can have month after month of breaking even or operating in the red followed by one month of generating enough profit to cover the difficulties they've had up to that point. As technology advances, certain apps and trends gain and lose popularity, the time of the year changes, even what some west coast celebrity just posted on their social, the performance of any given start up can fluctuate very quickly. Where SVB comes into this conversation is this means a start up making a killing and generating great revenues can be buried in less than a quarter and looking to withdraw massive amounts of “their cash”. (cash in the sense of modern banking means they are pulling funds from their account, it does not necessarily mean they are withdrawing cash)
How banks generally operate is they take in deposits and loan those deposits out. This is in the form of mortgages, car loans, personal loans, etc. They do this under the assumption that everyone is not going to come try and take all their money out at once. They entice depositors to keep their money in, especially for longer terms, by offering greater saving account interest rates, CDs, dividends, and more. Simply put, if the market has determined that a mortgage for a secure and healthy borrower should be at about 7%, the banks will use the tools mentioned to provide you with, just say 4% interest, to entice you to keep your money in the bank. They get to keep that difference of 3% as revenue generation and hopefully some profit. A bank that operates in a high risk environment may charge interest rates upwards of 10%, 12%, or even more depending on the risk evaluation. But, we do not operate in “normal conditions”. Normal conditions being quoted because we've been operating for so long in un normal conditions, they almost could be considered normal.
SVB operated in the same manner, but their primary clientele were, as stated, “high risk” upstarts. High risk, being emphasized because its not exactly the same kind of high risk as like a mortgage. Mortgages are relatively simple as you can look at the borrower's savings, down payment, income, ect. High risk in the world of startups are different because usually they have little to no revenue data. It is also not uncommon for new companies to operate at a loss for the first fewyears. Until a business can show stable revenues that generate profits for upwards of a decade, they can be considered high risk to banks just because of their age. As stated, this was the clientele that SVB catered to, it was their target audience.
SVB took the deposits and invested them in, for simplicity, US bonds and other safe securities. US bonds are how the government raises money. They provide very low rates of return because they are considered extremely safe, effectively no risk. SVB had been throwing depositors money into securities like this because for the last decade we have been going through a pretty strong technical boom. There has been an absolute flood of technical companies and fully remote companies that have been relying on SVB. You pretty much name it, there was a technical, officeless business started in the industry. Insurance, gaming, cryptos, digital universe, the list goes on and on. With the explosion of our digital world, the vast majority of these companies were doing very well. Well enough that SVB had no issue covering the demand for new loans while having left over reserves sitting there. These reserves are what they were dumping into low yielding, time dependent securities.
Where SVB failed was their capability to accurately analyze the economy and true political foresight. The United States has been operating in a credit bubble for some time now. Credit levels across the board are near or at record levels. Personal credit card debt, corporate debt, car debt, mortgages, home equity loans, student debt, and more. At the national level, a country can only operate like this for so long before you just simply can't continue to borrow anymore. Simultaneously, federal policy has been blowing the national debt, therefore inflation, non stop since the 2008 housing crisis. That's being conservative about it. Pile COVID inflationary policy on top of that and now we are where we are today with double digit real inflation rates. SVB obviously didn't see this coming or recognize it while it was happening. That is how they ended getting themselves shut down.
When they had all of their “safe”, time-dependent securities they were only getting maybe 3,4,5% returns on them at best. When inflation pushed up past that point, their investments were losing them money at maturation. This isn't necessarily too uncommon. To hold a 5% security in a 7% inflationary environment obviously is not preferred, but it's still better than holding cash deposits that are getting 0% interest in a 7% inflationary environment. Then, businesses started needing their money back. There's a lot of reasons businesses need cash in a downward trending economy, or a high inflationary economy. This was the combo hit. Loans, bills, payroll, maybe even stock buy backs (unlikely but still possible), just normal business operations when revenue no longer covers costs are just some of the reasons startups may need their cash. When you are a start up, the probability that you will need cash for all of those is even greater. To step back for a minute, these businesses were not necessarily unhealthy themselves, they just needed their cash for a variety of reasons. Unfortunately for SVB, there was a lot of them in a very short time span.
When SVB started seeing the waves of heavy withdraw requests come in, they found out relatively quickly that they needed the cash, and they needed it fast. They dug through their books and looked to their investment holdings to sell them off so they can give depositors their cash. The realization comes, their investments are no longer worth face value. For simplicity, let's say that they had $100 of deposits that they turned into a 1 year US bond that matured at 4%. After 1 year, they can turn the bond in and get their $104. In our inflationary environment, they would need at least $107 to maintain the buying power they had the year before. So they're all truly in the red. What makes it worse is when you have to sell that bond on the open market. No one will just willingly buy it for the maturation value, they're not going to give you $104 for $104 in 6 months from now. So you have to sell it at a discount. But everyone now knows the economic and inflationary situation we are in. So they really want it cheap, they want a discount for the known circumstances plus additional for the potential inflation that we will be facing when the bond comes to maturity. Suddenly now, the bond; purchased for $100, maturing for $104, but still not maintaining the buying power as when it was purchased, would maybe sell for $90. Extrapolate that over $175 billion of deposits.
SVB investments were not pulling in enough of a return to cover the deposits they held. Now steps in the FDIC. The FDIC stepped in and took over the bank to analyze the who, what, when, and how of the SVB’s incapability to provide depositors with their money. Because of the nature of SVB, almost all of the deposits were outside of what the FDIC guarantees, $250,000 per account. It is estimated by many analysts and outlets that at minimum 97% of deposits were not covered by the FDIC’s policy. So the FDIC did what every government entity does. They played the “no one could have ever seen this coming, we need to bail these depositors out” card.
At face value, it can be somewhat understood why someone would jump right onto this argument. Its not the depositors fault that any one bank would maybe be incapable of accurately analyzing and predicting the current and future state of the economy. At the same time it is the fact that we have the FDIC as to why depostors never look into what the bank does with their deposits. NO ONE DOES. Everyone just knows if the bank fails, the government will step in and save them. That moral hazard allows banks to do whatever they want with deposits. While the banks don't want to fail, they know it as well. So they can play the risk margins to try and pull in the returns they want without looking too risky. The government incentivizes banks to operate at a higher level of risk than the market indicates they should with the promise that they will be backed up if something happens. Now, everyone is not a finance major so, while I personally believe there should be no FDIC, I certainly understand how someone could make an argument for it. The real issue is what the treasury and FDIC did in response.
The treasury and the FDIC worked to pass emergency policy allowing complete coverage of all deposits at SVB. This is the real problem. For the every day person, deposits would be covered under the $250k insurance. Many businesses had much more than that, millions more. But businesses are not people. Businesses need finance majors, they need to understand corporate banking, they should be paying very close attention to who they bank with and what that bank is doing. I believe that many businesses just relied on the fact the SVB had been in business for 40+ years and didn't really have any true concern about what happened with their deposits. So I say yes, they should've know and the deposits shouldn't have been covered. Furthermore, it's not like 100% of their money was gone. They would have been able to get some portion of it back. Whether that be $.70 on the dollar or whatever, they would have received some of it back after the liquidation of the bank. The healthy businesses would have been able to go to a different bank to acquire small loans to cover the rest if they truly were a healthy business and could show that.
The FDIC and the treasury have absolutely undermined the banking system, the financial system, and the American people by covering all these deposits. The moral hazard they have opened the door to in the world of banking is unlimited now. Banks now know the $250k insurance per account is a lie. They can do whatever they want and their deposits will be covered. Where is all this money going to come from? If you take a look at the government's balance sheet, it's clear, they printed it. The government is socializing every aspect of society through the worst possible way, printing money to try and solve problems with the lie that we will pay it back in the future. Listening to Peter Schiff's podcast yesterday he was discussing how it is estimated that all taxes across the board; income, sales, property, etc. would need to be increased by 40% to generate enough revenue to stop running a deficit and need to print money. Some marginal tax rates in this country are already 45+%. They know they can't do that, so they destroy the value of the dollar in the name of taking care of us. They're not taking care of us US citizens, nor do they need to. The federal government checked all the boxes on this one. Overreach of federal powers - check, backdoor socialization of our systems at the federal level - check, greater incentivization for less personally responsible civilians - check.
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