Silicon Valley Bank collapse: bailout sends wrong message to other banks, investors, and regulators.
Yes, it’s a bailout—and yes, it’s unwise. The U.S. government will guarantee all customer funds in Silicon Valley Bank (SVB) after a series of bad decisions and a run on deposits led to the bank’s collapse. The decision creates bad incentives for financial institutions and their customers.
The Federal Deposit Insurance Corporation (FDIC) is supposed to guarantee money at insured banks up to $250,000 per depositor, per bank, in each account ownership category.* In this case, however, it will fully protect all depositors with no limit.
“Depositors will have access to all of their money starting Monday, March 13,” Treasury Secretary Janet Yellen, Federal Reserve Board Chair Jerome Powell, and FDIC Chair Martin Gruenberg said in a joint statement yesterday. The FDIC will also guarantee funds for customers at New York’s Signature Bank, which regulators closed on Sunday. “All depositors of this institution will be made whole,” announced Yellen, Powell, and Gruenberg.
The FDIC will sell off SVB assets to cover some costs but, beyond that, depositors will be paid with money from the Deposit Insurance Fund. This fund has been built up by fees collected from banks. Any losses to the fund “to support uninsured depositors will be recovered by a special assessment on banks,” write Yellen and company.
A lot of folks are insisting this isn’t a bailout and that it comes at no cost to taxpayers. For instance: The joint statement says, “No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.”
But this is misleading. For one thing, banks are themselves taxpayers. And in situations like this, the many institutions who act responsibly must bear the burden of bank fees in order to inoculate less responsible actors. Besides, these fees assessed on banks don’t exist in a vacuum that only burdens big businesses; banks pass on the costs of regulatory compliance to customers in a number of ways. So the idea that the government’s bailout funds come from some sort of magical pool of consequence-free money is silly.
“The public is always on the hook for any Fed program, no matter how much government insists costs won’t be borne by taxpayers,” commented former Rep. Justin Amash (L–Mich.) on Twitter, pointing out that “a bailout creates a moral hazard, even if it’s *just* a bailout of depositors at a bank; it doesn’t fix—but instead exacerbates—the systemic problem.”
Moral hazard is one of the major worries when it comes to bailouts like these. Both banks and consumers have less incentive to be cautious with their money if they can plausibly assume that the government will step in and save them from any mistakes. So, a bailout like this uses public money to compensate for risky or bad financial decisions and incentivizes more risky or bad decisions in the future.
It’s also likely to spur more rules and regulations that could further burden all banks and their customers. People are already calling for the Biden administration to tighten regulations on regional banks in response, laying blame on a supposed lack of government oversight rather than on SVB’s myriad bad judgement calls.
It appears this problem stems in part from the fact that SVB was flush with cash from a venture capital boom. “People kept flinging money at SVB’s customers, and they kept depositing it at SVB,” explains Matt Levine at Bloomberg Opinion. Typically, a bank flush with cash would loan out most of this money. “But [SVB’s] customers didn’t need loans, in part because equity investors kept giving them trucks full of cash and in part because young tech startups tend not to have the fixed assets or recurring cash flows that make for good corporate borrowers,” writes Levine.
So rather than make a lot of loans, SVB put a lot of its money into long-term, fixed-rate interest investments, such as Treasury bonds and 10-year mortgage-backed securities. (At the end of 2022, SVB reportedly had around $120 billion in investment securities and only around $74 billion of loans.) “This was mistake No. 1,” argues Andy Kessler at The Wall Street Journal. “SVB reached for yield, just as Bear Stearns and Lehman Brothers did in the 2000s. With few loans, these investments were the bank’s profit center.”
Then the feds raised interest rates and “SVB got caught with its pants down as interest rates went up,” as Kessler puts it:
Everyone, except SVB management it seems, knew interest rates were heading up. Federal Reserve Chairman Jerome Powell has been shouting this from the mountain tops. Yet SVB froze and kept business as usual, borrowing short-term from depositors and lending long-term, without any interest-rate hedging.
The bear market started in January 2022, 14 months ago. Surely it shouldn’t have taken more than a year for management at SVB to figure out that credit would tighten and the IPO market would dry up. Or that companies would need to spend money on salaries and cloud services. Nope, and that was mistake No. 2. SVB misread its customers’ cash needs. Risk management seemed to be an afterthought. The bank didn’t even have a chief risk officer for eight months last year. CEO Greg Becker sat on the risk committee.
Higher interest rates meant having to pay more interest on deposits. But SVB couldn’t compensate fully by getting paid more interest on loans, since it didn’t have enough loans. Meanwhile, higher interest rates also meant its long-duration, fixed-rate securities were losing value. So instead of profiting off higher interest rates overall, it was losing money.
Meanwhile, higher interest rates also meant that venture capital was drying up for a lot of SVB’s startup depositors. That meant less customers depositing new money and more customers withdrawing a lot of funds. And because a lot of SVB’s money was tied up in longer-term investments, it had to sell securities at a loss in order to pay back depositors, making its short-term financial situation even more precarious.
By January of this year, people were noticing SVB’s problems. In February, the tech and finance newsletter writer Byrne Hobart pointed out that “Silicon Valley Bank was, based on the market value of their assets, technically insolvent last quarter.” Accordingly, even more depositors started withdrawing more funds, further exacerbating its instability. This, of course, further frightened depositors, who yanked even more funds. “By the time the lender closed for business [last] Thursday, depositors had attempted to withdraw $42 billion,” The Wall Street Journal reported.
The situation came to a head on Friday, when SVB collapsed and the California Department of Financial Protection and Innovation took possession of it, appointing the FDIC as receiver.
In the end, “the culprit” in SVB’s collapse “wasn’t the kind of exotic derivatives and risk-taking that doomed banks in the 2008 financial crisis. Rather, it was a mismatch between deposits and assets—the building blocks of the vanilla business of commercial banking,” the Journal writers explain. “The episode has exposed a new set of vulnerabilities for the financial system. Bankers that grew up in the easy-money era following the 2008 crisis failed to ready themselves for rates to rise again. And when rates went up, they forgot the playbook.”
Still, SVB should stand as a lesson about making this same kind of mistake in the future. And perhaps as a lesson to depositors about putting too much into one financial institution, especially one trendy with startup businesses and overly focused on serving them.
Instead, it’s teaching that risk really doesn’t matter, because if things go sour the government will step in and bail you out.
Originally published by Reason Foundation. Republished with permission.
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