by Brandon Reiter
On Sunday, The Federal Deposit Insurance Corporation (FDIC) took control of Silicon Valley Bank (SVB), following bank’s historic collapse on Friday. This marks the 2nd largest bank collapse in U.S. history. Not long after, Signature Bank collapsed as well, making it the 3rd largest in U.S. history.
How did SVB Collapse?
SVB became one of the largest tech lenders in the nation, an industry that saw a massive boom since 2020, but has since regressed. Many venture capitalist firms and tech companies had been putting in massive amounts of deposits over the last few years. Just like any other business banks try to make money, and they do this by taking (some) of the money deposited with them, and generating a higher yield through lending and other investments.
In order to generate profit, SVB invested a large portion of their capital into bonds. Bonds are debt-securities, and are typically considered less risky compared to equity securities. Bond investors receive interest payments until the bond matures, when the principal of the bond is paid back. Typically, the interest payments are tied to the current interest rates.
Just like publicly traded stocks, bonds can be bought and sold on the open market. Therefore, when interest rates rise, the market price of bonds declines. Think about it… if I have a bond that pays a 4% interest rate, and someone can easily go and get a new bond at the current higher rate of, let’s say 6%, the market value of my bond will go down because it does not pay as much as the higher rate bonds available on the market.
In order to combat rising inflation, the Fed has been continuously raising interest rates, which lowered the value of the bonds SVB was invested in. Seeing the value of their investments plummet, SVB began to sell them at a huge loss in order to improve its liquidity and shore up its balance sheet, but instead it scared some of its larger investors and depositors, leading to a huge demand of withdrawals that the bank could not afford to pay back.
What Is The Government Doing?
The Biden Administration told the public that SVB depositors will receive all of their funds.
But how?
They are using FDIC funds, which is essentially an insurance program that banks pay in to cover accounts up to $250,000. Additional funds are being made available under the new Bank Term Funding Program (BFTB) which offers very low interest, short-term loans to banks. This allows the government to ensure depositors receive their money until the Fed can sell off SVB’s assets.
Is This a Bailout?
No. SVB is done. Out of business. All of their management has been fired. Investors in the bank’s stock or SOL as it is now worthless. According to the plan laid out by the Biden administration, they are not using taxpayer money to keep the bank in business, but instead keep public faith in the US banking system, and to ensure the deposit holders, and most importantly those small businesses who need their money to make payroll are made whole.
Why Didn’t Regulators Prevent This?
After the 2008 Financial Crisis, The Obama administration passed the Dodd-Frank act which enacted strict regulation in the banking industry. However, in 2018, the Trump Administration eased some of those regulations, most importantly the barometer of which banks would fall under this tight regulation. Under Dodd-Frank banks with assets under management of $50 billion or more were considered systematically important, but that was raised to $250 Billion in 2018. SVB had roughly $200 Billion in AUM, making it the country’s 16th largest bank.
Would the tighter regulation have prevented this? It’s hard to say for certain right now, before all the dust has settled, but one aspect of the act’s regulation was a stress test for banks in scenario’s where interest rates raise dramatically.
What Happens Now?
Hopefully, the actions taken by the government will ease concerns and prevent a ripple effect of depositors across the country withdrawing all of their funds from regional banks, which would be very very bad. But as for now, will have to wait and see. Biden has already asked congress to act quickly and pass a bill to enforce tighter regulation going forward.
