Too Local to Fail?

Rate Hikes & Intended Consequences

On Friday, the second largest bank failure in US history (the collapse of Silicon Valley Bank) jolted global markets, economists, and investors alike. Then, on Sunday, the third largest bank failure in US history, Signature Bank, followed suit. The panic caused by SVB's sudden collapse had triggered a similar run on Signature, whose primary customer base is law firms and real estate firms in the New York area, but was also extremely friendly to cryptocurrencies (hello, Silvergate). By Monday morning, President Joe Biden, Treasury Secretary Janet Yellen, and even foreign officials in the UK and EU, raced to assure markets and the general public that the banking system was solid. Fears of mass contagion were unwarranted.

"The American banking system is really safe and well-capitalized. It's resilient," Yellen told CBS's Face The Nation. "In the aftermath of the 2008 financial crisis, new controls were put in place, better capital and liquidity supervision, and it was tested during the early days of the pandemic and proved its resilience. So Americans can have confidence in the safety and soundness of our banking system."

Everything Is Different Now

So, what exactly happened?

It could take years to fully understand the minutiae of what happened and answer that question. But it appears that 3 major factors collided with perfect (imperfect?) timing.

First: Deregulation.

As the New York Times details, Barney Frank, former Congressman and namesake of the 2010 Dodd-Frank banking reform act, began lobbying in 2013 to reform his own landmark legislation. He wanted to "tweak" the regulations stating "that any bank with more than $50 billion in assets should face especially intensive federal supervision," and increase that threshold to $250 billion—which would then exclude all but the largest US banks. Silicon Valley Bank would be a beneficiary of this new deregulation, as would Signature Bank, for whom Frank sat on the board of directors. In 2018, with Donald Trump in the presidency and Republicans controlling both houses of Congress, and citing the belief that midsized/regional banks were not key to the financial system, this deregulation went into effect and negated certain capital requirements, stress tests, and living wills for these institutions.

Second, Rate Increases.

Without strict regulations on what regional banks could do with deposits and how leveraged they could be, Silicon Valley Bank began placing nearly all of its deposits into long-term treasury bonds. The tech industry’s boom times of 2020 and 2021 meant the bank's vaults were nearly doubling with deposits and management wanted to turn that into profits. Of course, the boom times went bust in 2022, and downsizing start-ups began withdrawing money from their accounts. To cover this, SVB was forced to sell bonds it had bought in the previous year. The problem was that rates had increased dramatically since 2021, so selling these low-yield bonds were less attractive and thus worth less. In turn, SVB was losing money in these sales just to cover deposits. And word began to spread.

Third, Speed.

Late on Wednesday last week, SVB revealed that it had lost $2bn from selling its entire $21bn treasuries portfolio over a single day. This news worried VCs and others around Silicon Valley. Some large VCs, including Peter Thiel, started telling the start-ups they invested in to pull all their money out of their SVB accounts. This quickly accelerated throughout the day on Thursday causing a bank run that collapsed SVB not 48 hours after fault lines began to appear. It was so fast, in fact, that House Financial Services Chair Patrick McHenry described it as "the first Twitter-fueled bank run" in history. Not only does Twitter and group chats spread information far and wide instantly (where, in the past, news of a teetering bank would take time to disseminate), but the adoption of mobile banking means that depositors no longer need to stand in line at a physical branch location to pull their money out, but can move millions of dollars instantly on their phones. What a world!

So, now what?

Silicon Valley and Signature banks were both FDIC insured institutions, meaning that deposits were insured by the federal government up to $250,000. However, as Time magazine notes, over 85% of SVB's deposits were non-insured. "Many Silicon Valley startups had millions, or even hundreds of millions of dollars deposited at the bank—money they used to run their companies and pay employees," Time continues.

OK. But after the FDIC took over SVB on Friday and froze withdrawals, some $175 billion in deposits were in limbo. What would be returned? What would be lost? How many companies would fail as a result of not being able to pay their bills? Or, at the very least, how many employees across Silicon Valley would not get paid because start-ups who banked as SVB couldn't make payroll by that Monday?

These questions raised fear among depositors at Signature Bank and various regional banks. With the swift collapse of SVB and the cratering of stock prices for First Republic and others, people and companies wanted their cash out and safe. In other words, even the appearance of instability was causing very real instability. So, in an unprecedented move, the FDIC decided to guarantee all deposits at SVB and Signature—even those above $250,000. Just don't call it a bailout.

“This is an important point: No losses will be borne by the taxpayers,” President Biden told the American public in a press conference Monday morning, reports the New York Times. “Let me repeat that: No losses will be borne by the taxpayers.”

Then what is it? "Mr. Biden noted that the cost [of the insurance] will be financed by fees paid by other banks into the Federal Deposit Insurance Corporation, or F.D.I.C.," the Times continued. "What he did not mention was that a separate loan program that the Federal Reserve has opened to help keep money flowing through the banking system will be backed by taxpayer money."

The failed banks themselves were not bailed, but the depositors were. Even if those depositors are (or are backed by) billionaire VCs. The move then raises the question of moral hazard, and what sort of precedent has just been set: the worry, as Mohamed El Erian told Fox Business News, is that the genie may never be able to be put back into the bottle. "Politically, it's going to be impossible not to extend this same full, unlimited deposit guarantee to all banks. "Once you do it for one bank, it's hard not to do it for another. Are you going to say that this bank was special because of Tech? That has all sorts of political issues with it."

By Tuesday, the stock market had stabilized, and money was flowing again for start-ups in Silicon Valley to pay their bills. But now what? Did 2008 prove that major banks are too big to fail, and this weekend teach us that regional banks are….too small to fail? Have we basically proven that banks have no risk of failure, only of success? And how many other banks are teetering on the edge of collapse?

As for Signature Bank and Silvergate Capital, "these were the two most bitcoin-friendly banks, supporting the lion’s share of fiat settlement for bitcoin trades between trading counterparties in the U.S.," Mike Brock, CEO of TBD at Block, told CNBC. Liquidity in the crypto world is basically dried up, raising concern that large investment funds or other banks with exposure to the sector will collapse in time. If and how the government will step in remains unclear.

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