What Just Happened in the US Banking System?

One week ago, Silicon Valley Bank (SVB) was one of the 20 largest banks in the United States of America. On Thursday, however, we witnessed a modern-day version of the bank runs from the Great Depression.

We are reminded of the Ernest Hemingway quote: "How did you go bankrupt?" "Slowly at first and then suddenly."

How did this happen so quickly? SVB was focused on banking for "start-ups" or newly formed companies in Silicon Valley and most of them operated in the technology space. These companies raised money to get their businesses started by selling stock to institutional investors known as "private equity" and many kept that cash in Silicon Valley Bank.

The problem is that the FDIC (Federal Deposit Insurance Corporation) only insures bank deposits up to $250,000 per individual and $500,000 for a husband and wife with a few other nuances I won’t get into here. Per an article by Richard Excell (1), only 2.7% of SVB clients were insured against bankruptcy by the FDIC. He adds that, as of 12/31/2022, SVB had $173 billion in deposits and $152 billion was uninsured. This $152 billion represented the holdings of 36,466 companies and individuals. Richard adds, (SVB) "...had a lot of customers who were not insured and therefore got very nervous, very quickly."

CNBC put it this way (2), "On Wednesday, Silicon Valley Bank was a well-capitalized institution seeking to raise some funds... The company’s downward spiral began late Wednesday when it surprised investors with news that it needed to raise $2.25 billion to shore up its balance sheet." The result of this news? A panic by institutions where, "Customers withdrew a staggering $42 billion of deposits by the end of business on Thursday, according to a California regulatory filing."

When people and companies have money deposited in a bank, it doesn't stay in the bank’s vault. They loan it out to others and/or buy other securities like US government bonds. It seems that SVB invested in long-term treasury bonds and, with the Fed raising interest rates, those bonds have lost money and have become difficult to sell. So, when the bank run started, SVB could not meet all the withdrawal requests as they were unable to raise cash quickly enough to pay out to customers. When that happens, the FDIC steps in and shuts you down as you have become insolvent.

Approximately 18 months ago, SVB stock was trading for around $760 per share. Last Monday, it was roughly $320 per share. On Friday, the FDIC stepped in and put the bank into receivership and, on Monday morning at around 3:00 am, HSBC acquired SVB's UK operations for $1.21 per share. It seems the Fed is trying to find a buyer for the US-based operations.

Signature Bank of New York

One phrase that comes to mind is that “There is never only one cockroach in the kitchen” and it’s the same with banking issues. Not many on Wall Street were surprised when, on Sunday, banking regulators also closed Signature Bank of New York for similar reasons as SVB. This was followed by a joint statement from the Federal Reserve, Treasury Department, and FDIC saying they are backstopping the US banking system to stem any banking crisis. (4)

It seems wise to remain skeptical of those who are saying, “This is handled. We can go back to business as usual.”

What Does All of This Mean?

That's a good question. The good news is that the FDIC, Treasury Department, and Federal Reserve acted quickly and decisively with both Silicon Valley Bank and Signature Bank. Many were comparing the bank failures to the start of the 2008 financial crisis. Zerohedge (5) put it this way, "After 2 days of frantically trying to raise capital to meet withdrawals, on Friday, the FDIC took over operations of the bank in what one can legitimately compare to the Lehman Brothers collapse which many regards as the beginning of the Great Financial Crisis in 2008".

The possible bad news: the Fed has been aggressively raising interest rates to slow the economy and combat inflation. As noted above, banks often invest in treasury bonds with excess cash from depositors. Many of those bonds have lost money due to interest rate hikes. On Sunday, per CNBC (6), “Goldman Sachs no longer expects the Fed to hike rates in March, cites stress on banking system”.

If this is the case, then it seems the Fed may be stuck between a rock and a hard place. On the one hand, inflation seems to be slowing but not nearly enough where it can be considered "under control". On the other hand, the rate increases are taking a toll on the banking system, which needs to be kept healthy.

Controlling inflation is important because, if left unchecked, is one of the biggest enemies to savers, investors, and consumers. The damage it imposes over the long term is intense and difficult for all American citizens to address.

For our clients, we want to remind you that we have been playing defense for most of the last two years. We are still partially invested but also have higher than normal balances in short-term bonds and cash. We are waiting for what we feel is a better environment to become more aggressive.

We are here to help. If you have any questions or concerns, give our office a call. We would love to hear from you.