Rising interest rates claimed their first big victim last week. The stunning collapse of Silicon Valley Bank (SVB), which was the 16th largest bank in the United States, as recently as last Wednesday took two days of relentless outflows before the Federal Deposit Insurance Corporation (FDIC) stepped in to shut them down. The lender, known for backing hundreds of venture capital firms, startups, and wineries, might now lead to their downfall. The easy money policies of the COVID era and their unintended consequences now come into focus, and we can see far-reaching effects.
Pundits will spend their airtime this week decrying the excessive risks SVB took; the recent stock sales from prominent executives will not help the optics of this failure. That being said, their mortal sin was trusting an interest rate regime that remained little changed for 15 years outside of a brief period from 2016 to 2020 before COVID hit. Recent interest rates sit at heights not seen since 2007, before the last banking crisis. The problem SVB experienced is simple. Deposits grew faster than their ability to lend them, going from $60 billion to almost $200 billion from 2020 to 2022. Searching for yield, they lent excess cash to the US government through “super safe” Treasurys and 30-year mortgages. Inflation and a surprisingly hawkish Fed pushed rates up quickly in 2022, causing paper losses to this bond portfolio. Normally, these investments would be held to maturity, protecting them from realizing these losses. But, with rates creeping up and the technology sector struggling, customers started to pull cash in the form of deposits and lines of credit. An attempt to raise capital spooked investors leading to a 60% one-day drop and a run on deposits. This forced the selling of their portfolio at a loss, and after an even bigger stock hit the following day, the FDIC shut them down.
As we speak, a late Sunday auction and emergency measures by the FDIC to stem the panic might help. Thousands of developing companies need their deposits to pay their employees this week. FDIC insurance will cover the first $250k of deposits. The streaming platform Roku kept $487 million of its $1.9 billion cash at SVB. Until yesterday, they did not know if they could recover any of it. So naturally, the government is looking to help.
Parallels to another banking crisis begin to form in my mind as I watch this unfold. In 2008, the Federal Reserve decided to save Bear Stearns by negotiating a sale to JP Morgan Chase for $2 a share after a bank run sparked a liquidity crisis. Sound familiar? When they then failed to do the same to protect Lehman Brothers, confidence fell in the whole system. The stability of the financial services industry was already in trouble. In the years leading up to 2008, one of our traders consulted Fannie Mae to help them design hedges against losses if higher mortgage rates affected borrowers’ ability to repay their loans. Remember that variable-rate mortgage loans were quite popular at the time, so even a small rate change could impact many customers. In typical government fashion, they did not implement any of the suggestions he made in time. I asked him when they knew the house of cards would collapse. He replied that he and the executives all knew by the Spring of 2008 that they were past the point of no return. The American public found out six months later.
How many variable-rate loans exist now? How many banks hold massive losses in their bond portfolios on the money they lent to the government? Perhaps, they might be less willing to lend it going forward. This would compound issues related to the government debt cycle discussed in this article.
Asset bubbles arise unpredictably, but recently government policy seems to be a common contributor. Four trillion dollars printed during COVID had to go somewhere. The unintended consequences of that action might just be starting.