Who killed Silicon Valley Bank?
If I asked you to look after £75bn, where would you put it? Assuming you managed to resist blowing the lot on a lifestyle of spectacular hedonism (nobody’s perfect), you’d probably walk into a bank and ask for £75bn’s worth of the safest investment in the world.
This was the fatal assumption that led Silicon Valley Bank (SVB) to become the second-largest bank failure in history. SVB was the 16th-largest bank in the US, and primarily served the tech industry. When a promising startup company received funding from venture capitalists, they would often deposit the money with SVB. During 2021 the amount invested by venture capitalists more than doubled on the previous year, to $612bn worldwide. Deposits flooded into SVB, and the bank – faced with the apparently enviable problem of having more money coming in than it could ever lend out – invested $91bn (£75bn) in “long-dated securities” such as ten-year Treasury bonds.
A Treasury bond is a loan to the US government, which pays a “coupon” (interest payment) each year until it repays the money. The US is the world’s largest economy and has never defaulted on its debt, so $91bn in “held to maturity” investments represented, to someone at SBV, ten years of guaranteed income from the safest investments in the world.
But because these securities were bought in 2021, when interest rates were extremely low (the US’s main interest rate remained at 0.25 per cent for the whole year), they also represented a $91bn bet that financial conditions wouldn’t really change. SBV should have been reading the New Statesman, in which the Bank of England’s former chief economist warned in June 2021 that assets across financial markets had been “priced for a prolonged period of inflationary somnolence” – and that central bankers would be advised to raise interest rates sooner rather than later to counter rising inflation.
When rates did eventually rise, SVB found it had $91bn in assets that were worth less, because they paid very little interest. These “unrealised losses” – money the bank would lose if it had to sell those assets – grew as rates rose. At the same time, SVB’s depositors began withdrawing their money, either because they needed to spend it as the easy money from low rates dried up, or because they could get better returns elsewhere.
Squeezed between shrinking deposits and poorly performing assets, SVB decided to realise some losses by selling some of those assets, fix its balance sheet, and pay for this painful but necessary operation by selling some stock. But the announcement that it planned to do so amounted to an admission that something was deeply wrong, and depositors took flight, withdrawing $42bn in a day. Even a serious bank with over $200bn in assets cannot withstand such a run; SVB’s share price collapsed and on Friday 10 March the US Federal Deposit Insurance Corporation (FDIC) took the bank into receivership. Its UK subsidiary, Silicon Valley Bank UK, was bought this morning by HSBC for £1.
At this point, investors became a lot more interested in remarks that the chairman of the FDIC, Martin Gruenberg, had made in a speech last Monday (6 March), in which he estimated the total unrealised losses of US banks from holding long-term securities bought at lower interest rates at $620bn. Bank stocks fell around the world.
To answer our headline, then, it would seem the person to blame is the person at SVB who decided to bet an eleven-figure sum on interest rates not rising when inflation was already beginning to appear. But as investors’ confidence in SVB fell, the run on the bank was precipitated and accelerated by the speed at which rumours and opinions are now able to spread. Ironically, the (social) network effects that made Silicon Valley rich were the undoing of Silicon Valley Bank. When those central to the networks – prominent venture capitalists – began advising their portfolio companies to leave SVB, what might have been a survivable balance-sheet problem became a fatal liquidity crisis.
The collapse of SVB is also a symptom of something bigger and potentially still more serious, in the long term. Central banks have spent 14 years hosing money into the financial system through quantitative easing, which involves buying up, among other things, tens of trillions of dollars’ worth of government bonds. In doing so they have created a situation in which nobody knows exactly what price to put on the most fundamental assets in the market. “The supposedly safest assets turned out to be more risky than anybody ever built into a model,” the economist and former pensions minister, Ros Altmann, says.
A Treasury bond is a loan to the US government, which pays a “coupon” (interest payment) each year until it repays the money. The US is the world’s largest economy and has never defaulted on its debt, so $91bn in “held to maturity” investments represented, to someone at SBV, ten years of guaranteed income from the safest investments in the world.
But because these securities were bought in 2021, when interest rates were extremely low (the US’s main interest rate remained at 0.25 per cent for the whole year), they also represented a $91bn bet that financial conditions wouldn’t really change. SBV should have been reading the New Statesman, in which the Bank of England’s former chief economist warned in June 2021 that assets across financial markets had been “priced for a prolonged period of inflationary somnolence” – and that central bankers would be advised to raise interest rates sooner rather than later to counter rising inflation.
When rates did eventually rise, SVB found it had $91bn in assets that were worth less, because they paid very little interest. These “unrealised losses” – money the bank would lose if it had to sell those assets – grew as rates rose. At the same time, SVB’s depositors began withdrawing their money, either because they needed to spend it as the easy money from low rates dried up, or because they could get better returns elsewhere.
Squeezed between shrinking deposits and poorly performing assets, SVB decided to realise some losses by selling some of those assets, fix its balance sheet, and pay for this painful but necessary operation by selling some stock. But the announcement that it planned to do so amounted to an admission that something was deeply wrong, and depositors took flight, withdrawing $42bn in a day. Even a serious bank with over $200bn in assets cannot withstand such a run; SVB’s share price collapsed and on Friday 10 March the US Federal Deposit Insurance Corporation (FDIC) took the bank into receivership. Its UK subsidiary, Silicon Valley Bank UK, was bought this morning by HSBC for £1.
At this point, investors became a lot more interested in remarks that the chairman of the FDIC, Martin Gruenberg, had made in a speech last Monday (6 March), in which he estimated the total unrealised losses of US banks from holding long-term securities bought at lower interest rates at $620bn. Bank stocks fell around the world.
To answer our headline, then, it would seem the person to blame is the person at SVB who decided to bet an eleven-figure sum on interest rates not rising when inflation was already beginning to appear. But as investors’ confidence in SVB fell, the run on the bank was precipitated and accelerated by the speed at which rumours and opinions are now able to spread. Ironically, the (social) network effects that made Silicon Valley rich were the undoing of Silicon Valley Bank. When those central to the networks – prominent venture capitalists – began advising their portfolio companies to leave SVB, what might have been a survivable balance-sheet problem became a fatal liquidity crisis.
The collapse of SVB is also a symptom of something bigger and potentially still more serious, in the long term. Central banks have spent 14 years hosing money into the financial system through quantitative easing, which involves buying up, among other things, tens of trillions of dollars’ worth of government bonds. In doing so they have created a situation in which nobody knows exactly what price to put on the most fundamental assets in the market. “The supposedly safest assets turned out to be more risky than anybody ever built into a model,” the economist and former pensions minister, Ros Altmann, says.
by Will Dunn, New Statesman | Read more:
Image: David Paul Morris/Bloomberg via Getty Images
