A recap post that will collect observations about the sudden collapse of Silicon Valley Bank
Silicon Valley Bank (SVB) Shutdown – a Recap
This is my log of insightful blog posts and articles that provide context and analysis on what happened. It’s my effort to make sense of both what happened and the implications for entrepreneurs. I will be updating it as events warrant at least through the end of April.
Oct-22-2021 (h/t Byrne Hobart) Patrick MacKenzie “Community Banking and Fintech” The financial system is a policy arm
- The U.S.’s financial system is best conceived of as a public/private partnership. Each financial institution is in constant competition with all others for customer relationships, deposits, loans, and ancillary product revenue. However, the government does put a thumb on the scale, particularly for politically powerful groups.
- Community banks are surprisingly powerful in the U.S., largely because they are very popular with their customers relative to Big Finance, they are indispensable for politically powerful local groups like landlords, real estate developers, and farmers through their commercial loan books, and they have earned an appealing narrative about financial access. It is difficult to overstate how dependent commercial real estate is on community banks in much of the country, and it is a symbiotic relationship; the investors who organize them are usually local business owners with heavy real estate interests.
- Branches are not cheap to create or operate, and the large banks concentrate them in densely populated areas with relatively wealthy customers and businesses nearby. Community banks are willing to take worse economics to have branches in places where the large banks don’t; this keeps those places tied to the national financial system.
- This is a policy aim of the government, both due to the economic impacts and because most residents being banked is core to orderly provision of benefits, taxation, and other government functions. A bank branch is a retail point-of-presence for the SSA getting funds to a pensioner, for the IRS collecting payroll taxes, and for the DEA interdicting fentanyl, staffed and funded by the private sector.
- SKMurphy Take: A good explanation for the reasons why the US Government does not want to allow for a massive consolidation that would wipe out 90% of the regional banks.
Mar-10-22: Yeva Nersisyan and L. Randall Wray, “No, the Fed cannot engineer a soft landing, but can wreak havoc trying“
- Many economists and pundits have been calling on the Federal Reserve to raise interest rates to fight inflation.
- Pundits suppose that the Fed can engineer a soft landing, i.e. lower inflation without hurting economic growth, by managing inflation expectations. A steady stream of small rate hikes spread over a year or two is supposed to signal to markets that the Fed is serious about fighting inflation. That lowers inflation expectations, so that workers reduce their wage demands and firms temper price increases.
- The Fed has never managed to guide the economy to a soft landing with rate hikes. Many point to Fed Chairman Paul Volcker’s interest rate hikes in the 1970s — to 20 percent and beyond (and above 15 percent for a couple of years), but conveniently leave out what followed. The economy crashed into a deep recession, and a series of financial crises (the thrift crisis of the early 1980s, the developing nation debt crisis later in the 1980s, and the big bank crisis at the end of the 1980s) can all be traced to Volcker’s experiment. Chairman Alan Greenspan’s tightening in the early 1990s brought on a recession followed by our first jobless recovery, and his tightening in 2004 helped to bring on the global financial crisis in 2008 and another, even longer, jobless recovery.
- The only realistic way in which monetary policy can affect inflation is by significantly slowing down the economy and raising unemployment to alleviate wage pressures. Small rate hikes do not reduce inflation. It takes large rate hikes that create financial crises, insolvency, and bankruptcies severe enough to crash the economy—followed by jobless recoveries.
Dec-19-2022 Seeking Alpha article by “Cash Flow Hunter” SVB Financial Blow-Up Risk If deposits bleed, the company could be forced to reduce its investment portfolio to fund those outflows. As of the end of Q3, the company had $27 billion of AFS (available for sale) securities and $65 billion of HTM (hold to maturity) securities. These securities are primarily (close to 80%) agency RMBS and CMBS mortgages. Given the bulk of this portfolio was acquired in a lower interest rate environment, there are unrealized losses, $17 billion in the HTM portfolio alone. While these losses are run through earnings, they are not run through regulatory capital unless they are realized. Fully recognizing this loss would essential wipe out the company’s tier 1 capital and force a capital raise. SIVB was one of if not the most aggressive banker to many start-up companies. That worked brilliantly in the VC funding boom but could cut the other way as the industry retrenches.
Jan-31 tweet stream by Tom Loverro (@tomloverro) PREDICTION: There’s a mass extinction event coming for early & mid-stage companies. Late ’23 & ’24 will make the ’08 financial crisis look quaint for startups. Below I explain when, why, and how it will start and offer *detailed advice to founders* on surviving the looming die-off.
SKMurphy Take: the leading edge of the set of risks identified by Loverro put pressure on SVB but the full effect is still to be felt in 2024-25.
Silicon Valley Bank goes boom at the tail end of every tech cycle, and I knew that, and I still somehow managed to not be on the short side of the current implosion. It’s off almost 50% today.
Paul Kedrosky Mar 9 tweet
The next day (Mar-10-2023) Silicon Valley Bank was taken over by Federal regulators. Time to pull out the diary entries for 2001 and 2008 and make a list of what else to expect over the next 6-12 months. Related Arrington’s 2007 lament of “once bitten twice shy” made him look prescient for 2008.
- Marc Rubinstein: The Demise of Silicon Valley Bank “We’ve never really had a bank run in the digital age.”
- Fortune: A Silicon Valley Bank short seller explains how he knew the bank was in trouble months ago profiles Dale Wettlaufer at Bleecker Street Capital who observed, “It’s insane. I’ve never seen anything like this, I’ve never seen a balance sheet crumble this quickly.” More Discussion on HN: https://news.ycombinator.com/item?id=35105418
- Mike at Non-GAAP Investing: “Held to Mortem Investing” Examining recent disclosures in the 2023 Preliminary Proxy, a governance-based argument could be made insiders were quite aware the situation was serious throughout 2022. In particular, the most interesting disclosure is the company didn’t have a Chief Risk Officer for much of 2022, and (from what I can gather) doesn’t explicitly communicate this to shareholders until the 2023 Preliminary Proxy is filed on March 8, 2023.This non-disclosure immediately makes me wonder what caused former Chief Risk Officer Laura Izurieta to leave the role and create such a glaring hole in risk oversight during such a critical time. (See also follow up Fri-Mar-17: “SVB: Available-FUD-Sale”)
- FDIC Creates a Deposit Insurance National Bank of Santa Clara to Protect Insured Depositors of Silicon Valley Bank, Santa Clara, California Silicon Valley Bank, Santa Clara, California, was closed today by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver.
- Noah Smith: “What Was There a Run on Silicon Valley Bank?” 93% of SVB’s deposits were not FDIC insured. So SVB was vulnerable to a classic, textbook bank run. Why did SVB have so many uninsured deposits? Because most of its deposits were from startups. Startups don’t typically have a lot of revenue — they pay their employees and pay other bills out of the cash they raise by selling equity to VCs. And in the meantime, while they’re waiting to use that cash, they have to stick it somewhere. And many of them stuck it in accounts at Silicon Valley Bank. Taking giant deposits from startup companies instead of individuals and small businesses made SVB a very weird bank, which made it vulnerable to a run.
- Lulu Cheng Meservy https://twitter.com/lulumeservey/status/1634232327168557057 SVB made the responsible decision to strengthen its financial position with a cap raise. It made sense. Where things went terribly wrong was the communication, specifically: (1) WHAT they said, (2) WHO the audience was, (3) WHEN they did it, and (4) HOW they framed it.
- Bank of England on on Silicon Valley Bank, UK “SVB UK has a limited presence in the UK and no critical functions supporting the financial system. In the interim, the firm will stop making payments or accepting deposits.”
- TechCrunch: SVB contagion: UK arm shuts down Government scrambles and startups brace for the worst. The move could affect as much as 30% of UK tech startups, with potentially 10% in trouble, industry sources estimate.
- “SVB-UK is a trusted and valued partner of the entire innovation ecosystem powering founders and the venture capital industry. It plays a pivotal role in supporting and financing Britain’s startups. In the event that SVP-UK were to be purchased and appropriately capitalised, we would be strongly supportive and encourage our portfolio companies to resume their banking relationships with them.” UK VC joint statement
- tinyurl.com/vccommunitysvbstatement “Silicon Valley Bank has been a trusted and long-time partner to the venture capital industry and our founders. For forty years, it has been an important platform that played a pivotal role in serving the startup community and supporting the innovation economy in the US. The events that unfolded over the past 48 hours have been deeply disappointing and concerning. In the event that SVB were to be purchased and appropriately capitalized, we would be strongly supportive and encourage our portfolio companies to resume their banking relationship with them.
- https://www.linkedin.com/posts/hemanttaneja_several-venture-capital-leaders-met-today-activity-7040158442191298560-fsAH (h/t https://techcrunch.com/2023/03/11/vcs-are-declaring-their-allegiances-in-the-wake-of-svbs-collapse/ ) related Mar-10 tweet by Hemant Taneja @htaneja
SKMurphy Take: Bank runs are psychological as much as a financial. They offer a “stag hunt” to depositors: suffer the hassle of getting out early or hope to organize a group large enough to avoid a shared failure. (Stag hunt: a small sure gain vs. chance for a share of a large pie. Unlike prisoner’s dilemma there are two equilibrium points: one that minimizes risk–hunt the rabbit or withdraw funds–and one that maximizes the payoff–hunt the stag or hang tough with other depositors and stop the run).
- We, the undersigned, are deeply concerned about the rapid failure of Silicon Valley Bank, a leading financial institution that has played a vital role in supporting the technology industry in the United States. We are not asking for a bailout for the bank equity holders or its management; we are asking you to save innovation in the American economy.
- We ask for relief and attention to an immediate critical impact on small businesses, startups, and their employees who are depositors at the bank. According to the NVCA, Silicon Valley Bank has over 37,000 small businesses with more than $250,000 in deposits. These balances are now unavailable to them, and without further intervention, according to the FDIC website, may be inaccessible for months to years.
- Macro Trading Floor: Panic in the Bankiing System (YouTube) A walk through of the dynamics throughout 2020 – 2023 that caused SVB to fail, and what risks lie ahead for the broader banking system. SVB was poorly managed in at least the last year. They have had no risk manger for at least six months and did not hedge long bond positions that were vulnerable to interest rate swings.
- Joint Announcement by Treasury, Federal Reserve, and FDIC After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer. [..] Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.
- Dave Kellog “My thoughts on SVB Meltdown” This is a great roundup with a number of good references. Two points by Kellog stand out and one references in particular is worth reviewing and incorporating into your checklist for “next time.”
- Startup death is a natural part of the Silicon Valley ecosystem, the Darwinian process that produces the innovation that drives a large part of our economy. Startup death is a natural part of the process — but it should result from a bad idea or a unworkable product. Not from your bank failing.
- You cannot overstate the interconnectedness around SVB. I know startups with all their money there. I know VCs who are unable to provide bridge loans to startups because all their working capital is also at SVB. I’ve heard of founder/CEOs who have all their personal money there as well, so they are unable to even use their own funds to bail out their companies.
- The best what-to-do-about-it advice thread is from Brett Adcock.
- HSBC to buy Silicon Valley Bank UK for £1 in rescue deal The government has struck a last-minute deal for HSBC to buy Silicon Valley Bank’s UK operations, saving thousands of British tech startups and investors from big losses after the biggest bank failure since 2008. The takeover will override the Bank of England’s initial decision to place SVB UK into insolvency, after a run on the lender that was originally sparked by fears over a multibillion-pound shortfall on the US parent company’s balance sheet.
- Ask HN: Post-SVB, what are other areas where groupthink leaves us vulnerable? by Travis Fischer
(@transitive_bs “I know groupthink didn’t cause the SVB collapse alone, but it did lead to many otherwise very sophisticated founders being put at risk by taking their deal because “everyone does it”. As one lesson from this debacle, I think it’s useful to ask ourselves what are other areas of groupthink that leave us in the tech industry particularly vulnerable? E.g., as an OSS developer, I’ve used the MIT license for 10+ years because other devs I trust use it, but I don’t have any real reason why. What are other examples to be aware of?
- Stratechery (Ben Thompson) “The End of Silicon Valley (Bank)” HN https://news.ycombinator.com/item?id=35134608 I made two fundamental errors: (1) the venture capitalist set knew about Silicon Valley Bank’s situation; (2) Silicon Valley broadly was in the business of taking care of their own. Both were totally wrong: the panicked reaction to Thursday’s failed capital raise made it clear that nearly everyone in tech was blindsided by Silicon Valley Bank’s situation — which again, absent a bank run, was an issue of profitability, not viability — and the bank run that resulted made it clear that everyone, from venture capitalists to the startups they advised, were solely concerned about their own welfare, not about the ecosystem as a whole. This increased uncertainty and destabilization will continue to drive demands for more government intervention that in turn will replace trust with more rules, regulations, and restrictions–which will have a long-term effect on innovation. This may be the inevitable outcome of tech having set disruption as its objective function: the ultimate casualty may be the Silicon Valley that once was, not just its bank.
- John Thornhill (Founder of Sifted) “SVB shows that there are few libertarians in a financial foxhole “It turned out that one of the biggest risks to our business model was catering to a very tightly knit group of investors who exhibit herd-like mentalities,” one senior bank executive told the FT. The near-death experience of thousands of start-ups exposed to SVB is certain to have a salutary impact across the tech sector. “If we can’t manage our own money better, that is on us, not the taxpayer,” one founder concluded at the weekend.
- Dan Walters (CalMaters) Is Silicon Valley Bank’s failure an omen for California? The failure of Silicon Valley Bank struck California’s economically important high-tech industry while it was already facing difficult headwinds. The question is whether the bank’s failure is a harbinger of Silicon Valley’s decline.
SKMurphy Take: this to me is the central question. It seems that a number of factors contributed to the shutdown:
- Venture Ecosystem funding had a rapid rise in 2017-2021 followed by a significant drop. See Clear in Hindsight: April 2022 ended a Minsky boom for startups. The full effects have yet to be felt and will echo into at least 2024
- Mistakes by bank leadership–some of this may be hindsight bias.
- Herd mentality among depositors that earlier benefited the bank now turned against it.
- Regulatory regime decisions as far back as 2008 may have lit the fuse: to the extent that we see more banks failing or being forced into acquisition I think this factor gathers force and gets moved to #1.
- Peter Zeihan (@PeterZeihan) “The Financial Crisis of 2023” The problem for Silicon Valley Bank and the smaller Silvergate and Signature Bank is that they all took on a questionable amount of exposure to illiquid assets. For SVB, it was a variety of long-term bonds and securities with long durations. Then interest rates started to go up–way up. And SVB was not left with many tools to manage interest rate risk it had not hedged for. […] The real thread connecting all of these banking mishaps, however, is one that’s not going to go away anytime soon. Rising capital costs. Many of these banks and their customers have been operating in a world where money has been as close to free as it has ever been in human history. Over the past year, we’ve seen interest rates rise–sharply–and there’s little reason to believe that we’re anywhere near done yet. The fundamental operating paradigm for banks and the financial paradigm of the past decade and a half is shifting, and we’re going to see which financial institutions are able to deal with the change and which ones won’t be able to keep up.
- Yeva Nersisyan and L. Randall Wray in “The collapse of SVB shows why monetary policy is the wrong tool to fight inflation”
- But unlike what happened during the Global Financial Crisis, the bank didn’t go on a reckless lending spree. Instead, it took the safer route of buying securities either issued by the U.S. government or guaranteed by it (such as agency-backed mortgage-backed securities). While these securities had little-to-no default risk, they were subject to interest rate risk. If the Federal Reserve were to raise interest rates, the market value of these bonds would collapse, lowering the bank’s capital and potentially making it insolvent. But the Fed had kept rates low for a generation.
- After more than a decade of near zero interest rates, the Fed hiked rates extremely quickly — by 400 basis points (4 percentage points). All balance sheets that had been built during the period of low rates immediately became toxic.
- The Volcker experiment in the 1970s is often used as evidence that the Fed has the tools to disinflate the economy. Everyone acknowledges that the disinflation was not costless — we had two back-to-back recessions as a direct result of Volcker’s actions. What is less recognized is that the Fed caused a series of financial crises — from the demise of the Savings and Loan (S&L) industry in the U.S. to the collapse of bond markets in developing countries. Higher rates doomed the S&Ls that were holding fixed-rate mortgages on their balance sheets. Their cash inflows were fixed, while their cash outflows were increasing with increasing interest rates. Government attempts to rescue S&Ls through deregulation that eliminated interest rate ceilings on their deposits made things worse.
- What is missing from the debates over monetary policy today is the understanding that the Fed was not established to control inflation. It was created to prevent financial crises by acting as a lender of last resort in times of distress. Indeed, that’s exactly what the Fed is doing now — opening up its lending facilities to banks in need. But rather than focus on maintaining financial stability, the Fed has become obsessed with controlling inflation, something it cannot really do without causing either a recession or a financial crisis (or both).
- Byrne Hobart: The Banks: What’s Next? There are two basic frameworks for looking at systemic risk:
- The more literal, object-level one goes like this: if a bank fails, and deposits are unavailable for a while, depositors may struggle to pay other debts, leading to other bank failures. […] This is an asset-based view of systemic risk, since the direct effect of failures is to make other institutions’ assets worth less.
- The other kind of systemic risk is liability-based: a failure at one institution makes lenders (including depositors) less likely to want to work with similar-looking institutions. This is a more amorphous problem, because similarity is so hard to define. An important consideration with liability-based systemic risk is that it’s indifferent to the asset side, and all about liquidity. Which, in one sense, makes liability-side contagion easier to solve: find the financial institutions experiencing outflows, and get so much cash that there’s no net impact on their liquidity position and thus no reason for deposits to flee or for loans not to be rolled over. On the other hand, it’s a harder problem, because it’s dealing with fundamentally incommensurable things: money as a solution to a psychological problem.
- The Economist: “America’s banks are missing hundreds of billions of dollars” After the fall of SVB, America’s small and midsized banks fear deposit outflows. The problem is that monetary tightening has made them still more likely. The Fed has raised the rate on overnight-reverse-repo transactions from 0.05% in February 2022 to 4.8%, making it much more alluring than the going bank-deposit rate of 0.4%. For now, the banking system is dealing with a slow bleed. But deposits are growing scarcer as the system is squeezed—and America’s small and midsized banks could pay the price.
- Ashley Rindsberg “How the Bank Collapse Goes Nuclear” This isn’t a Silicon Valley problem, it’s a global debt crisis. We have just witnessed the collapse or near-collapse of five banks, including Credit Suisse, an institution of systemic importance. The current crisis is a toxic byproduct of the government’s response to the ’08 crash: an era of loose monetary policy. The Fed cut interest rates to 0% for the first time in history and kept them under 1% for almost 10 years. […] Far from the 0.1% rate that was predicted by the Fed in 2020, rates have risen to 4.7%, which means the Fed missed its own estimate by 47 times. What this means is that banks behaving with the Fed’s projections in mind now have a Titanic-size hole in their books. The value of those long-duration bonds banks snapped up in 2020 (when it was the safe thing to do) has plummeted, worth up to 10%-50% less than they were supposed to be worth. Meanwhile, banks have incurred liabilities in the form of loans and investments predicated on 2020 bond prices. The banks are, in simple terms, underwater—and not just in Silicon Valley due to greedy tech bros but, as The Economist recently reported, across the country.
- FDIC: “First-Citizens Bank & Trust Company, Raleigh, NC, to Assume All Deposits and Loans of Silicon Valley Bridge Bank, N.A.”
- Wolfe Richter (Wolf Street) “FDIC Sells Much of Silicon Valley Bank to First-Citizens Bank. Total Cost of SVB Collapse to Deposit Insurance Fund: $20 Bn” On the day that Silicon Valley Bank collapsed and the FDIC became its receiver – March 10, 2023 – it had $167 billion in assets and $119 billion in deposits, along with some other liabilities — which is what the FDIC took over. Total estimated cost of the collapses of Silicon Valley Bank is $20 billion which comes out of the Deposit Insurance Fund that had a balance of $128.7 billion on December 31, 2022.
- Zerohedge: “How The Collapse Of SVB Led To A $16 Billion Taxpayer-Funded Gift For One Bank” FCNCA stock has almost doubled, soaring to the highest on record. But why would the value of the Raleigh, North Carolina-based First Citizens double in seconds if all it did buy assets which until just a few weeks ago were viewed as worthless. Well, because they were not worthless.
Bottom line: virtually no risk – and what little risk is left after acquiring this portfolio of deeply discounted loans is shared 50-50 with US taxpayers – and only upside. First Citizens got $16 billion (and arguably much more) in assets for free. What’s more, FCNCA not only got $16BN in assets for free, but the combination of the two banks creates a $143 billion loan portfolio and turns the little-known North Carolina bank into one of the country’s largest lenders to the venture capital and private equity industries. It also means First Citizens will now be one of the top 15 US banks, with more assets than the likes of Morgan Stanley or American Express Co., according to Federal Reserve data!
“First Citizens has a history of troubled banks,” said Herman Chan, an analyst with Bloomberg Intelligence. “It’s a strategy to grow the bank when times are difficult — to conduct M&A at advantageous prices.”
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