What Really Went Wrong at Silicon Valley Bank

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Shed without tears for investors in Silicon Valley Bank (etc). On March 10 the bank, which had $212bn of assets, failed with surprising speed, making it the biggest lender to fail since the global financial crisis of 2007-09. Most of SVBthe investors were Bay Area tech startups with accounts holding well in excess of the $250,000 that is insured by the federal government. They fled and their panic was justified. By uploading long term bonds, SVB has taken a big, unhedged bet on interest rates staying low. That bet went wrong, leaving the bank broke (or close enough). The fact that shareholders are wiped out and bondholders take huge losses is not the failure of the financial system. A bad business was allowed to collapse.

Next up are the flaws in America’s banking architecture. SVB they may have had enough assets for investors to get all or nearly all of their money back—but only after a long wait. This left many tech companies facing life in financial crisis; Roku, the streaming giant, had nearly $500m tied up SVB. Across the technology sector, there were shutdowns and disruptions. And regulators and the American government seemed to fear that investors were losing faith in other banks as well. On March 12 they gave birth SVB too big to fail and guarantee all the bank’s deposits. If the sale of its assets does not cover the costs of the investor’s support, funds financed by all banks must step in, punishing the entire industry for the negligence of one institution .

At the same time, management had to deal with the risk that other banks could face as well. At the end of 2022 there was $620bn of unrealized securities losses on banks’ books. On March 12th regulators also closed Signature Bank, another medium-sized lender – the third bank to fail in a week, as Silvergate, an institution heavily exposed to digital currency, collapsed on March 8th. And the fall in the markets continues. As we published this leader on March 13, bank stocks were falling. Those of First Republic, a bank of comparable size to etcdown more than 60% on the day.

To dig other banks the Fed offers them support on extremely generous terms. A new program is ready to provide loans against long-term financing and mortgage-backed securities, such as those SVB was tired A central bank providing loans would normally apply a haircut to the market value of the securities offered as collateral. On the other hand, the Fed will make loans up to the face value of the securities, which, for long-term bonds, can be more than 50% above market value. The haircut back promises another bank with a similar bond portfolio SVBPeople would have enough access to money to pay investors.

The investment commitment was inevitable, a given SVBand size (and in any case it can be completely covered by SVB‘ assets). The same cannot be said for the generosity of the system-wide liquidity support, which is a major extension of the Fed’s tool. Falling share prices in banks partly reflect investors waking up to the risks of long-term bond holdings for profit. But where etcunknown losses were enough to wipe out its capital to a large extent, other banks look flexible with room for relaxation.

The Fed is right to lend against good collateral to stop runs. But there is no need to do so on such good terms, and subsidizing bank shareholders. And while it is likely that the Fed will stop the system in banking, policymakers should not have gotten to a point where dramatic interventions were needed.

SVBfailure was so chaotic in part because it was exempt from excessive regulations designed to prevent impromptu bank rescues of the kind the Fed has just engineered. After the financial crisis, the American Dodd-Frank Act forced banks with more than $50bn in assets to follow several new rules, including creating a plan for their own orderly resolution if they fail. The hope was that a combination of thick capital buffers for banks and careful planning would protect deposits and payment systems while losses were passed on to investors in an orderly manner. Regulators planned to rapidly restructure the biggest banks by converting some of their debt into equity – a “bail-in”, in the jargon.

In 2018 and 2019, however, Congress and bank regulators loosened both the resolution and liquidity planning rules, especially for banks with $100bn-250bn of assets, many of which had lobbied for lighter regulation . There have never been bailout plans for banks of SVBand size. Instead, the bank asked briefly last week to rebalance itself by issuing new shares.

The lack of robust failover planning has meant that controllers have had to work on the fly. The problem was compounded by the speed with which SVB lost deposits because Bay Area officials diverted money using their banking apps. Regulators usually try to resolve banks over the weekend. The run was so fierce SVB, however, must be closed during the working day on March 10. even if SVB had been solvent and eligible for emergency funding from the Fed – it had enough assets to post as collateral – it is unclear whether there would have been time to arrange it.

Some conclude from the ability of investors to flee and the willingness of regulators to back them up that it would be better to eliminate deposit insurance limits altogether – and banks to put forward for full protection. But with adequate capital buffers and resolution planning, investors would be less caught up in the crisis. SVBfailure would have been less of a threat to the economy and the financial system. Full deposit insurance for the banking system could lead to further irresponsibility. It would encourage banks to take greater risks to promote the benefits they could offer to investors, who might be attracted by higher returns but would have no reason to leave a bank because of irresponsible.

This moral hazard is not the only danger. The other is that the Fed, having seen how SVB As interest rates rose, it now chooses to deal with inflation for fear that monetary tightening will lead to more failures. Having bet a week ago that rates would reach 5.5% this year, investors now hardly expect any further tightening – and that interest rate cuts will start within six months.

The Fed should not take its eye off inflation (although higher bond prices will reduce the pressure on banks’ balance sheets). Now that deposits are safe and the banking system has substantial liquidity support, the crisis is unlikely to significantly delay the American economy. Furthermore, it is not the job of monetary policy to protect borrowers’ profits. The right decision to withdraw etcit is a failure that the management of banks that were large but not terrible has been adequate with the risk they pose to the economy. The job of policy makers now is to correct that view.

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