Late last week, you may have started hearing about Silicon Valley Bank “SVB,” and certainly, more information has come out over the weekend. I wanted to share a high-level summary of what happened at SVB and what it may mean for other banks and the investment markets.
First, SVB is the 16th largest bank in the United States in terms of deposits, and with the news on Friday, it is the second-largest bank failure in the history of the United States. To better understand what happened at SVB, let’s look at how banks work. Banks make money by borrowing money at low interest rates over the short term (i.e., checking accounts, savings accounts, CDs) and loaning money at higher interest rates for the long term (i.e., mortgages, car loans, business loans, and buying U.S. Treasuries and other bonds). The difference in interest paid vs. interest earned is their profit.
Now if everyone were to withdraw their money at once, banks would have a level of short-term reserves to meet some of the requests, but the dollars tied up in long-term loans and investments would not be available to pay account holders immediately.
Silicon Valley Bank has run into trouble because they had loaned out a significant amount of their deposits at extremely low interest rates because of the Federal Reserve keeping rates at or near record low levels. To meet the customer demand for withdrawals, SVB would need to sell some of their investments. Unfortunately, the value of their fixed-income investments has dropped considerably. They loaned (or invested) about $80 billion to the federal government at a 1.6% interest rate – the going rate a year or two ago. Now investors can earn 5.0% or more on the same investments, so why would they want to buy the old bonds from SVB? They wouldn’t unless SVB drastically cut the price of their investments.
SVB tried to avoid having a fire sale on their investments, so they tried to borrow money and even issue some new stock late last week to raise the dollars necessary to me customer demands. Unfortunately, one roadblock they encountered was that a cryptocurrency-based bank, Silvergate, failed last week for cryptocurrency-related reasons, so there wasn’t any demand for their new stock issuance.
Individuals with money at an FDIC-insured institution generally have insurance on $250,000 of their deposits. Silicon Valley Bank does a significant amount of business with venture capital firms, technology firms, and startup companies that have significantly higher balances than the general public. In SVB’s case, only 7% of their accounts are eligible for FDIC insurance (or fell under the $250,000 limits).
The big question most wonder is, “How will this situation impact me?” First, the short-term investment markets will be volatile to start the week as this all gets sorted out. Second, there is a chance this will impact other banks if customers start demanding their deposits back – creating a “run on the bank”. One interesting thing to note, the biggest bank failure on record was Washington Mutual in 2008. In that situation, 100% of depositors were made whole.
Late Sunday afternoon, the Fed and the U.S. Treasury announced they will be making all depositors whole, including uninsured deposits. They indicated their steps won’t constitute a “bailout” because stock and bondholders in the bank won’t be protected. They went further and said that taxpayers won’t be responsible to foot the bill but it will likely fall to increased FDIC insurance premiums from all banks (and all depositors, i.e., taxpayers).
A few things to remember with your bank accounts are to keep them below the $250,000 limit. If you are married, a joint account has a $500,000 limit. If you are above those limits, you can use different account ownership on accounts and CDs to bump it up. You can also use multiple FDIC-insured banks to hold your accounts.
Lastly, keep in mind that these short-term events will create volatility in the markets over the short run. Over the long run, this event will fall into a similar category as the war in Ukraine, the technology bubble, or a pandemic – something the markets absorb and continue to move forward.