What Really Happened to Silicon Valley Bank
If you thought Big Finance and its regulators learned prudence and humility from the financial crisis, the past week’s events were a rude wake-up call. The collapse of Silicon Valley Bank has several subplots. The most obvious was its astonishingly stupid investment strategy of concentrating its assets in instruments whose market value would decline as interest rates rose. But that alone doesn’t explain what’s happening here. SVB’s business was inseparable from the anything-goes venture capitalists of Silicon Valley. And the third central character in this mess is the Federal Reserve. The Fed oversees both interest rates and banks’ balance sheets. But as it pushed up interest rates to put a brake on inflation, it ignored the threat that those rising rates posed to banks whose assets would fall sharply.
At the end of 2022, SVB’s asset portfolio was dominated by $91 billion in mortgage-backed securities issued by Fannie Mae at an average interest rate of 1.64 percent and another $30 billion in U.S. Treasury securities at even lower rates. This position was defensible only so long as the Fed kept interest rates very low, and one could expect the Fed to continue to do so. A reasonable investor started to question those expectations in the early spring of 2021 when inflation began to inch up. After several months of debate over whether the inflation would persist, it became obvious that the Fed would raise interest rates soon—and it did. In 2022, the Fed raised rates seven times, from near zero to 4.75 percent; each time, the value of SVB’s assets took a hit.
Another subplot at play was the unusual character of SVB as an institution. While SVB was a “regional” institution mainly serving Silicon Valley clients, it was also enormous. At the end of 2022, the Federal Reserve ranked SVB the 16th largest bank in the United States, with $209 billion in assets. Moreover, its funding depended on a sweetheart arrangement with Silicon Valley’s large venture capital companies: SVB lent money to the VCs and the startup companies they backed, and the VCs directed their client companies to hold their proceeds from those VCs in accounts at SVB. That’s why more than 85 percent of SVB’s deposits were in accounts exceeding the FDIC’s $250,000 per account guarantee. And since those accounts held the startups’ daily and weekly operating funds, SVB’s failure was an immediate threat to the survival of hundreds of young technology companies.
A third subplot here was the panic itself, which showed that SVB’s public responses to its problems were as dull-witted as its investment strategy. As its financial position continued to deteriorate in 2023, SVB scrambled to attract new investors and prop up its stock price—and several large hedge funds took the bet. But three days before its demise, SVB decided to trumpet a new $2.25 billion stock issue and a fire sale of $21.5 billion of its assets to Goldman Sachs. SVB booked a $1.8 billion loss on the sale, not counting the $100 million fee Goldman Sachs demanded to sweeten the deal. Instead of reassuring anyone, SVB’s public campaign signaled how dire its situation was to the VCs and its own depositors.
The next day, word spread that Peter Thiel’s VC fund had advised its client companies to pull their SVB accounts. Since most of SVB’s depositors relied on those accounts to keep their doors open, and most of those accounts exceeded the FDIC guarantee, SVB was quickly overwhelmed by a modern bank run. California regulators arranged for the FDIC to take over the bank, and over the weekend, Treasury and the Fed moved to quiet the panic by waiving the $250,000 ceiling on the FDIC guarantee.
The fourth subplot in this saga is the inattention and carelessness of the regulators, especially the Federal Reserve. Much has been made of the 2018 change to the Dodd-Frank financial reforms exempting banks with assets of less than $250 billion from mandatory “stress tests” by the Fed. Those tests try to determine if a bank can survive under unusual conditions—such as fast-rising interest rates. But the fact that the test wasn’t mandatory in this case does not excuse the Fed from its primary responsibilities: Its mission, in its own words, is to “promote the safety and soundness of individual financial institutions” and “monitor financial system risks.”
It’s unsurprising that some bankers are stupid and greedy—SVB CEO Greg Becker and other bank executives sold $4.5 million of their SVB stock weeks before its collapse and distributed employee bonuses just hours before the end. But the extent of the Fed’s negligence is sobering. Certainly, the Fed cannot plead ignorance since Becker was a director of the San Francisco Federal Reserve Bank up to the day that his own bank collapsed. And although the reckless change in Dodd-Frank was not dispositive, it did bespeak the dangerous and self-serving attitude prevalent in Big Finance and Big Tech that markets always know best and government oversight is unnecessary and destructive. Now the pressing question is whether the Federal Reserve has finally learned that rigorous regulation to protect the system is far preferable to picking up the shattered pieces.
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