Silicon Valley Bank: A (Tragic) Tale of Compound Errors

On Friday March 10, the Federal Deposit Insurance Corp. (FDIC) closed the Silicon Valley Bank (SVB), took control of the bank’s assets, and placed them in a new bank. Before we dive in to the details, the banks collapse hits very close to home. Many of my close friends, founders themselves, held their money in SVB. The several million dollars their company held in the bank was what they relied on to make payroll every month. Needless to say, the reckless chain of event of the banks collapse, may end up (unnecessarily) impacting peoples ability to support their families and their livelihood. It’s not about the investors or the founders, its about the hundreds if not thousands of employees who are at risk of not getting their hard earned salary, in the coming months.

But for now bank to the unfolding tragic collapse of SVB. On Friday March 10, the Federal Deposit Insurance Corp. (FDIC) closed the Silicon Valley Bank (SVB), took control of the bank’s assets, and placed them in a new bank. Failure of the 40-year-old bank, based in Santa Clara, CA., was the second largest commercial bank failure in US history, second only to the 2009 failure of Washington Mutual. SVB had $209 b. in assets at the end of 2022; many Silicon Valley hi-tech companies, including my previous company Waycare, held cash there and many had borrowed from SVB. It was the default bank for all VC’s and start-ups banking in the U.S.

Small depositors (up to $250k.) were assured they would get their money. But big depositors (Roku, for instance, had $487 m. in SVB) had to await Federal efforts to recover assets and were likely to take small or big hits.

What went wrong? Here is a chain of events and missteps that led to SVB’s failure:

1. FTX, the crypto exchange and hedge fund, went broke on November 11, 2022, sparking a crypto crisis. SVB had only minor crypto holdings. But FTX’s failure came as a surprise and raised general risk perception in financial markets.

2. SVB invested its deposits in low-interest-rate bonds. Bond prices are high when interest rates are low. When the Fed under Jerome Powell began hiking interest rates in March 2022, SVB’s bonds took a big hit.

3. SVB listed its bonds on its balance sheet as “hold-to-maturity”. That means, it did not have to recognize losses on the bonds until they were actually sold. But VC depositors were savvy enough to know that big financial losses lurked.

4. SVB bank management lobbied hard to loosen rules, promulgated after the 2008/9 financial crisis, about capital requirements. President Trump’s administration approved this in 2018. This let SVB buy bonds with its cash rather than hold it.

5. California bank regulators fell asleep. A rapid and fairly small emergency loan to SVB could have prevented the failure. When depositors became nervous and started pulling their money out, SVB had to sell bonds at bargain-basement prices to pay them, swallowing a big loss. That loss, in turn, made depositors even more nervous. A Fed loan could have forestalled this.

6. Advised by Goldman Sachs, SVB management chose to raise new equity from a VC, General Atlantic, and to sell convertible bonds to the public. But the decision to raise new money signaled to SVB’s client base that SVB was in trouble, and the VC’s advised their clients to pull their money out.

7. The General Atlantic money could have been raised overnight, to meet depositors’ demands. But bank management chose also to sell convertible preferred stock, which couldn’t be sold until the following day. That delay gave depositors time to pull their money, and proved disastrous.[1]

This was a classic bank-run, but turbo charged by hyper connected tech founders who share information on a 24/7 basis.

As the Bob Dylan song asks, when will they ever learn? The bankruptcy of Lehman Brothers greatly aggravated the 2008/9 crisis. It could have and should have been prevented, by a Fed emergency loan. Nearly all experts agree on this. But some believe a personal vendetta between the Secretary of the Treasury Henry Paulson and the heads of Lehman Brothers led him to veto any bailout. The cost was immense. Lehman Bros went bankrupt on Sept. 15, 2008. It had $639 billion in assets. Financial markets melted down as a result.

Will SVB depositors ever get their money? Likely yes. SVB has had an iron clad reputation for the last 30 years and it will likely (and hopefully) find a suitable acquirer who will take on their deposits. However, in the scenario that no acquirer materializes, The FDIC will pool SVB assets and try to liquidate them in an orderly fashion over time. But depositors will lose heavily, because those high-price bonds SVB bought are worth a whole lot less today. The year 2022 was the worst year for bond prices in 250 years. And bond prices will not recover until interest rates fall, that won’t happen for some time, as the Fed is still focused on fighting inflation.

In next week’s blog, we will look at what role the VC’s, who for decades, were buddy buddy’s with SVB, played in fostering this bank run.

[1] Source: “Why did Silicon Valley Bank Collapse?” New York Times, Dealbook, Andrew Ross Sorkin et al., March 11, 2023.

Originally published on Noam Maital's Medium account.