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Moment that mattered: Silicon Valley Bank collapses

 

People queue outside a branch of Silicon Valley Bank in Santa Clara, California, on 13th March 2023, hoping to retrieve their funds from the failed bank

People queue outside a branch of Silicon Valley Bank in Santa Clara, California, on 13th March 2023, hoping to retrieve their funds from the failed bank. 

Anita Ramasastry awoke on the morning of 10th March to a feeling of déjà vu. After 48 hours of intense speculation and a run on its deposits, the California-based Silicon Valley Bank (SVB) had fallen. “We have tonnes of bank failures [in the US], it’s not that they don’t happen,” says Ramasastry, a professor at the University of Washington School of Law and a former banking regulator. “It’s just that this was a big one. It was quick and sudden.”

SVB was America’s 16th largest bank and a titan in the tech sector, especially among startups in the San Francisco Bay Area. At the end of 2022, it held over $200 billion in assets. But by noon on 10th March US regulators had stepped in and seized control, after the biggest bank collapse since the 2008 financial crisis. The failure sparked fears that as well as depositors losing their shirts, further collapses could be prompted throughout the global financial system. Bank stocks plummeted and two smaller banks, Signature Bank and First Republic, both went to the wall. In the days following SVB’s collapse the Swiss central bank had to step in to prop up Credit Suisse, which was later sold to UBS.

Before Ramasastry became an academic, she was a regulator at the US Federal Reserve (known as the Fed) during the Obama administration, where she was part of the team dealing with the fallout from the global financial crash of 2008. In its aftermath, the US passed the 2010 Dodd-Frank Act, an attempt to rein in banks and avoid a repeat of the meltdown that was sparked, at its root, by the overselling of mortgages in the US to customers who had no prospect of ever paying the banks back. The Federal Deposit Insurance Corporation [FDIC], formed in 1933, was beefed up and would henceforth guarantee bank deposits up to $250,000 in the event of bank failure. And Dodd-Frank mandated regular stress tests on banks holding $50 billion or more in assets to ensure they had the necessary cash to cover their obligations. In theory there would be much tougher oversight of banks to spot any trouble coming.

Yet SVB still failed. The system of supervision that was meant to spot an imminent failure didn’t work for a number of reasons. After years of banks being able to borrow money at a low cost, rising interest rates prompted by runaway inflation put unforeseen pressure on SVB’s investments. Its explosive growth had come from one industry, tech, dangerously concentrating the risk in case of a tech industry dip of the sort that has taken place in recent years. On top of that, 90 percent of the bank’s customers had deposits over $250,000, which meant that they were uninsured by the FDIC above that amount.

Perhaps most significantly, though, a 2018 law brought in under Donald Trump’s presidency had raised the $50 billion threshold for more intensive oversight from the Fed to $250 billion. This meant that smaller banks with assets between $50 billion and $250 billion had less scrutiny and much smaller requirements on the amount of liquid assets they needed to keep available, to prevent liquidity crises. SVB was one such bank that benefited from that change after SVB’s chief executive Greg Becker argued during Congressional testimony that mid-sized banks like SVB did not present a wider “systemic risk”.

Ramasastry believes that SVB collapsed due to a unique combination of all those factors and although most economists broadly agree, there was also a counter-narrative, largely pushed by right wing media: SVB failed because it was too woke. Fox News host Tucker Carlson, who has since left the network, blamed the Dodd-Frank Act for imposing “diversity, equity, and inclusion standards” while host Jesse Watters claimed that SVB was “a woke Biden bank” that had taken its eye off the ball by being distracted by “lesbian visibility day” seminars. “The [right wing] narrative started to change, that SVB was this big woke bank,” says Ramasastry, “and it was because the board was investing in diversity.” Much of that narrative, Ramasastry says, was “more about this bank being in California,” a liberal state that votes Democrat.

The Fed did its own postmortem, and owned up to the fact that they were a little bit asleep at the wheel”
Two days after SVB failed, in an attempt to restore confidence in the market the FDIC announced that, despite most of the bank’s deposits being above the $250,000 threshold, the entirety of its customers’ deposits would be protected. Depositors were made ‘whole again’ but not through a government bailout – the money came from the Deposit Insurance Fund, part of the FDIC, which is funded by a quarterly charge on financial institutions. At the time of the SVB crisis, the DIF held over $100 billion which was more than enough, according to the US government, to cover all of SVB’s deposits. “It’s collective risk-sharing among financial institutions,” explains Ramasastry. “It’s coming out of bank money.”

For Ramasastry the SVB collapse was significant not just because of the size of the institution that failed, but also due to the Fed’s response. A month after SVB collapsed, an investigation was published by Michael Barr, the Federal Reserve’s top regulator, looking into both the reasons for the collapse and also the Fed’s own failure to see it coming. “That’s pretty significant [because] it is the Fed doing its own postmortem, and owning up to the [fact] that they were a little bit asleep at the wheel,” says Ramasastry.

The Barr report concluded that SVB had been mismanaged. As with most banks, deposits were invested with the expectation of regular returns but they didn’t properly anticipate what Ramasastry calls “external forces”, especially the rise in inflation and the hikes in US interest rates to try to tamp it down. “What Silicon Valley Bank was holding on its books quickly became devalued,” Ramasastry says. “So the bonds they had invested in, as interest rates are rising, returned lower payouts which meant that their actual market value, if they had to sell them, went down quickly.” When they did have to sell a package of bonds at a loss, they triggered a bank run.

The Fed itself had missed some key signals including the bank’s explosive growth and in the report it admitted failures in its supervision of SVB. But, significantly, there was a new factor that had turned concerns about SVB’s financial health into a bank run at lightning speed. The report stated that: “Social media enabled depositors to instantly spread concerns about a bank run, and technology enabled immediate withdrawals of funding.” On Thursday 9th March, panicked SVB clients had tried to withdraw $42 billion in a single day, mostly through online banking.

“What’s unprecedented about this is the report mentioning social media and how it played a role in the run on the bank. This is a new thing. That was not foreseen [by the Fed],” says Ramasastry. “The message [that SVB was in trouble] and the medium meant this sort of run happens much faster than it normally would [in the past].”

It is technology and the speed at which money can move that now keeps Ramasastry up at night. As flawed as the response to SVB was, she says, at least there was some regulatory oversight and a safety net in place when it failed. The Barr report recommended several courses of action including greater monitoring of bankers’ pay and a rolling back of the Trump-era deregulations. None of that happens, she says, when money is invested in cryptocurrencies or other unregulated markets, which have become popular especially among young people, many of whom can’t afford to lose their investments.

This, she fears, could lead to a serious financial crisis, for which we are wholly unprepared. “It’s the idea that if you have unregulated institutions that have all our assets, and they disappear overnight,” Ramasastry says. “You can’t get your cash out, then the world grinds to a halt because there’s no way for people to transact. It’s a doomsday scenario that we saw in the 1920s. As we’re seeing with Sam Bankman-Fried [whose cryptocurrency exchange, FTX, failed in November 2022] there is no protection.”

When it comes to SVB, Ramasastry believes the system worked – just. But in the age of cryptocurrencies and new technology allowing huge and rapid money flows, the next crisis could be bigger if regulators don’t learn from the mistakes made this time. “We trust there is this regulatory system, that all is fine, that the lessons of the past inform the future,” says Ramasastry. “And what we’re learning now is that [isn’t always] the case.”

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