What’s telling about the Silicon Valley Bank collapse is that no one saw it coming. When, on a visit to a London business school after the 2008-09 global financial crisis the late Queen Elizabeth asked why nobody saw it coming, no one had a clear answer. Why, in a financial world crawling with regulators, did no one realize that subprime mortgages were toxic and on the brink of falling apart?
It looks like the regulators dropped their guard again. Had they come to simply and blindly assume another set of false beliefs that ultra-low interest rates, designed to help tackle recession, were here to stay?
Entire business models were built on this assumption. But then inflation returned and interest rates shot up. And now we’re learning just how many banks bet the house on the idea that rates would never rise again.
Regulators closed Silicon Valley Bank, which catered to the tech industry for three decades, on March 10. After an old-fashioned bank run, it did not have enough cash to pay its depositors. It was the biggest bank to fail since the 2008-2009 financial crisis and the second biggest ever, after Washington Mutual fell in the wake of the collapse of investment bank Lehman Brothers, which nearly took down the global financial system.
During the COVID pandemic, Silicon Valley and other banks were raking in more deposits than they could lend out to borrowers. In 2021, deposits at the bank doubled.
But they had to do something with all that money. So they invested the excess in long-term ultra-safe U.S. treasury securities and mortgage bonds. But rapid increases in interest rates in 2022 and 2023 caused the value of these securities to plunge.
The bank said it took a $1.8 billion hit on the sale of these securities and was unable to raise capital to offset the loss as their stock began to drop. The bank’s client base, which included a lot of tech companies, exacerbated the problem. Venture capital firms advised companies they invested in to pull their business from the bank. This led to a growing number of the bank’s depositors to withdraw their money, too. The investment losses, coupled with withdrawals, were so large that regulators had no choice but to step in and shut down the bank.
Despite being the 16th largest bank in the United States, Silicon Valley Bank was exempt from many stress- testing regulations other banks were compelled to follow. It did its best to show it was one of the good guys. Last year, for instance, it publicly committed $5 billion in “sustainable finance and carbon neutral operations to support a healthier planet.”
But how sustainable were the bank’s own finances? It turns out its business model was hugely sensitive to interest rate hikes. It had tied up its money in government bonds, which decrease in value as rates rise.
Here again the Queen’s question is relevant: Why did no one see it coming? In this case, why was the bank so complacent in the year leading up to the crisis, when inflation was soaring? And what other problems are lurking in the banking system as interest rates move back toward historical averages?
Silicon Valley Bank’s collapse highlights how blind regulators were to the scenarios that ultimately led to the bank’s demise—large and rapid increases in interest rates. Do the Federal Reserve’s bank regulators not talk with or read about what their monetary brethren are doing? Are the regulators fighting the last war, the last crisis?
More laws and regulations don’t always help if regulators are incompetent. If they are, they should be terminated – along with the senior management at failed banks.