The banking sector was hit hard by the failure of Silicon Valley Bank. But the bank had stashed money in the supposedly safest asset. What happened?
TIMOTHY A. CLARY/AFP via Getty Images
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TIMOTHY A. CLARY/AFP via Getty Images
The banking sector was hit hard by the failure of Silicon Valley Bank. But the bank had stashed money in the supposedly safest asset. What happened?
TIMOTHY A. CLARY/AFP via Getty Images
Risk. It’s tough. Try to avoid a number of risks, you may just end up exposing yourself to another. That’s exactly what happened to Silicon Valley Bank.
“Silicon Valley Bank was a very good bank… until it wasn’t,” says Mark Williams, a professor of finance at Boston University and a former Federal Reserve bank examiner.
A victim of his own success
Williams says that Silicon Valley Bank’s problem really started with its wild success. Many of his tech company clients made money during the early pandemic.
“Silicon Valley Bank was just now,” he says. “Its deposit base has tripled between 2020 and 2022, with billions and billions of dollars poured into it.”
Much of those billions came from all the risks the bank took by lending money to startups and corporations that couldn’t get credit from other banks. These risks have paid off.
And the Silicon Valley bank took all the billions it had made from taking those risks and put them into what was supposedly the least risky asset of all: US Treasuries.
Bonds: The risk-free investment
Bonds are like a small loan that you give to the government for 3 months, 1 year, 10 years, etc. depending on which bond you buy.
At the end of that time, the government will pay you back the loan, plus some interest. US bonds are considered the safest investment in the world. The US always pays back its debt. They are often referred to as a risk-free asset.
The disadvantage? Government bonds don’t pay much. Super safe, not super profitable. However, some of these bonds are slightly more profitable than others.
Longer-dated bonds (like 10-year bonds) typically end up paying more than 3-month or 1-year bonds, which makes sense: Long-dated bonds mean you’re agreeing to give the government your money for years to come lend. You get more yield – a bigger payout – for that wait.
“Basically, Silicon Valley Bank wanted a bigger payout,” says Alexis Leondis, who writes on bonds for Bloomberg. “So they basically wanted to go for longer-dated bonds because I think they felt like what they were going to get from shorter-dated bonds was kind of a joke.”
A risky venture
Silicon Valley Bank has put billions of dollars into 10-year bonds. But there were risks it didn’t see.
Risk #1: Access. These billions have now been locked up for years. It would not be easy to get hold of this money in an emergency.
Risk #2: Interest rates. As interest rates began to rise, the market value of Silicon Valley Bank’s bonds fell.
That’s because the bank bought its government bonds before interest rates started to rise. The price you get from bonds is directly tied to interest rates. When interest rates rise, the market price of older bonds falls because new bonds pay higher interest rates.
As interest rates began to rise rapidly, Silicon Valley Bank’s bonds plummeted.
Risk #3: Really, really rich customers. When rumors spread about the bank, customers panicked and started withdrawing their money. Because they were wealthy individuals and corporations, this meant multi-million, even multi-billion dollar accounts were being paid out at once.
Silicon Valley Bank needed a lot of cash fast. But of course, much of its cash was locked up in 10-year bonds. Now it had to try to sell these now to get cash.
Emergency sale of government bonds
Here’s where interest rate risk bit Silicon Valley Bank: Trying to sell these low-yielding second-hand bonds at a time when all newly issued bonds were paying out much more wasn’t easy.
“Now the same bond and the yield would be about 20 times higher,” says Mark Williams. “So to encourage investors to even consider your old bond, you would have to discount it.”
Discount like in a sale.
Silicon Valley Bank suffered huge losses selling its bonds, and more investors panicked and fled. Williams says it was a bank run on a scale not seen in the US since the Great Depression.
“In a single day last week, depositors knocked on the door and withdrew 41 billion depositor dollars,” Williams says. “That’s about a quarter of their total deposits. No bank, no matter how strong, could ever survive that kind of withdrawals… that kind of bank run.”
The rest of Silicon Valley Bank’s depositors were bailed out.
guilt by association
Mark Williams says that even though the Silicon Valley bank made a number of very specific mistakes, people across the country got scared and started pulling money out of smaller banks.
“That means these smaller, regional banks are potentially destabilized,” says Williams.
Where are these nervous investors putting their money? Williams says much of that is deposited with big banks, which customers see as safer. Also, many people invest their money in US Treasury bonds.
Demand for the risk-free asset has surged throughout the week.