For weeks now, we’ve been hearing about the banking crisis. It was the top story in newspapers and other media, day after day. The stock market was shaken, and it caused the whole economy to quiver a bit – or more than a bit, depending on what you read.
On March 10, Silicon Valley Bank fell, and hedge fund, private equity, and tech entrepreneurs were wondering how they’d get their cash back. A far more legendary name across the ocean, Credit Suisse, dramatically showed its own vulnerability to the turmoil. But then the federal government stepped in to guarantee deposits at Silicon Valley Bank and Signature Bank, which was experiencing similar problems, and before long the news stories from Switzerland were about whom new owner UBS was sending in to calm things down at Credit Suisse, and self-appointed prognosticator Elon Musk was already warning about the next financial crisis.
Now that things are a bit calmer, but not yet entirely behind us, it’s a good time to hear from someone who can better explain what’s happened, why it happened, and what might happen next. We turned to Timothy Koch, distinguished professor emeritus in the Department of Finance at the Darla Moore School of Business.
Koch wanted to get one thing straight right off: “I have a very strong bias,” he said. “I am a community bank advocate. I’m from Iowa, with many rural banks and limited involvement by the nation’s biggest banks. I have a very strong preference for community-focused banking and the importance of relationships.”
“We have these too-big-to-fail banks, the biggest banks in the country, that were protected by the federal government from insolvency during the 2008-2010 financial crisis,” and he is not a fan of this preferential treatment. “Part of the issue today is, our regulators see the big ones as indispensable, specifically labeled ‘systemically important’ so they are Too Big To Fail. They can essentially do whatever they want and not worry about the firm going under.”
Consequently, he says, there was “really poor regulation” by the federal government in the case of Silicon Valley Bank. The management, and the regulators, “kind of lost focus on the importance of risk management.” Market participants generally knew the bank was in bad shape, but “The regulators basically did nothing about it prior to failure.
For instance, Silicon Valley did not have a chief risk officer for almost eight months prior to failure – which regulators should have required. The bank also grew by almost four times from 2018 through 2022, signaling that management awareness and compliance controls couldn’t keep up. Similarly, at the time of its failure, more than 90 percent of the bank’s deposits were uninsured because the balances were too large.
Closely tied to the venture capitalists, big tech and cryptocurrency sectors – as its name suggested – Silicon Valley had fewer loans than investment securities. Its tech entrepreneur customers weren’t seeking loans so much – they preferred venture capital. Usually when a bank fails, it fails because managers make bad loans. This was “nothing like that,” said Koch.
Silicon Valley Bank purchased many longer-maturity Treasury and mortgage-backed securities yielding little more than the rates it paid on deposits. The Federal Reserve is, in part, responsible for this unusual (and risky) strategy. As late as 2021, the Federal Reserve Open Market Committee was ‘guiding markets’ by suggesting that rates would remain low for another 3 years. Implicitly, many bank managers assumed that buying 10- to 30-year maturity securities with fixed rates wasn’t too risky. Of course, when Fed Chairman Powell and his colleagues raised the federal funds rate by 4% in less than a year, it upset the applecart.
Most of the deposits at Silicon Valley were held by tech-related entrepreneurs and used for transactions purposes, meaning that they could be withdrawn at any time. When the bank had a $1.8-billion after-tax loss from bonds it sold, it also announced it was going to sell $2.25 billion in new stock. These actions triggered a run on deposits, which happened faster than anything you saw in 1930 or in “It’s a Wonderful Life.” “Some of these tech venture-capital folks got spooked, and spread the word by high-tech communication.”
As a result, $42 billion flowed out in a couple of hours, and the regulators shut Silicon Valley Bank down. “If they’d fully understood this, they would have waited until the weekend,” Koch said of the regulators. They could then have created the borrowing facility that was ultimately created and had Silicon Valley borrow funds to meet the deposit withdrawals. As they later did, they could have promised that all of the bank’s depositors would be paid in full. “That stops the liquidity problem.” One of the positive results of this sequence of events is that some market discipline was imposed, as Silicon Valley Bank’s management and directors lost their jobs and stockholders lost their investments. This somewhat limits the moral-hazard problem that flows from government intervention to protect losses.
“If the deposits hadn’t been withdrawn, no big deal, they could have survived,” said Koch. “This is a liquidity problem for an institution like SVB. I wouldn’t call it a crisis.”
Looking at the bigger picture, “If you’re asking, is my money safe? Yes,” he says, unless you have more than $250,000 in a bank and haven’t taken steps to see that it’s FDIC-insured. In the case of Silicon Valley, “The deposit holders weren’t primarily the traditional general public. The most significant holders of Silicon Valley Bank’s uninsured deposits were venture capitalists and tech companies with large balances – hence, big businesses. For example, on March 10, Roku reported that it had $487 million on deposit at Silicon Valley, Roblox held $150 million, BlockFi had $227 million, etc. Most of us don’t have those kinds of balances. We don’t have to worry about that.”
Community bankers – the kind Koch has dealt with for years as president of the Graduate School of Banking at Colorado until his retirement – didn’t see deposits flow out in these magnitudes, “because they don’t deal with those customers.” However, some commercial customers with large deposits did move their balances from smaller banks to the nation’s largest banks. In the week following Silicon Valley Bank’s failure, the Federal Reserve reported that the nation’s 25 largest banks gained almost $120 billion in deposits, while all other U.S. banks lost a combined $108 billion. Too Big to Fail still exists, and that rewards the biggest banks at the expense of community banks.
“I’m not bashing the big banks,” he said. “I’m just citing facts.”
Is it all over? Not entirely. “This is not going to be over until this contagion disappears,” he said. And, “It’s headlines that cause the contagion. It’s media-driven.”
With the headlines having calmed down a bit, the situation looks better. But Koch says this sort of thing is likely to happen to a bank whenever “your focus isn’t on your customers’ needs” – which he sees as a failing too common among bigger banks.
But for the moment, he expects that soon, “This too shall pass.”
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