Last Friday, Silicon Valley Bank (SVB) failed. It was deemed systemically unsafe by the U.S. Treasury and federal regulators. The bank was put into receivership to be administered by the Federal Deposit Insurance Corporation (FDIC). As late as last Wednesday, the bank’s holding company was in the process of raising capital to stabilize operations. Within 48 hours, the bank’s capacity to meet depositors’ demands had failed. The bank collapsed.
What happened?
Silicon Valley Bank management erred in allowing the commercial loan portfolio to be overconcentrated. Further, unwise exposure to long-term treasuries yielding 1.78%, strategically betting that interest rates would not continue to rise, resulting in a loss on the treasuries and a short-term liquidity crisis. Bank management also made a mistake in subscribing portions of relief capital in convertible instruments that could not be immediately used for critical cash flow. However, SVB might still have survived if not for a bank run.
SVB is the first bank to experience a bank run (customers demanding their deposits en masse) in the digital age. Venture capitalists partnered with the bank and startup tech companies. It may have been that some of these same VCs are who the bank executives went to in a panic to secure short-term capital in an effort to reinforce the bank’s capitalization. When it was obvious that market capital was not readily available, someone tweeted to other entities with deposits in the bank warning of imminent financial problems. This resulted in a run on the bank that ultimately caused its failure. An investigation will shed further light on the sequence and substance of events. If whoever sent the tweet was an officer of the bank or had inside information, there could be liability for the action.
Normally, such a bank failure would be determined a singular event without further repercussions to the financial banking system. There have been over 500 bank failures in the U.S. since 2010. The last two years averaged two per month. None of these failures stand out as harbingers of future financial crises. SVB was not involved in cryptocurrency, heavily involved in derivatives, or in possession of substantial bad loans. As the 16th largest bank in the country, it did not partner portfolios upstream to a correspondent bank. SVB was not insolvent; it was illiquid.
On Friday, Treasury Secretary Janet Yellen announced that SVB posed no threat to the overall system and deposits of $250,000 would be covered pursuant to contract. By Sunday morning, an emergency press conference was called by the Secretary to inform the public that all deposits would be covered, regardless of amount. Why the about face? Chatter on social media over the weekend was threatening futures on major stock exchanges. It was necessary to calm the public’s fears to quell panic.
Why was this situation different than recent bank failures?
The public in general distrusts all national institutions. They believe that Members of Congress are corrupt in that they are deceitfully pursuing their own agenda. Fears of a digital currency drive emotions that the government intends to confiscate wealth and manipulate personal finances. The unusual nature of a bank run unnerved people. When the public is not told the whole truth, prudent action is minimized by the disruption of information necessary for rational thought.
The FDIC insures the deposits in over 4,000 U.S. banks with $23.6 trillion of creditor assets. The estimated cash on hand within the FDIC to meet its obligations is less than 2% of capital required. Historically, 2% was adequate as long as bank failures were predictable. The potential for bank runs now changes that risk analysis equation.
There is a process by which Congress can, if necessary, immediately recapitalize the FDIC without a vote. But this requires borrowing more money and the current debt ceiling restricts borrowing flexibility. The deadline for negotiations between the White House and Congress to raise the debt ceiling is July of this year. The public’s fear could be exacerbated if the debt ceiling negotiations are perceived to impede financial tools that are available to cover citizens’ deposits.
Further, the FDIC is in no position to cover all deposits above $250,000 of all future bank failures. At some point, a future bank collapse could trigger “the domino effect” and become a self-fulfilling prophecy.
Progressives are now demanding further control and regulation of all banks. Their ultimate goal is to nationalize the banking system. Doing so limits innovation, and therefore, opportunities of the capitalist free enterprise system. It’s like the lanes of a bowling alley. The gutters are set at the approximate width of the ten pins. They act metaphorically as a regulation to keep the balls from going too far off course and disrupting the next lane, while permitting the optimum opportunity to knock down all pins. This is necessary and appropriate.
Certain elected officials want to narrow the lane with gutters to less than the width of the ten pins. The bowler can only hit a strike with perfect trajectory down the center of the lane. He or she cannot throw a curve ball or approach the head pin from an angle. Such overregulation in banking will result in many fewer strikes produced and opportunity lost.
Ultimately, overregulation and government intervention defaults to the moral consequence of the government controlling all commercial banking transactions.
The President and the Speaker of the House should immediately meet in emergency session and agree to cut the administrative costs of Congress and the Executive Branch reciprocally by 10%. This would be more than just a symbolic gesture. It would begin to build trust with the American people that we’re all in this financial situation together. In so doing, no government programs or services to the people need be jeopardized or eliminated. They should immediately dispose of any threat that the United States government will ever default on its obligations to its debtors or its contractual commitments to the U.S. banking system. This would re-instill trust in the system.
Most banks in the United States are sound and operating with capable management. The United States of America is the safest place in the world to invest personal savings. The answer to the question, is the U.S. banking system safe? is not just a matter of economic structural fault lines…
It is a matter of the integrity and moral intentions of our government leaders to put partisanship aside to honor the trust relationship the people so desire.
My name is Marc Nuttle and this is what I believe.
What do you believe?
