Weekend reading: A bank blows up

What caught my eye this week.

This might be a Mini Budget moment for the US. Its regulators moved yesterday to shut down Silicon Valley Bank and to take control of its deposits. It’s the biggest US bank failure since 2008.

Silicon Valley Bank’s shares had already been pummeled this week as the Californian lender tried to secure extra funding to shore up its balance sheet. But in the face of a bank run, its regulator cited “inadequate liquidity and insolvency” and pulled the plug, taking control of its $175.4bn in deposits.

Financial shares sold off on fears of contagion – even here in London – but this doesn’t look like a ‘Lehman moment’. However that doesn’t mean the failure is not significant.

Silicon Valley Bank was the dominant lender to the US venture capital industry, was the 16th biggest bank in the US, and it was valued at over $44bn at the end of 2021.

It’s failure is probably not systemically disastrous, except in exactly why Silicon Valley Bank got into trouble and what it reveals (again) about the state of the financial system.

Because its failure isn’t really due to troubles in the venture capital ecosystem that it serves  – despite the well-documented collapse in tech and start-up valuations over the past 18 months.

No, it has been undone by our old and now clearly not so risk-free friend – fixed income.

On the run

At the height of the post-pandemic growth mania, everyone was throwing money at the venture capital sector.

The biggest VC companies ballooned. Some began to pivot their strategies to become permanent owners of the companies they funded. Meanwhile at the other end of the spectrum, VC newsletter writers and podcasters launched one-man firms and raised real money.

One way or another, much of this froth ended up on deposit at Silicon Valley Bank. As the FT explains, the bank then decided to park $91bn of these deposits into low-risk but – crucially – long-dated assets, such as mortgage-backed securities and US government bonds.

Well we know what happened next. But in case you’re still oblivious to the regime change, central banks around the world hiked interest far faster and further than anyone predicted. This crashed everything from blue sky tech firms to Amazon and Apple to the 40 in your 60/40 portfolio.

It also saw Silicon Valley Bank’s portfolio of safe assets that stood behind its customer deposits fall $15bn underwater.

Which wouldn’t in itself have been a problem – the assets have a positive yield-to-maturity, and will pay out their face value in the long run – unless sufficient depositors got scared and began to demand their money back in droves.

Which is what happened this week.

As economist Noah Smith explains in a comprehensive piece, the US FDIC scheme – the equivalent of our FSCS guarantee – was beefed up after the financial crisis to try to stop this happening:

Because everyone knows the federal government will cover their deposits, they aren’t worried about losing their money in a run, so they’re never in a rush to pull it out. And because they never rush to pull it out, runs can’t even get started.

For a normal bank, about 50% of deposits are FDIC insured.

But there’s a but:

But 93% of SVB’s deposits were not FDIC insured. So SVB was vulnerable to a classic, textbook bank run.

Why did SVB have so many uninsured deposits?

Because most of its deposits were from startups. Startups don’t typically have a lot of revenue — they pay their employees and pay other bills out of the cash they raise by selling equity to VCs. And in the meantime, while they’re waiting to use that cash, they have to stick it somewhere.

And many of them stuck it in accounts at Silicon Valley Bank.

Smith gives an excellent summary of how the run got started. It was down to the usual alchemy of initial lemming-like behaviour transforming into rational action once everyone else is at.

Just as we saw 16 years ago with Northern Rock.

We are gonna make it…

The consensus of opinion this weekend is that Silicon Valley is an outlier that over-served a concentrated customer base. And so that the rest of the financial system isn’t very exposed.

I imagine US regulators are pulling all-nighters to try to ensure that narrative holds over the weekend. Ideally they’d probably want to get the bank’s business shifted into bigger and safer hands by Monday.

However the episode is another example of the rapid ascent from near-zero interest rates leading to a mild calamity. We previously saw it with the Mini Budget-provoked pension crisis here in the UK, and I’d argue with the collapse and bankruptcy of much of the cryptocurrency infrastructure.

The more of these blow-ups we go through without a system-wide meltdown, the more confidence we’ll have that the financial system was sufficiently shored-up following the dramas of 2007-2009.

I mean, just imagine what would have happened to bank balance sheets following the collapse in fixed income asset values last year if they had still been levered-up like in 2007.

On the other hand, the more of these blow-ups we see, the more we might fear that one of them is going to get us eventually. (My best bet would be something connected to the global housing market.)

So let’s hope inflation calms and rates can stop rising soon.

Have a great weekend!

From Monevator

Stocks and shares ISAs: Everything you need to know – Monevator

The Annual ISA allowance: How it all works – Monevator

Is cash a money maker for you or for your broker? – Monevator

From the archive-ator: How should you invest for your age? – Monevator

News

Note: Some links are Google search results – in PC/desktop view click through to read the article. Try privacy/incognito mode to avoid cookies. Consider subscribing to sites you visit a lot.

‘Cut stamp duty to boost UK stocks’, brokers urge [Search result]FT

Spring Budget 2023 rumours: what could be announced? – Which

Why the chancellor wants this budget to be boring – BBC

FCA urges banks to consider cutting mortgage payments for those struggling – Guardian

Gary Lineker: a stand-off with no clear exit strategy – BBC

The UK’s housebuilding crisis [PDF]Centre for Cities

Products and services

Zopa and Tandem launch new best buy savings rates – This Is Money

Open a SIPP with Interactive Investor and pay no SIPP fee for six months. Terms apply – Interactive Investor

A new solar offering from Ripple Energy – DIY Investor UK

When do lockdown-era airline credit notes and vouchers expire? – Which

Open an account with InvestEngine via our link and get £25 when you invest at least £100 – and an additional £100 if you invest at least £10,000 into an ISA before 2 May (T&Cs apply. Capital at risk) – InvestEngine

Fears pensions are being overlooked in DIY divorces – Which

Could you afford your home at today’s mortgage rates? – This Is Money

Homes with film connections, in pictures – Guardian

Comment and opinion

Putting guardrails around your retirement spending – Humble Dollar

Active versus index funds: latest results – Mathematical Investor

Dying with millions – Best Interest

Is it easier for investors to forecast the short or long-term? – Behavioural Investment

Morgan Housel has started a podcast [Podcast] – via Spotify

Bonus – Indeedably

How to make a fortune out of secondhand furniture – This Is Money

Backtests are unemotional. Humans are not – A Wealth of Common Sense

Priceless possessions that cost next to nothing – Humble Dollar

Things important and unimportant – JL Collins

Commodity investing and its role in a portfolio [Nerdy, PDF]Vanguard

Naughty corner: Active antics

Why Tim Ferris wouldn’t do as well starting angel investing today – Tim Ferris

Private company valuations defy fall in listed stocks, adviser says [Search result]FT

Enough: the forgotten lesson of Ben Graham’s life – Neckar Substack

Jeremy Grantham’s market meat grinder [Podcast]Bloomberg

Why you shouldn’t launch a hedge fund – Russell Clark

Kindle book bargains

Antifragile: Things that Gain from Disorder by Nassim Taleb – £1.99 on Kindle

Bank of Dave by Dave Fishwick – £0.99 on Kindle

Never Go Broke by Lee Boyce and Jesse McClure – £0.99 on Kindle

Green Living Made Easy: Hacks to Save Time and Money by Nancy Birtwhistle – £0.99 on Kindle

Environmental factors

Do fund managers really believe in ESG? – Klement on Investing

Hunt’s Budget to announce £20bn funding to cut carbon emissions – Guardian

How to stop cigarette butt litter – Hakai

AI, minds, matter mini-special

You are not a parrot – Intelligencer

What plants are saying about us – Nautilus

In AI, is bigger always better? – Nature

Off our beat

Staying alive – Humble Dollar

Psychological paths of least resistance – Morgan Housel

Gold old times, innovation edition – Klement on Investing

Peak TV is over. Welcome to Trough TV – Slate

Productivity and bullshit – Dror Poleg

A ‘claxonomy’ of Mexico City’s traffic [Multimedia]Allegra Lab

Infinite games – Young Money

Lang Lang gigs on the St Pancras concourse – Guardian

And finally…

“When you have more words to describe the world, you increase your ability to think complex thoughts.”
– Yeonmi Park, In Order to Live: A North Korean Girl’s Journey to Freedom

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