From Cinderella Stories to Bank Runs: Understanding the Recent Financial Shake-up
We looked forward to Cinderella stories, buzzer beaters, and “one shining moment.” Instead, we got bank collapses, government backstops, and fear. I’m talking about the banks (Silicon Valley Bank and Signature Bank) that have dramatically exited the financial system — raising concerns over the financial system and economy.
The situation is still evolving, and the ripple effects started registering through payroll disruptions and limited cash access. In response, government officials from the Treasury, Federal Deposit Insurance Corporation (FDIC), and Federal Reserve have announced that depositors will be made whole, even those beyond the $250k FDIC insurance limit. Some argue this was necessary to prevent a larger meltdown. Others see it as a bailout for the wealthy tech elite.
Like a top-seeded team on the ropes against a doggedly determined upstart, it’s not time to panic. John Wooden coached UCLA to a ridiculous ten national title victories. As a Kentuckian, I wished this wouldn’t have happened, but it did, and it’s worth learning from. Over 14 years, Coach Wooden developed his “Pyramid of Success.” One of the 15 blocks that compromise the pyramid is poise, which Wooden defined as “never fighting yourself.”
“There was never a show of panic or any inclination to abandon the game plan.” — John Wooden
For investors, maintaining poise is critical, but poise does not always equate to inaction. In determining what, if any, steps need to be taken, it’s useful to try to understand the situation.
What happened with Silicon Valley Bank?
Banks profit by borrowing short and lending long. They pay customers interest on deposits (which must be available when the client wants their deposit back) and lend that money out longer (at higher rates).
From 2019 to 2021, Silicon Valley Bank’s deposits skyrocketed (3x growth from $61B to $198B). Due to their geographic proximity to America’s innovation center and well-established connections in the tech industry, they were uniquely positioned to capitalize on a flood of deposits from the government pandemic response and the SPAC and VC bubbles.
All that cold, hard cash had to go somewhere. In response to the pandemic, the Fed took rates to the floor, so to earn higher yields on those assets, management decided to tap into longer-dated bonds with higher yields.
Silicon Valley Bank poured funds into long-duration mortgage-backed securities (over $80B worth). Since then, deposit growth has slowed to a trickle, and the Fed aggressively raised rates with to curb inflation. That’s bad news for long-term debt holders like SIVB — because when interest rates go up, the value of existing bonds goes down. This isn’t a problem if the bank can hold the securities to maturity — but when deposits drop significantly, the bank is forced to sell (at a loss) to obtain liquidity.
Silicon Valley Bank is highly integrated into the tech startup space. Its corporate customer base comprises many venture capitalists (VCs), tech companies, biotech startups, etc. The VC community is tight-knit, which creates a concentration of influence — once a few influential actors begin to move money, others follow suit.
Word spread like wildfire that SIVB was raising equity to offset losses in their bond portfolio, sparking a mass exodus ($42B in withdrawals in just two days) — that was non-survivable.
What is a bank run?
Bank runs may be the best example of mimetic behavior in finance. Banking is a trust-based system, and maturity mismatch makes banks vulnerable to runs. A bank run occurs when there is a loss of faith in a bank which can occur for various reasons (economic shock, deteriorating balance sheet, loss of confidence in leadership, etc.).
When trust declines, customers rush to move their deposits from the bank. This creates greater deterioration of trust — when banking clients see others moving their money from the bank, they feel compelled to do the same, and momentum quickly turns from a simmer to a violent boil.
Ultimately, bank runs are the result of humans acting like humans.
What is the FDIC?
The FDIC was created in 1933 in response to the great depression. The idea is that if deposits are insured, there is less reason to panic — making bank runs less frequent.
Per the FDIC website: “The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category. Since the start of FDIC insurance on January 1, 1934, no depositor has lost a penny of insured funds as a result of a failure.”
What should you do?
Make sure your deposits are insured. If you have significant cash deposits, you should spread them across multiple insured banks (if over the FDIC standard insurance amount.
Don’t abandon your plan. Investing is challenging because our cognitive biases lead us to make poor long-term decisions in periods of fear and panic. No one knows what is around the corner, and a calm, disciplined approach generally beats panic-ridden flailing.
If recent events have you rethinking your plan, review it with regard to your risk tolerance, objectives, and time horizon — don’t make any rash decisions that are misaligned with your goals.
What next?
I don’t know.
The financial system is a tangled spaghetti of complexity — Covid 19 bullwhips, rapidly rising interest rates, government regulators, etc. But I do know that out of challenge emerges innovation. It’s said that constant change is more correct than stability — change is the human default mode.
Volatility is the price of admission to participate in long-term returns, and the last several years have provided an abundance of volatility. For now, patience is required to get through the latest round.
