On March 7, 2023, Silicon Valley Bank got featured in Forbes’ annual list of best American banks. Three days later, the shocker came as the financial institution was taken over by the United States government, after its shares tanked by over 60%.
US financial regulators have rolled out emergency measures to arrest the aftereffects of the crisis. The bank depositors will now get access to their money. Other banks will also be able to borrow from the Federal Reserve for 2024, as long as the loans are matched by safe government securities.
US Treasury chief and veteran economist Janet Yellen, however, decided not to compare the situation with the 2008 financial crisis, when the collapse of large banks threatened to bring down the global financial system.
Understanding The Gravity Of The Crisis
Silicon Valley Bank had assets valued at USD 212 billion and these were primarily lent to tech start-ups.
The bank has been placed under the Federal Deposit Insurance Corporation (FDIC) control, with the latter guaranteeing deposits of up to USD 250,000 for the affected parties.
Silicon Valley Bank’s woes have also resulted in the downfall of the values of other US regional financial institutions. New York-based Signature Bank has been shut down by the FDIC. The regulatory body has also taken control over the bank’s USD 110.36 billion worth of assets and USD 88.59 deposit storage (as per December 2022 stats).
First Republic Bank, Western Alliance and PacWest too have been affected by the crisis.
In the United Kingdom, HSBC will take over SVB’s operations in the country. This will override the Bank of England’s initial decision to place the entity into insolvency, apart from protecting the finances of the bank’s 3,500 customers, including hundreds of tech start-ups.
Crypto company Ripple Labs had “business exposure” to Silicon Valley Bank but remains in a strong financial position, clarified CEO Brad Garlinghouse. Ripple, currently engaged in a lawsuit with the United States Securities and Exchange Commission (SEC) over the status of the cryptocurrency XRP, had reportedly stored some of its cash reserves at the Silicon Valley Bank.
What Went Wrong For SVB?
As the world went into COVID lockdowns in 2020 and 2021, remote working became a part of the mainstream economy. This resulted in the rise in the fortunes of tech start-ups, as companies bet big on technology to keep their operations going amid business disruptions.
The tech companies used Silicon Valley Bank for payroll and other monetary services and the bank received an influx of deposits. SVB used the investors’ money in US government bonds, including those supported by mortgages. The prices of these bonds generally go down when the Federal Reserve hikes interest rates. As the Joe Biden government started its monetary policy tightening in 2022 beginning, it resulted in SVB’s bond portfolios undergoing value losses.
The only feasible option for the bank would have been to hold onto these bonds till their maturity stage, in order to get the capital back.
As the tech sector went into a financial bloodbath in 2022, SVB’s customers reportedly started drawing on their deposits. The bank sold some of its bonds at massive losses.
On March 8, 2023, it announced a USD 1.75 billion round of capital raising, while informing its investors about the need to ‘plug a hole’ caused by the sale of its loss-making bond portfolio.
However, aware of SVB’s mess, its customers started withdrawing money en masse, which was reportedly stored in larger accounts.
On March 10, the collapse finally happened. It is now the largest bank failure in the United States since the 2008 global financial crisis.
Revisiting The 2008 Mess
In 2007, global financial markets started showing signs of the negative fallouts of the cheap credit binge. Not only did two Bear Stearns hedge funds collapse, but BNP Paribas also warned investors that the latter might not be able to withdraw money from the bank’s funds. British bank Northern Rock reportedly mulled emergency funding from the Bank of England.
However, only a few investors could anticipate the onset of the worst crisis in nearly eight decades, which brought Wall Street’s giants, triggered the Great Recession and cost people their jobs, savings and homes.
The 2008 financial crisis began with cheap credit distribution and relaxed lending standards, along with years of low interest rates, fuelling the creation of a housing bubble. As it burst, banks were left holding trillions of dollars of worthless investments in subprime mortgages.
The Federal Reserve lowered its rates from 6.5% (in May 2000) to 1% (in June 2003), in order to boost the US economy by making money easily accessible to businesses and consumers.
The move resulted in an upward spiral in home prices. Subprime borrowers, those with poor/no credit history, were also able to buy homes.
The lenders then sold these loans on to Wall Street banks, which, in turn, packaged these entities into low-risk financial instruments such as mortgage-backed securities and collateralized debt obligations (CDOs). The whole chain created a big secondary market for originating and distributing subprime loans.
The US Securities and Exchange Commission (SEC) in October 2004 relaxed the net capital requirements for Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns, and Morgan Stanley, thus freeing the latter to leverage their initial investments by up to 30/40 times.
Eventually, interest rates rose and homeownership reached a saturation point. In 2006, the Fed rate was revised at 5.25% and it remained as it is until August 2007. By 2004, US homeownership peaked at 69.2% and by 2006, home prices started going down. The US homeowners couldn’t sell their properties, as they owed a high amount of money to their lenders. Subprime borrowers were stuck with mortgages beyond their payment capacities.
In 2007, subprime lenders went into a bankruptcy spree. Bear Stearns stopped redemptions in two of its hedge funds, prompting banking giant Merrill Lynch to seize USD 800 million from the funds. Northern Rock had to approach the Bank of England for emergency funding due to a liquidity problem. In October 2007, Swiss bank UBS announced losses worth USD 3.4 billion from subprime-related investments.
By 2008, the United States and world economies entered the recession phase, and financial institutions’ got surrounded by liquidity struggles. Northern Rock got nationalised. Bear Stearns collapsed and was taken over by JPMorgan Chase. IndyMac Bank too failed. Two of the United States’ biggest home loan lenders Fannie Mae and Freddie Mac, were seized by the government. The crisis reached its zenith with the downfall of Lehman Brothers in 2008 September.