SVB and Silvergate Bank – Why?

March 31, 2023

How does a “bank run” lead to the death of a bank? Isn’t money just electronic now? Why can’t a bank just give people their money back if they want it?

The failures this week of Silicon Valley Bank and Silvergate Bank are, in simple and straightforward terms, caused by a situation where “panic meets terrible investment decisions”. How so?

When you deposit cash at your bank, that cash is on the banks balance sheet. This means they can do pretty much anything they want with it…so they use your cash for their benefit (and hopefully profit) and make loans, invest in bonds, invest in stocks, buy life insurance contracts, fund litigation receivables, and other investments. If the bank screws up and makes bad investments, the FDIC steps in to cover depositors up to $250,000 per beneficial owner of an account (e.g. a pension fund may have a billion dollars on deposit but is fully covered by the FDIC as the insurance reaches through the entity to cover the people in the fund)

This works just fine when deposits are stable. The bank keeps enough cash on hand to cover their depositors general use, and invests the bulk of their deposits in all the stuff mentioned above.

Now, in the event that the media publishes some scary news about the bank it’s human nature to go get your money out. And tell friends to go get their money out. Thus starts a “bank run” where more people want their money than the bank has available in cash…so they have to sell their investments to free up cash to cover the deposit withdrawals. Yes, the bank has some capacity to borrow cash from the Fed, FHLB, Promontory and others but can quickly exceed that and thus have to sell investments to cover depositor withdrawals. 

Now, in 2020 when interest rates hit zero, the banks were frantic to make investments in whatever they could in order to generate income to cover salaries, office rent, etc. So they bought 30-year Treasuries at 1%. They made home loans at 2.25%. And other investments and historically low interest rates. They kept doing this for years. Then interest rates started to go up…so they prayed they’d never have to sell those 1% Treasuries or 2% loans because any new buyer would only offer them $0.40 on the dollar…thus as long as deposits stayed stable and continued to grow, they’d never have to sell those and at some point in the future the investments would mature and repay in full – they’d only lose money if they had to sell them early (and on a 30-year Treasury or a home loan, “early” is a long time). 

A bank run is their worst nightmare. This forces them to sell those investments at massive losses. They don’t have enough money to pay everyone standing outside the doors demanding their cash. And the losses wipe out their regulatory-required capital. 

The bank closes, the FDIC steps in and gets depositors their money back up to $250K, and a new (big) bank steps in and takes over the failed banks branch offices, employees, and accounts (that does NOT include the failed banks accounts that were over $250K as that money is gone, vaporized).

Silvergate Bank was a one-trick pony servicing the crypto industry (it could have been any industry, crypto is not the cause…instead it was what regulators call over-concentration servicing a specific industry or clientele). When those depositors started withdrawing, the bank had no other deposits from other businesses/industries to rely on and so as their core deposits shrank they had to sell the astoundingly stupid investments they had made and, ultimately, didn’t have enough cash available to give to depositors.

SVB, while more diversified, shot themselves in the foot by timing a nerve-wracking, bank-run-causing press release the same time as the Silvergate news hit, causing a run on their bank. As big as SVB was, the losses they took selling their investments meant there wasn’t enough cash to cover investor withdrawals…and so the FDIC stepped in and ate their lunch. Connie at TechCrunch wrote a terrific article on this.

Lessons Learned:

First, ensure you never have more than $250K per beneficial owner at any bank (and be sure the account is titled correctly to reflect it).

Second, when you see news on something, move immediately, with no hesitation. SVB collapsed in less than 48-hours. Sadly I know of account holders there, including many venture funded startup’s, who’ve lost their entire funding. It’s not coming back…it’s gone.

WARNING: we see a lot of firms in payments and in Web3 who hold cash and other assets with firms who only have money transmitter licenses. These include Wyre, Zero Hash, crypto exchanges, and others. Money transmitters, like banks, hold your cash and assets on their balance sheets. They can…and generally do (or will, as greed pretty much always prevails) use your cash and assets to make investments for their own benefit, just like banks do.

But unlike banks, they are not FDIC insured.

So use them at your own risk. It’s stupid, in my opinion, to hold any assets whatsoever with a money transmitter. 

Only trust company’s and clearing brokers are required to hold customer cash and assets off from their balance sheets. We are not permitted to make those ridiculous investments with your cash. We can only hold it in FDIC-insured accounts or in financial instruments of the US Government (e.g. very short term Treasury notes). And absolutely no third-parties have any claims on them (again, unlike a money transmitter where creditors are ahead of “depositors”). It must be protected at all times. 

CONCLUSION: The world is not melting down. The failure of these banks is not an indication of 2008-style systemic problems. The banking system is fine. Only a very few banks are going to see this spiral of bank-run-meets-investment-losses-resulting-in-FDIC-takeover (and, yes, a few more will likely happen). Think about it, the cash being withdrawn is going somewhere…it’s going to other banks who are not experiencing a bank run but, rather, a deposit increase. Those banks are all fine, they have capital and operations and a team to keep servicing their customers and the markets just fine. 

Crazy times.

Disclaimer: as always, these are just my musings…my thoughts and observations as someone who is deeply involved in both crypto and banking. That said, I am in no way making a recommendation that anyone invest or divest in anything, ever. Only rely on the advice of your licensed investment, legal, and accounting professionals. These matters are extremely complex and something as short as my blog is just to reflect my opinions, not a complete analysis of any of the events or situations I discuss. So only make decisions after consulting with the professionals you employ.


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