Banks Fail, Don't Panic
A disclaimer. I am not a banking liquidity expert, so take everything I write with a few truckloads of salt. Still, my job is to learn about complicated events and describe them to students. The SVB collapse is big in-the-news event that I wanted to figure out well enough to explain to my students, so I thought “why not lay it out for my dear readers?” I hope this helps make everything clearer for a few folks. (It did for me!) For more in-depth coverage by someone who actually knows economics, read Noah Smith’s “Why was there a run on Silicon Valley Bank?”
What happened?
Silicon Valley Bank (SVB) shut down on Friday. Its assets have been taken over by the Federal Deposit Insurance Corporation (FDIC), the organization that underpins America’s banking system. The FDIC created a new Deposit Insurance National Bank of Santa Clara and transferred SVB’s assets to the new entity. NBSC will now supervise the hopefully smoothish transition that will ensure depositors recoup as much of their money as possible (which may mean all of it).
This is a medium big deal because SVB was a medium big bank. As of December 31, 2022, the Federal Reserve listed it as the 16th biggest bank in the United States, with assets of $209 billion. That’s a lot of cheddar, but it’s dwarfed by the assets of the big four banks: JPMorgan Chase ($3.2 trillion), Bank of America ($2.4 trillion), Citibank ($1.8 trillion), and Wells Fargo ($1.7 trillion). If you add up the assets of the top 2,124 commercial banks listed by the Fed ($21.7 trillion), SVB’s assets make up slightly less than 1% of the total.
Why did it happen?
SVB experienced a classic bank run.
Banks get their money from investors (who expect a return on their investment) and depositors (who expect the bank to not lose their cash). Banks take this money and invest it in other things (like real estate and tulip futures). So when you put your $387.02 in Friendly Bank Corp, they take most of it and buy stuff like the mortgage on Auntie Mame’s Bait and Cosmetics Shoppe. Typically, if you want your money back this isn’t a problem because they’ve kept adequate cash on hand to deal with normal transactions. Large banks must maintain cash reserves of at least 10% of the money deposited with them. This is usually enough to cover any withdrawals by customers. If everyone wants their money back all at once, however, there’s a problem because most of a bank’s assets are not very liquid, meaning easily sold (because you gave Auntie Mame a 10-year loan).
Earlier in the week, SVB’s customers began to be afraid their money wasn’t safe anymore. They hurried to withdraw it. The first on line got lucky, but as panic spread, it soon became impossible for SVB to cover all the customers who wanted to take out their money. The bank was forced to shut its doors.
Yes, but WHY did it happen?
A few things seemed to have gone wrong.
First, SVB made some bad investments. They put a lot in long-term fixed-rate securities, but the post-pandemic rise in inflation caught them by surprise. The Federal Reserve naturally raised interest rates to fight inflation, and this decreased the value of SVB’s relatively low payout investments (because they were purchased when the inflation rate was lower), and investors could now find higher yields elsewhere.
Second, some big venture capitalists, including Arjun Sethi of Tribe Capital and Peter Thiel of Founders Fund, advised their clients to pull their money out of SVB. Their clients listened, and then other clients listened, and then everything went tumbling down in a classic panicky bank run.
Finally, much of this seems to be rooted in a slowdown in the tech sector. SVB had an unusually high proportion of risky tech money deposited in its accounts. There was probably some groupthink going on here. “Oh, you bank at SVB? I guess I will too!” The general slowdown in tech investment meant SVB was seeing less venture capital money flow into its coffers while its tech startup clients were burning through their cash at high rates. It was a bad combination.
Why is it such a problem?
It’s probably not a problem for you. The FDIC covers most bank deposits up to a total of $250,000. Your money is fine. Assuming there’s still an America tomorrow, you’ll still have your cash.
SVB, however, was unusual because about 93% of its clients had deposited over $250,000. None of this money is insured. SVB was the bank of choice for a lot of startup tech firms. Those companies got millions in investment money that they then stashed away in the bank while they tried to make a bundle on their new invention the AI-LawnMower. Most of that money—any amount over $250,000—is not insured by the FDIC. That’s why this bank collapse is a bigger deal than usual.
This all means that scads of startups may have a hard time paying employee salaries and covering other necessary expenses. For those companies, this is a huge deal.
There is also the risk of a wider financial panic. If too many people look at what happened to SVB and become alarmed, this could cause other bank runs. This seems extremely unlikely to affect big banks (like my own Chase) but smaller regional banks might be at greater risk.
Of course, the FDIC is working overtime to make sure nothing too bad happens.
Wait, what’s the FDIC?
The Federal Deposit Insurance Corporation is a semi-independent government corporation created by the Banking Act of 1933 to prevent bank runs, an endemic problem in 19th and early 20th century America. The FDIC’s income comes from member banks that pay dues, essentially insurance premiums. It is run by a five-person board of directors. The current chairman, Martin Gruenberg, has served on the board since 2005 but was only chairman under Presidents Obama and Biden.
When a bank fails because of insolvency (not having enough funds to cover its customers’ withdrawals), it is closed by its chartering organization (either a state government or the United States Comptroller of Currency), and the FDIC is appointed to protect depositors and supervise the transfer of assets.
The main goal of the FDIC is to achieve a smooth transition. Ideally, the bank’s assets are sold to another bank that then takes responsibility for guaranteeing some or all of its deposits. In the meantime, the FDIC will do its best to protect the interests of depositors.
So what happens now?
For now, the temporary entity created by the FDIC—the Deposit Insurance National Bank of Santa Clara—will handle the bank’s assets and guarantee depositors access to their money up to the $250,000 limit. The FDIC will also be busy trying to find another bank to buy what’s left of SVB. This may not be too hard because the new bank would be getting some assets and lots of new customers.
The FDIC has promised depositors that their $250,000 insured money will be available Monday morning. Depositors who have money over that insured amount will get an advanced dividend—a percentage of what they are owed—later in the week. They will also receive a receivership certificate, which guarantees them additional money as the FDIC sells the bank’s assets.
If the FDIC can find a new owner,1 that bank and the FDIC will do some higgledy-piggledy adding and subtracting and figure out how much of SVB’s assets can cover what percentage of its deposits. It’s quite possible, likely even, that all of the depositors’ money, including the amount over the insured limit, will be reimbursed. There’s a lot of pressure on the FDIC and the federal government to figure out some way of refunding 100% of depositors’ money because nobody wants to see widespread panic.
Why would you take the risk? It seems to me like a no-brainer to make all depositors whole.
— Megan Greene, chief economist Kroll Institute
And who loses? Quite probably the bank’s investors. Their money wasn’t insured and they’re going to pay the price for making a poor investment.
To be clear, this will probably not involve a government bailout.
Assuming the FDIC handles this, your taxes will not pay for SVB’s mistakes. The FDIC is funded by banks, not by tax dollars. Bank insurance rates may go up, which may have a small indirect effect on you if you’ve invested in bank stocks. Whatever price is paid will be spread across a wide range of institutions. This seems a reasonable cost to pay for a banking system where depositors aren’t terrified that bank runs will happen every five minutes.
Could things get bad?
I don’t know who Jason Calacanis is except that he’s an investor with gobs more money than me (and follows me on Twitter), and so maybe he’s correct, but the people I’m reading suggest that this will all settle down without any giant crisis. (Famous last words, eh? Given his use of all caps, I think it’s funny that Calacanis has been a major investor in Calm, a popular meditation app.)
This is not 2008, when a bunch of banks had overinvested in mortgage-backed securities. This is one unusual bank with an unusually high number of uninsured deposits. The American economy is humming along pretty well; unemployment is at 3.6%, GDP rose 2.1% in 2022, and while the stock market is below its 2021 peak, it’s well above what it was pre-pandemic. A single bank going under will not destroy the economy.
Of course, banking, like everything else financial, is based on trust. Panic is real. Contagion is real. If everyone thinks the banks are failing, the banks will start to fail. If every single American freaked and rushed to withdraw their cash from their local bank so they could stuff all those sweet Benjamins into their collective mattresses, we’d be pretty darn verkakte.2
It’s like FDR said in his first inaugural address: “the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.”
For this reason, government officials are working overtime to fix this mess. Even more importantly, they are working to convince Americans that they are fixing this mess.
I’ve been working all weekend with our banking regulators to design appropriate policies to address this situation.
We want to make sure that the troubles that exist at one bank don’t create contagion to others that are sound. We are concerned about depositors and are focused on trying to meet their needs
— Treasury Secretary Janet Yellen
They do have the tools to handle the current situation. They do know the seriousness of this, and they are working to try to come forward with some announcement before the markets open. I’m hopeful something can be announced today [Sunday].
— House Speaker Kevin McCarthy
I’m not worried. I don’t think we Americans are that scared. It’s one medium-sized fairly anomalous bank. Some investors will get burned, but the economy as a whole will trundle along without a big hiccup.
To sum it all up
A bank failed partly because of poor investments, partly because of panicky human nature. This bank had an unusually high proportion of uninsured deposits by tech startups. This is going to create some serious short-term problems for those companies. The FDIC is stepping in to ensure a smooth transition to new ownership. Most, perhaps all, deposits will eventually be saved. Everything is fine. Probably.
Edit: Breaking News, Sunday, March 12, 6:24 pm
All depositors’ money will be covered.
After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the president, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, Calif., in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.
— Joint statement from Treasury Secretary Janet Yellen, Federal Reserve Chair Jerome Powell, and Federal Deposit Insurance Corp. Chair Martin Gruenberg
Edit: Final Postscript
Click to read this 700-word tweet describing the SVB panic and bank run from the POV of one CEO client. Just a slice of what it must have felt like to be in the middle of the madness.
This may be more difficult than it would be with other banks because SVB was awkwardly a bit too big. As Matthew Yglesias put it in a tweet, “The issue with SVB is that the VC and startup communities and their social peers all clustered into this one bank to the point where it became awkwardly sized and the list of feasible buyers is very short.”
Verkakte - Shitty, crappy, bad.
The short version: it's entirely possible that this is a one off, other banks will be fortified, and the FDIC will protect the deposits. In a few weeks/months this will be just another bank failure and we all move on to the next Huge World Ending Crisis (Trademark Pending).
The Long Version: Please watch the Big Short
I had Noah’s latest post just before this one. I love his blog, but oftentimes when he gets in the weeds about economics, my little brain is in the habit of turning off. After reading your post I feel like I have an understanding of what happened. Thank you teacher!