It’s personal.
When I hear about the biggest failure of a U.S. bank since the 2008 global financial crisis, and the second biggest U.S. bank failure on record, it really does feel that way.
As you probably know, I’m talking about Silicon Valley Bank (SVB).
When I heard the news, I recalled my career on Wall Street.
In the ’90s, I worked as a strategist at Lehman Brothers and as a senior managing director at Bear Stearns. Both collapsed during the 2008 crisis.
Back then, the banks were aware of internal problems. And they hoped they would weather the storm.
This month, the same scenario played out with SVB. Insiders were aware of trouble below the surface. But the downturn didn’t pass.
So when the 16th-largest bank in the U.S. failed, people were quick to blame the bank and its poor management.
That’s fair – and not entirely wrong. But what makes this time different from 2008 is the Federal Reserve’s role.
So, today, I want to dive into the reasons that took this “too big to fail” bank to the brink of collapse… and show you what it means for your money.
Trouble at One of the “Best Banks” in America
For five years straight, Silicon Valley Bank was voted one of the best banks in America. And yet, it was terribly mismanaged.
There’s plenty of blame to go around, and many are pointing the finger at SVB CEO Greg Becker.
As I wrote to you last week, Becker was one of the people who lobbied to deregulate his own bank. He led the bank’s half-million-dollar push to reduce scrutiny of his institution, citing its “strong risk management practices.”
Yet, SVB was lacking in that exact department. The bank suffered from internal issues. For example, it failed to properly manage its assets, liabilities, and risk hedging.
In fact, the only risk management that CEO Becker did was sell $3.6 million worth of his shares – less than two weeks before the bank’s downfall.
And when problems started piling up, Becker publicly confessed to the extent of the bank’s financial troubles… before ever preparing the necessary financial support to weather the storm.
That news unleashed a wave of panic across Silicon Valley. Up until that point, SVB served as a key lender to tech companies and startups.
The result?
Customers tried to pull out $42 billion in deposits on March 9 alone. SVB had a negative cash balance of about $958 million by the end of that day. Its stock price declined by 60%.
Not long after, regulators shut down the bank.
The Fed Broke SVB
But the story behind the collapse is bigger than just mismanagement.
You see, the Federal Reserve helped break SVB.
Remember, the SVB fiasco happened under the watchful eyes of the Fed and its thousands of bank regulators.
And as you well know, the Fed’s been hiking interest rates aggressively since March 2022.
This has wreaked all sorts of havoc on the broader economy.
But it also took a toll on banks…
For one, with rates going up quickly, banks had to compete with government-issued Treasuries. They were late to the rate-hiking party, and they failed to raise interest rates on their deposits fast enough.
So when people chose to put their money in Treasuries instead of bank deposits, the banking sector was in trouble. It lost over a trillion dollars in the first three quarters of 2022 alone.
But that’s not the only problem banks are facing…
When rates went from zero at the start of 2022 to over 4% by the end of that year, bond prices fell fast on the open market.
This meant that any bank that bought these bonds before the rates went up saw a big paper loss. Here’s why…
When new bonds are issued with a higher-paying rate, investors are better off buying them. So this makes existing bonds with lower rates less attractive.
You wouldn’t pay the same price for a five-year bond that pays 1% on the open market versus one that the government now pays you 4% to buy. The 1% bond is giving less interest, so you’d pay less for it.
As bond investors act on these rate changes, the value of existing bonds on the open market drops.
Now, normally, a bank holding these bonds should not face any problems… As long as it keeps the bonds for the duration of their maturity.
But what if there’s a bank run and you need to process withdrawals you no longer have? Well, you’d have to sell some of those assets right away.
Yet, those government bonds would still be underwater. So your “paper” losses turn into actual ones.
It also means you’d get a lot less money than what you need to pay back your customers.
Which is exactly what happened to SVB.
When SVB’s CEO announced that the bank was selling $21 billion worth of bonds (and mortgage-backed securities) at a $1.8 billion loss… customers rushed to withdraw their money.
And SVB collapsed.
But it wasn’t the only bank at risk.
After all, the Fed’s steady rate hikes caused the value of banks’ reserves – their balance sheets – to plummet.
In fact, banks are currently saddled with $600 billion in unrealized paper losses on their portfolios of government securities.
You don’t have to be a finance wiz to see why this is a problem.
It’s like banks are sitting on a financial time bomb. You never know when the next bank run will happen. But as we’ve seen, when they do, those “paper” losses become very real.
What This Means for Your Money
Poor risk management may have spurred the SVB failure, but the Fed’s rate hiking was central to it. After all, even the biggest banks are not immune to the central bank’s aggressive policies.
So, what does that mean for you?
Here’s what Bloomberg wrote last week:
The cliché is that the Fed must tighten until something breaks. Now that something’s broken, it’s far more plausible that the Fed will change course.
They are referring to the Fed’s pivot to a more neutral monetary policy, which I’ve been talking about since August. (For a refresher on that, check out this video update.)
As you may recall, the Fed raised interest rates by 0.25% at the Federal Open Market Committee (FOMC) meeting in February.
And yesterday, at their March meeting, the Fed raised interest rates by another 0.25%.
This means the Fed chose to tread carefully. And it means that we remain firmly in what I call Stage 1 of the Fed’s pivot.
But, given the banking uncertainty, it would not surprise me to see Stage 2 take place earlier than expected. Stage 2 would mean a pause in rate hikes. It could happen as soon as the Fed’s next meetings in May or June.
If this happens, the markets will breathe a sigh of relief. And they may begin an, albeit choppy, path toward higher prices.
With the Fed’s three-stage pivot in action, the question then becomes: Are we going to see a dramatic collapse of the global banking system? In other words, is this truly the next Lehman moment?
We already know that SVB was just one of three U.S. banks to collapse. Silvergate and Signature Bank collapsed the same week. And in Europe, Credit Suisse failed not long after.
I’ll have more to say on this next week, where I’ll dive into the contagion risk in the global financial system. I’ll also show you what it means for you… and how you can counter these effects in your portfolio.
In the meantime, as I wrote last week, there are things you can do to be prepared.
The most important precaution you can take is to make sure your deposits are FDIC-insured. You can find out which banks are insured through this directory.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins