There have been some big market moves after the second biggest bank failure in US history. Overseas bank stocks continue to fall, while Bitcoin is flying once again. Perhaps the largest moves have been in bonds. Overnight, the 2-year note yield fell 61bps, the biggest one-day decline in 40 years.

How to make sense of all this? In this article, we’ll answer four key questions that investors have about the fallout from the closure of Silicon Valley Bank (SVB).

What caused the crisis?


It’s hard to fathom that SVB’s market cap was US$44 billion just 16 months ago, and now it’s essentially worthless. How did it go so wrong so quickly?

The simple answer is that there was a run on the bank. A flood of deposit withdrawals overwhelmed SVB. Bank runs have happened thousands of times throughout history, and SVB is little different in this regard.

Yet, if you dig deeper, there’s a story of management incompetence.

Silicon Valley Bank

A flood of deposit withdrawals overwhelmed SVB. Picture: AP

SVB took short-term deposits from tech companies and venture capitalists and invested in 10 to 30-year debt. It’s what accountants call a classic asset-liability mismatch.

Management didn’t consider that if there was a significant withdrawal of the short-term deposits, they might be forced to sell their long-term debt early at a loss.

The counterargument is that SVB was just investing in safe government bonds. How could it have known that they’d have to sell these bonds early?

In a way, it’s understandable that SVB did invest in these bonds as the US Federal Reserve and US government had implored banks to do just that after the 2008 downturn. And in government stress tests after the GFC, owning these bonds got banks ticks of approval from regulators.

But the key point here is that SVB took short-term money and invested long, which is a rookie banking error.

Zooming out further, there’s a deeper cause for this crisis. The US Federal Reserve and other central banks including the RBA, kept interest rates post-GFC at historic lows for the better part of 10 years. These rates were kept at emergency levels even when the patient (economies) had largely healed.

The cheap money caused a bubble in many assets, from real estate, to bonds, crypto, tech, art, start-ups, venture capital, private equity, and the list goes on.

When Covid-19 hit, central banks again flooded economies with printed money, but unlike during the GFC, a lot of that money went directly to people rather than through intermediaries such as banks. And this time, that printed money caused inflation.

The inflation spike meant central banks had to raise rates, and quickly. However, if these banks hadn’t kept rates low for too long, they wouldn’t have had to lift rates as fast as they did.

With SVB, it was inundated with deposits as tech startups made squillions during the Covid crisis, largely from the printed money of central banks ending up in the hands of consumers. SVB unwisely chose to invest that money in long-term bonds.

And as the tech bubble unwound, the deposits start to flow out, slowly at first, and then en masse.

It’s interesting that even the San Francisco Federal Reserve has belatedly acknowledged the risks of keeping interest rates low for lengthy periods.

In a working paper published last month called “Loose Monetary Policy and Financial Stability,” it concludes that “when the stance of monetary policy is accommodative over an extended period, the likelihood of financial turmoil down the road increases considerably.”

And: “This study provides the first evidence that the stance of monetary policy has implications for the stability of the financial system.”

The first evidence? It might be the first evidence for the San Francisco Fed, but history is littered with instances of low interest rates causing bubbles and financial instability.

Was this a bank bailout?


Despite what politicians, bureaucrats, and tech billionaires tell you, this certainly is a bailout.

The US government announced that it would backstop all bank deposits at SVB and other failed banks through an insurance fund rather than through taxpayers. The government was at pains to emphasise this part of the plan. A bit like a magician distracting your attention via one hand while conducting the real trick in the other.

Because the other part of the plan is more important. For banks that continue to stay open and hold long duration bonds that are underwater, the Federal Reserve will lend against those bonds at full value, or 100 cents on the dollar. That means other banks will get full value for their investments, well above what they’re currently worth.

The result is these banks are being bailed out with Federal Reserve money, aka taxpayers.

The government’s plan has echoes of 2008, when the SVBs of the day, like Lehmann Brothers, were allowed to fail, but other banks benefited from the TARP (Troubled Asset Recovery Program) plan to stabilise the financial system. TARP provided collaterialised loans to these banks, charged interest, and the government eventually made a large profit from them.

Are there more bank runs to come?


Possibly. While the US government’s rescue plans included protecting SVB depositors, they wiped out equity and bondholders in the company.

Given the precipitous falls in US regional bank stock prices, investors think equity holders in these businesses may also be in trouble. Note that many of these banks hold long duration bonds that are significantly underwater, and they may be forced to sell these – if they get the chance.

The larger point is that when bubbles unwind, they usually take a few years and involve several credit events.

During the GFC, the first signs of trouble were from the bankruptcy of New Century, an American REIT specializing in subprime lending, in April 2007, almost 18 months before a full-blown crisis happened. Then there was a rolling wave of bank troubles in the US and worldwide that culminated in the events of October 2008.

SVB may be just another domino to fall as central banks normalize interest rates.

What impact will this have on interest rates going forward?


It’s hard to tell. Bond markets are saying that the bank failures will force the Fed and the RBA to pause interest rate hikes, possibly immediately.

The price of Bitcoin is suggesting a similar story: that the Fed will back down from fighting inflation to save the financial system.

The problem for the Fed is the vast debt in the global financial system. If it raises rates further, more things will inevitability break. If it pauses or starts to cut rates, it risks fuelling inflation.