SVB’s fall is not a Lehman redux but Washington has a problem

At the simplest level, SVB’s bet was that interest rates would stay largely the same. They didn’t. The US Federal Reserve also had a role to play. In early 2020, after covid broke out, it increased money printing to drive down interest rates and encourage consumption. Some of this printed money ended up with venture capitalists (VCs), which then invested this money in startups. SVB was a banker to both. Second, the Fed also indirectly handed over a lot of the printed money to the US government, which in turn put it in the hands of people, increasing their purchasing power. This, along with supply chain problems during the pandemic, led to very high inflation. These factors then led to the unravelling of SVB.

For the three months ended December 2019, SVB had average deposits of $55 billion, average total lending of $29.9 billion and fixed income investments of $27.8 billion. Around a fourth of the investments were in US Treasury securities. As the Fed printed more money, the average deposits of SVB for the three months ended December 2021 went up to $147.9 billion. Its lending was at $54.5 billion. So, while its deposits expanded at a fast pace, lending didn’t. Meanwhile, SVB’s investment in fixed income securities had jumped to $111.7 billion. Clearly, when it came to raising deposits, the bank had great relationships with VCs and startups, but was unable to give out loans at a similar pace.

For the three months ended December 2022, SVB’s average deposits were at $173.1 billion, with loans of $74.3 billion and investments in fixed-income securities of $117.4 billion, largely in Treasury and mortgage-backed securities (MBS). In March 2022, the Fed started raising interest rates to control inflation. Now, bond prices and interest rates are inversely related. As interest rates went up, bond prices fell. Treasury securities are bonds issued by the American government. MBSs are bonds issued to securitize mortgages.

Indeed, SVB had loaded up its balance sheet with such securities. Their prices fell. The Economist reports that the bank sold its “entire liquid bond portfolio" and took a loss of $1.8 billion. On 8 March, the bank announced that it was raising $1.75 billion through fresh share sales to fill this gap.

This news was negatively received and SVB’s stock price crashed. Further, as the news of this crash went viral on social media, depositors started withdrawing money, leading to an old-styled bank run. Now SVB was a banker to startups and VCs. Given this, the size of its average deposit was large and 93% of its deposits were greater than $250,000, and hence uninsured.

Even the best bank cannot withstand a sustained bank run. Depositors want their money back immediately, but that money is tied up in loans and investments. Given this, while the bank isn’t really insolvent, it’s just not in a position to be able to convert its assets into cash immediately to pay these depositors.

This dynamic forced government authorities to close the bank on 10 March. Once this happened, VCs, who are otherwise huge votaries of allowing a market failure to play out, started talking about the government needing to rescue the bank, saying that if that did not happen, there would be more bank runs.

On 12 March, in a joint statement, the American Treasury department, the Fed and the Federal Deposit Insurance Corporation (FDIC) announced that depositors of SVB will have access to all their money from 13 March. The cost of this arrangement will not be borne by taxpayers, but the shareholders and many bondholders of the bank will get wiped out. The FDIC will step in if needed.

In fact, many newbie commentators have compared SVB’s fall to the Lehman crisis of 2008. This is totally wrong simply because this isn’t a case of indiscriminate lending that had caused the fall of Lehman Brothers.

If comparisons are to be made, the fall of SVB is closer to many American savings and loan (S&Ls) institutions, which got in trouble through the 1980s and early 1990s. S&Ls borrowed for the short term through their passbook savings account and lent long-term in the form of fixed-rate 30-year mortgages (i.e., home loans).

In August 1979, Paul Volcker took over as Fed chairman. Back then, the US was facing very high inflation. To restore price stability, Volcker began raising interest rates. The rates at which S&Ls had to borrow went up as well, but they were not matched by higher rates on existing mortgages. These mortgages had fixed rates. So, both SVB and S&Ls bet on rates remaining the same. That assumption turned out wrong.

To conclude, the bigger question is how big the unrealized losses are of other US banks on account of rates going up and bond prices falling. Economist Nouriel Roubini tweeted on 12 March that US banks have roughly $620 billion of unrealized losses, amounting to 28% of their equity of $2.2 trillion. For many smaller banks, this ratio is closer to 50%. Factoring in this reality, the Dow Jones US Banks Index fell by 7.3% on Monday. Given this, it’s safe to say ‘Washington, we have a problem.’

Vivek Kaul is the author of ‘Bad Money’.