Here Are Two Things That Went Wrong at Silicone Valley Bank

It is no longer news that one of the IT industry's preferred lenders and “startups bank,” Silicon Valley Bank (SVB), has ceased operations in what has been called the largest financial catastrophe since the 2008 financial crisis. Real estate investor and automobile lover @GrahamStephan takes to Twitter to try to untangle the knotty problems that have forced one of the largest banks in the United States to close its doors.

What Went Wrong?

Stephan pointed out how Silicon Valley has always placed large bets that have paid off handsomely over the past decade. This was the case, particularly in 2020, when stimulus and rate cuts flooded the banking system with cash.

Nevertheless, when banks began using a technique known as fractional reserve, they kept a fraction of their deposits (usually more than 10 percent) and invested the rest. Here is where things started to go wrong.

Apparently, most of SVB's assets were in relatively secure investments like U.S. Treasuries. But according to Stephan, even the safest bets become risky if you put all your eggs in one basket.

The Fed began raising interest rates last year. SVB placed a risky wager on the Fed's pace slowing down. They invested $100 billion in government-backed bonds and secured them for three to four years at a 1.79 percent interest rate. But they were wrong because the rate increases accelerated rapidly.

According to Stephan's analysis, this meant that if SVB put $100 in bonds at a 2% yield, they'd be paid back $108 in 4 years. If rates suddenly hiked to 7%, they could make $131 instead. But the bonds they hold would now be worth only $77 – and if they can't afford to wait it out, they'll have to sell at a loss for liquidity.

But they could have handled a loss like this if they were diversified. What played out instead is that SVB's clients were mostly startups, which were seeing less funding and withdrawing more money to pay for expenses.

On the other hand, SVB needed money to fund withdrawals and had to take a loss on bonds of $1.5 billion on their bond positions to do this.

As a result, on March 8, the company announced it would sell a third of its ownership to raise $2.25 billion. But the next day, the stock dropped by 60% when word got out that the bank was facing insolvency issues.

The FDIC Twist

Stephan further notes that while it is true that all accounts were insured and depositors had high hopes of the possibility of accessing their funds, the problem is FDIC Insurance covers only up to $250,000. And 97.3% of accounts at SVB are bigger than that because they are business accounts.

Though the companies might get some of their money back when assets are sold, it might take YEARS. SVB holds $342 billion in client funds. For all those companies, this is a crippling blow for no fault of theirs.

Stephan concludes that it's shocking that the 18th largest bank in America had this level of concentration and took bets on what the Fed would do. No bank should be allowed to take this level of risk. Second, he notes that an FDIC Insurance of $250K makes no sense for businesses.

“Businesses and individuals are not the same. A business has way higher working expenses,” he tweets. “If businesses fail, they affect 1000s. Their FDIC limit should be higher. Maybe a % of their deposit, not a number.”

What Is Good Investing?

Twitter users on the thread applaud Stephan's analysis and weigh in on what they think good investing entails.

Replying to @GrahamStephan, @compoundingQuality tweeted:

“Good investing is not about maximizing your return, it's about minimizing your risk. Like Warren Buffett about Long Term Capital Management: If you risk what you need in order to gain what you don’t need, that is foolish. It’s just plain foolish.”

@gailusNFT put it in very simple terms. “When you have people who don’t understand risk management, it’s a matter of time before you hit the fan.”

@J. Amill Santiago commented that Banks shouldn’t be treating their clients’ assets as if they’re in a casino with borrowed money.

For @SpecuIVestor, FDIC Insurance should be done away with and suggests letting the free market handle it. Or even better, they said, “let trustless Defi protocols on Ethereum be the solution instead of these fallible/mismanaged financial institutions”

More Issues

Other users identified other problems Stephan might have missed.

@hrbstr thinks that while lack of diversification might be part of the problem, Silicon Valley failed because of sheer incompetence. According to them, all the banks that did not go under figured it out. One negligence would have been the bank’s failure to hedge its interest rate exposure which many have pointed out.

Even depositors get their share of the blame.

@charitybyte notes that depositors messed up to mitigate their risk and protect their shareholders. According to them, they should’ve held a basket of short-term treasuries for the funds not insured or needed for, say, 90 days. Then they go ahead to employ the FED to only help the victims, not those who made bad choices.

The SVB collapse is negative news for everyone.

This original thread inspired this post.

This article was produced and syndicated by Wealth of Geeks.

Amaka Chukwuma is a freelance content writer with a BA in linguistics. As a result of her insatiable curiosity, she writes in various B2C and B2B niches. Her favorite subject matter, however, is in the financial, health, and technological niches. She has contributed to publications like Buttonwood Tree and FinanceBuzz in the past and currently writes for Wealth of Geeks.