March 23, 2023

Reading through the often frenzied commentary about the collapse of Silicon Valley Bank (SVB), it’s important to note how much that chatter conflates or confuses what are distinct if complex issues. The most high octane issue is watching the dyed-in-the-wool libertarians and anti-regulation voices who run Silicon Valley suddenly demanding a bailout. Specifically, many are demanding that the FDIC backstop all the bank’s deposits rather than simply those up to $250,000 because of the number of startups which could quickly go under without money to make payroll and cover other on-going costs of doing business. (SVB’s deposits, roughly 95% of which are uninsured, are heavily concentrated in the tech start-up ecosystem.) It’s a hypocrisy that merits all sorts of guffaws and mockery. But hypocrisy isn’t new or terribly surprising.

Bailouts Aren’t the Question

The only reason to even consider such a federal bailout would be if it were shown that SVB’s failure posed some sort of systemic risk to the broader economy. At least for now, that doesn’t seem to be the case. (That said, a banking system is highly complex and mixes fundamentals such asset values and intangibles like sentiment and fear, all of which can interact in unpredictable ways.) SVB’s holdings are highly concentrated in one region and sector of the economy – the Silicon Valley start-up ecosystem. There are lots and lots of analysts and regulators from the Fed, the FDIC and adjacent federal agencies deep in SVB’s books right now figuring that question out. So we shouldn’t be asking whether should be a bailout. There shouldn’t be. The only question is whether there is some threat to the broader economy that would justify extraordinary actions.

Where’d The Money Go?

Another key part of this story gets obscured in the current coverage. If you’re a SVB depositor you will have full access to your insured $250,000 on Monday morning. But at least 95% of deposits (reports vary) are not insured. (In other words, they’re in accounts with more than $250,000 on deposit.) If you read the current coverage you could easily get the idea that that money is basically gone, that a start-up with $5 million in deposits has lost all its money. That’s almost certainly not true.

In modern bank failures/bank runs, the great or overwhelming majority of the deposits are recovered. There’s every reason to believe SVB has assets at least in the ballpark of its outstanding the deposits. The issue is liquidity. Depositors started to lose confidence in the bank’s solvency; everyone wanted their money at once; and the bank didn’t have access to enough cash to cover withdrawals so it failed. Over time though that money is probably mostly or even all there. You can actually see the most concrete evidence of this in the reports that SVB depositors are being inundated with offers from hedge funds to purchase their deposits for prices ranging from 60 – 80 cents on the dollar. Given the time it will take to unwind SVB’s holdings, the inherent risk of such offers and the big returns hedge funds look for those offers tell you pretty clearly those hedge funds expect SVB’s assets will cover the overwhelming majority of the deposits. The hedge fund has the luxury of time; the tech start-up does not.

What About My Bank Account at Chase?

I mentioned above the hypocrisy of high-flying tech bros who’ve been lecturing us about free markets forever suddenly demanding bailouts because people they know or they themselves are seeing their ox getting gored. Is this likely to happen to Chase or Citibank or other big national banks? Probably not. One big reason is that those banks are under much closer regulatory scrutiny by the Feds. Another reason is that they’re not so concentrated in a single sector of the economy.

If you look at SVB’s practices it was involved in a lot of pretty high risk investing. One way it kept its hold over depositors was offering higher returns on deposits than the big banks. Making good on that required riskier investments. SVB wasn’t just the go-to bank of deposit for Silicon Valley start-ups. They were also deeply enmeshed in that ecosystem’s world of speculative equity investing. That’s risky business, literally and figuratively. But as others have noted, the whole tech start-up ecosystem was and is deeply tied to the regime of ultra-low interest rates of last 15 years and more broadly the last 25 years. A sharp rise in interest rates was always going to be a problem for that world.

The issue of bank regulation is always going to come to a fundamental trade off. If the federal government is going to backstop a bank’s holdings, it’s going to need greater regulatory oversight of the bank’s business. If a bank gets so large that its potential collapse endangers the whole economy (i.e., too big to fail) the federal government is going to need even more scrutiny and oversight of its operations. The entire push and pull over financial services regulation essentially comes down to the finance sector wanting less regulation (and thus riskier and more profitable investments) while still wanting the federal backstop or the feds to pick up the pieces if things go wrong. As the Times noted on Friday, back in 2018, President Trump signed a partial repeal of the 2010 Dodd-Frank financial services reform law, which reduced regulatory scrutiny for regional banks like SVB.

Greg Becker, SVB’s CEO, was a strong backer of the change.

Addendum (4:18 PM): One thing that has come out of my exchanges with readers is unclarity about just what counts as a “bailout”. In one sense it is in the eyes of the beholder: a bailout is when someone else gets it. The more important thing is that term has no real or precise meaning. In general it’s any radical departure from the existing legal/contractual set of rules and obligations in response to a financial crisis. Websters defines it as a “rescue from financial distress.” Clearly the shareholders, i.e., the owners, of Silicon Valley Bank should be wiped out entirely or at least be last in line for any proceeds if the bank goes through a liquidation. They had a business and it failed.

The operative question is the bank’s depositors. What’s being discussed is whether the FDIC should step in and guarantee all the deposits rather than just the 2% or 3% which the FDIC guarantees up to $250,000. What complicates the question is that SVB did very, very little consumer banking. It mainly held deposits of venture capital funds and the start-ups those funds invested in. As noted earlier, the bank likely has enough or close to enough assets to cover all deposits. What it lacks is time and liquidity. So the best solution is for the bank to be purchased by another bank which has time and liquidity. Depositors are protected; risks to the broader economy are prevented; employees at the businesses which banked there have their paychecks covered. That is certainly what regulators are trying to accomplish right now. The question is what happens if they can’t. What basically all the high profile Silicon Valley notables are demanding now is that the FDIC back all the deposits. That’s a bailout by any definition. The point I tried to make above is that such a move could only be justified by grave risk to the broader economy. And that’s a factual question that regulators at the Fed, the FDIC and the Treasury will have to answer.

A final point: I’ll leave the precise details to people with more technical knowledge. But there are a lot of tools federal regulators have to cushion a situation like this. It’s not just let it rip versus protect everyone from any downside of the bank’s collapse.

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