As Robert Sanders, Co-Chief Investment Officer at Capital Investment Advisors, recently said on my Money Matters radio show, the number one job of a bank is to not run out of money. Unfortunately, Silicon Valley Bank broke this rule, as a timing mismatch left them short on dry powder — cash reserves a company maintains to meet obligations in times of economic stress.
Generally speaking, banks need to invest a large share of their deposits in short-term bonds in order to satisfy withdrawals at any given time. However, years of low-interest rates seduced SVB into investing cash in longer-term bonds that boasted higher interest rates and therefore higher income for the bank. And because SVB was so accustomed to the consistent flow of new deposits from a booming tech sector, they ostensibly thought it was a safe play. Unfortunately, they were wrong.
Bonds have an inverse relationship to interest rates. So, when the cost of borrowing money rises, bond prices usually fall. And bonds with further out maturities fall even more. So, as the Fed raised interest rates, SVB’s long-term government bonds lost value. Thus, when SVB had to sell these bonds to cover its clients’ routine (short-term) business cash needs, it did so at a loss.
Furthermore, SVB’s client base was composed of more underinsured companies than most — many with tens and hundreds of millions of dollars sitting in cash. These clients were well aware that the FDIC only covered up to $250,000, so as soon as they learned of SVB’s bond losses, tech entrepreneurs and CFOs in California were spooked. They went to their smartphones and laptops and quickly moved money to other banks. As a result, nearly 25 percent of the bank’s assets walked out the door in a single day, far surpassing the most extensive prior modern-day bank run (less than 10 percent in outflows over nine days).
Is This Another Global Financial Crisis Like 2008 and 2009?
In short, I doubt it. The Global Financial Crisis of 2008 and 2009 stemmed from a credit problem. Many bank assets were worth far less than they showed on their books, and therefore were at significant risk of not getting repaid on their loans. This contorted reality put bankruptcy on the radar for many of our largest financial institutions.
Silicon Valley Bank’s problem was liquidity. Credit had nothing to do with it. The ill-advised long-term bonds they purchased will very likely be worth more than they paid for them over the life of the bonds. Most are AAA-rated U.S. government debt, the highest rated in the world. The problem was that they simply did not have the time to wait for the bond value to recover because too many depositors were pulling out their money.
Good assets. Bad timing.
In the short time since SVB’s collapse, the U.S. government has already gone to great lengths to buttress any cracked foundations by providing money to banks suffering similar problems. While SVB may not have had enough flexibility to wait for longer maturity bonds, the U.S. government does. So, they took what they believed to be a necessary step to ensure all depositors’ money continued to be safe.
What Does This Mean Going Forward?
First, the U.S. government’s safety measures greatly lower the risk of many Americans losing the money they have deposited at U.S. banks over the $250k FDIC limit. In addition to standard FDIC rules, Janet Yellen announced on Wednesday, March 22nd, that if there’s a contagious bank run, the Treasury would likely pursue an exception that would permit the FDIC to protect all depositors of the failed banks. This would be considered on a case-by-case basis.
Secondly, what are the market implications? Again, I avoid short-term market predictions, but for the long-term, there are a few salient points of note:
- The financial system appears to be in much better shape than it was during the crisis of 2008 and 2009.
- As stated previously, the issues at SBV were a liquidity problem, not a credit problem.
- History shows that buying high-quality dividend-paying stocks and mostly high-quality debt typically leads to success over the long run.
Though governmental actions to quell financial unrest seem to have stabilized a potentially volatile situation, it’s normal for anxieties to linger, especially for folks looking to live on a fixed income. I’m sure I’ll continue to discuss developments on my radio show and Retire Sooner podcast. If you have more questions, speaking with a financial advisor can sometimes be helpful. At Capital Investment Advisors, we’re always happy to help.
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