On March 10th, a historic bank run occurred on the Silicon Valley Bank. It has been marked the second largest bank failure in the history of the United States. Due to the current state of the economy and the mere size of the bank, the nature and implications of the falling need to be examined.

Pointed Summary

• 16th largest bank in the U.S.
• Loss to Silicon Valley 
• Economic implications of a bank failure

Relevance

As noted above, the Silicon Valley Bank was the 16th largest bank in the entire United States, with about $167 billion in assets and $119 billion in deposits. It is not uncommon for a bank to fail, but the last time there was a bank failure of this magnitude, the economy was in the Great Recession. This failure did not end up harming any of those who had deposits at the bank because the FDIC insured them in full, a countermeasure established post-2008; however, it does not mean all is well.

The FDIC typically only insures up to $250,000, but in this case they have said, “The transfer of all the deposits was completed under the systemic risk exception approved yesterday. All depositors of the institution will be made whole.  No losses associated with the resolution of Silicon Valley Bank will be borne by taxpayers.” Around 85% of the deposits in SVB would previously be considered uninsured, and the reason for this rule in the first place was that insuring large deposits would require significant funding towards the FDIC, which doesn’t exist.

The FDIC now insuring all of these funds will certainly cause greater deficit spending, which is extremely important given the current context of the debt crisis and debt ceiling conversation. On top of that, the FDIC only ensures depositors, not shareholders, meaning those who had massive stakes in the bank and invested billions of dollars are at a complete loss. Major institutions such as Blackrock and Vanguard were leading shareholders in the bank meaning the losses they incurred can have lasting impacts on any of the business ventures they’re a part of. 

Besides the mere losses the bank had and the need for the FDIC to step in, Silicon Valley is at a loss as well. Silicon Valley largely depended upon this bank for the development of startups, as it served as a baseline for entrepreneurship. Not only does this reduce the immediate means for individuals to bankroll a company, but it also may disincentivize entrepreneurs from looking for loans in the first place due to fear of their bank failing.

SVB being as large as it was means that people have “seen a god bleed,” which will only reduce their trust in said “gods.” Silicon valley has made a name for itself, especially in the technology scene, but this type of failure could worsen the overall reputation of wanting to go there in the first place. Overall, the attractiveness and growth that have long symbolized Silicon Valley could be greatly harmed which could have unforeseen consequences on the economy as a whole. 

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History

The United States has had a long history of bank failures. In 1819, just 32 years after the Constitution was ratified, the Napoleonic Wars in Europe led to a global market collapse and a reduction in funds supplied to state banks.  This in turn led to a lack of funds available to local banks and the end of the Second Bank of the United States in 1833. 

Similar events took place in 1837 and 1907, as well as during the Great Depression, with the stock market and banking crash of 1929, known as Black Tuesday. When stock prices continued to inflate and companies were dishonest with investors about their assets, many rushed to withdraw their deposits, leading to a shortage of on-hand cash in the banking system. Due to the loss of millions of dollars in savings and the failure of about 9,000 banks, the government established the Federal Deposit Insurance Corporation, which guarantees that any amount deposited over $250,000 will be insured in the case of bank failure. 

In the case of Silicon Valley Bank, its failure was due to a traditional bank run not dissimilar to that of 1929. Silicon Valley Bank was founded in 1983 with the goal of providing funding for the budding California tech industry. By December 2022, SVB was one of the largest banks in the country and supported about half of American venture-backed tech and healthcare firms.

Whereas most banks are risk-averse, meaning that they are hesitant to invest in companies without positive cash flow, SVB did not shy away from funding new companies and fostering innovation. However, because the majority of SVB’s clients were businesses that deposited more than $250,000, most of its savings were not FDIC insured, which could lead to a problem down the line. 

When the Federal Reserve raised interest rates, after years of near-zero interest rates, the billions of dollars that SVB invested in long-term maturity bonds were lost, as the value of this once conservative investment plummeted. When the bank announced that it had sold its assets at a loss and would need to sell more than $2.25 billion in new shares to raise revenue, customers withdrew their money, which triggered others to do the same. Two days after the bank run started, the state of California turned control of the bank over to the FDIC, who liquidated the bank's assets and began the recovery process. 

Current Stances

There are two main opinions on the SVB bank failure: some economists and experts believe that the bank run was an isolated event, while others think it gives insight into the general state of the financial sector and acts as a precursor for more economic turmoil. 

In one regard, this was a bank run like any other, meaning, it is a psychological phenomenon that has to do with human behavior and fear-mongering. As people took to Twitter to discuss how they were withdrawing their deposits, others followed, until SVB did not have enough assets to satisfy deposit demand. Since the enactment of the FDIC, consumer-driven bank runs have been rare, as the majority of people have deposits of less than $250,000. But because the majority of SVB’s clientele were companies whose amounts greatly exceeded that value, they panicked, knowing that millions of dollars were uninsured.

This viewpoint implies that the SVB bank failure was an isolated event arising from unique circumstances, and is an example of a typical fear response that is instigated by social media. Additionally, the venture capital world is widely different from personal finances, so it is unlikely that turmoil in the tech-space will overflow to banks, where the majority of deposits are insured and unrelated to that industry. 

Others believe that the SVB bank failure signifies structural issues in the financial system and is the product of an unhealthy economy. By investing in bonds that would lose value if the interest rate rose, SVB shows that it relied on near-zero interest rates to maintain financial stability. This issue can be generalized to banks that invest in securities whose values depend on interest rates, knowing that they can change at any time.

However, most of the turmoil related to the collapse will affect venture capital-backed businesses, as firms must find a replacement for SVB which will hedge their bets on cash flow negative businesses. ‍

Tried Policy

Immediately after SVB was taken over by federal regulators, the FDIC guaranteed that all clients would have access to the full amount of funds by the next day, even if the amount exceeded $250,000. Nonetheless, this government action is not classified as a bailout, because all of the funds were used to pay off the depositors, not the institution. During the bank failures of the Great Recession, shareholders, investors, and depositors were bailed out, but in this case, only depositors were compensated for their funds. 

The money will not come from taxpayer funds, the Fed said, but instead from the Deposit Insurance Fund, which is run by the FDIC. 

Policy Problem

Stakeholders

The Silicon Valley Bank had benefited from “zero money” interest rates for more than a decade as tech venture capital poured into the bank. With the money merely sitting around, the bank decided to gain a return by investing in long-term US Treasury Bonds. However, with interest rates having risen sharply as of 2022, the bank was forced to sell some of those bonds at a loss, a problem that only compounded when depositors demanded higher return rates.

Having seen the effects on a significant bank due to continuously rising inflation, central bankers face a dilemma: continue to raise interest rates to get a grip on inflation or continue tightening the money supply. On March 16th, 2023, Secretary of the Treasury Janet Yellen stated to the Senate Finance Committee that “more work needs to be done” in regard to inflation.

Continuing on Yellen’s statement, the need for swift action on inflation was proven to be even more severe when Goldman Sachs analysts more than tripled the chance that the United States will enter a recession in the next 12 months, from 10% to 35%. That swift action, whether that be a tax code reformation or limiting discretionary spending is sure to cause controversy no matter what, if anything, happens.

Risk of Indifference

The total value of the deposits at SVB was estimated to be around 175.4 billion dollars in December 2022. These deposits include major holdings from large corporations like Roku, who stored 487 million dollars at SVB, or about 26% of their total cash. Biden and the FDIC stepped in following the SVB collapse and insured that all deposits would be secure, even though the government is only responsible for insuring a minimum of 250,000 dollars per deposit.

With over 90% of SVB’s deposits over the guaranteed 250,000 dollars, customers and corporations with deposits would have faced significant loss and the 250,000 dollar return would have done little to compensate in return. 

Policy Options

SVB’s collapse exposed many of the banking sector’s vulnerabilities, pushing congress to reexamine the banking regulations and potentially implement new ones. One idea floated by Congressional Democrats, most notably Massachusetts Senator Elizabeth Warren, is repealing many pieces of President Trump’s legislation that deregulated large banks such as the Silicon Valley Bank.

In a Q&A, Warren stated that “At no time is the need for strong, expanded regulatory authority more painfully clear than when we look at the burgeoning national economic crisis posed by letting banks due as they please.” However, any legislation that greatly increases regulation on corporate entities that prefer large trading blocs, such as banks most notably, is likely to be struck down by a now Republican-majority House.

Congressional Republicans have committed themselves to keeping the economy as free as possible. Speaker McCarthy even stated “When the bureaucracy makes more rules, those rules limit the freedom and opportunities of real people—people that are just trying to work hard, make a living, and support themselves and their families,” showing that House Republicans are unlikely to increase regulations that could limit the bank’s power to purchase bonds as long as they control at least one half of Congress.

The Silicon Valley Bank is only the sixteenth largest bank in the US, yet has the potential to trigger a massive banking crisis that could throw the US into recession, leaving many Americans to question the fragility of the US banking sector. Furthermore, despite rising interest rates being the major factor in SVB’s collapse, the Fed once again raised rates to just under 5% in late March, continuing their efforts to lower inflation. However, with bank failures fueling rising concerns of economic downturn, the Fed will have to consider how many more rate hikes the country can withstand without throwing the economy into recession. 

Acknowledgment

The Institute for Youth in Policy wishes to acknowledge Brady Zeng, Ahad Khan, Harry Tong, and other contributors for developing and maintaining the Policy Department within the Institute.

Works Cited

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