Friday was abuzz with chatter about Silicon Valley Bank’s demise, the second largest bank failure in U.S. history. For many it evoked memories of the iconic scene from the movie It’s a Wonderful Life: George Bailey is newly married and headed to his honeymoon, stepping out of his taxi only to see a crowd gathered outside the Building & Loan. Not long after…
George Bailey: Now, just remember that this thing isn’t as black as it appears. I have some news for you folks. I was just talking to old man Potter and he’s guaranteed cash payments at the bank. The bank’s going to reopen next week.
Concerned Depositor: But, George, I got my money here.
Another Concerned Depositor: Did he guarantee this place?
George Bailey: Well, no, Charlie. I didn’t even ask him. We don’t need Potter over here.
Concerned Depositor: I’ll take mine now.
George Bailey: No, but you…you…you’re thinking of this place all wrong. As if I had the money back in a safe. The, the money’s not here. Well, your money’s in Joe’s house… that’s right next to yours. And in the Kennedy House, and Mrs. Macklin’s house, and, and a hundred others. Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can. Now what are you going to do? Foreclose on them?
That is a bank run in a nutshell. If too many depositors want their money all at once and the bank depletes its “cash in the safe,” it can’t call on its borrowers to repay their loans quickly enough to honor withdrawal requests. At the end of the day, banks depend on the faith of their depositors.
That faith is propped up by the Federal Deposit Insurance Corporation (FDIC). The FDIC is an independent agency created by Congress to maintain the stability and public confidence in the nation’s financial system. In the event of a bank failure, depositors are guaranteed to receive up to $250,000 of their deposits from the FDIC. That goes a long way to creating confidence.
But Silicon Valley Bank was a very unique bank. Most of its depositors were venture capital firms and the companies they invested in had accounts measuring in the tens or hundreds of millions of dollars. A $250,000 guarantee to that sort of depositor does not create much confidence.
But let’s step back a second. What brought on the initial break in depositor confidence? This story began during the pandemic when there was a boom for technology companies. As we all visited on Zoom, watched Netflix, and shopped on Amazon, Instacart, and DoorDash, the companies that manage and build the plumbing of the internet saw their fortunes soar. In that environment, venture-backed companies were awash in fresh money from investors keen to cash in.
Silicon Valley bank was in the catbird seat. It catered to the venture capital funds and the companies they invested in. The bank’s deposits soared. But over the past year, as the pandemic-fueled tech boom faded, deposit inflows turned into outflows. This was a consequence of venture-backed companies not receiving new funding while depleting the funding that they did have. This meant SVB had to sell bonds – their equivalent of cash in the safe – to cover the withdrawals.
Except, the value of bonds had fallen as interest rates had risen over the past year. If SVB had been able to hold the bonds to maturity, there would have been no loss. But they could not. And word of the loss got out because the bank was trying to issue and sell new stock to shore up its “cash in the safe.”
The bank’s financially sophisticated customers caught wind of what was going on and, given their enormous deposits, took no comfort in a $250,000 guarantee. Thus, on Friday, there was a classic It’s a Wonderful Life run on the bank.
The largest U.S. Bank failure ever was Washington Mutual in September 2008. That was a very different time than now. A real estate asset bubble was popping, homes were being foreclosed, and unemployment was skyrocketing. The real economy was legitimately a mess.
Contrast that with the current environment. The economy is too strong, so much so that the Federal Reserve is raising interest rates to slow it down and limit inflation. And despite the Fed’s efforts, job creation appears (for the moment) unstoppable. To the extent that there are layoffs today, they are largely concentrated in tech. Silicon Valley Bank was the bank to the technology industry.
What about the big banks like Citibank, Wells Fargo, Chase, and their kind? They have seen their stock prices decline a little less than 2% so far this year. Small regional banks have seen greater losses, but less than 10% year-to-date (as of last Friday). Contrast that with SVB, whose stock price declined 60% on Thursday before it was shut down overnight by the FDIC.
At Abacus, we believe in the market’s ability to weigh new information faster and more accurately than any individual actor in the market. The market is not worried about widespread ‘contagion’ outside of those few banks with a similar profile to SVB. And neither are we.
But this is a reminder that if your bank deposits exceed $250,000, it is a good idea to spread your deposits over multiple institutions. Bank failures are still exceedingly rare in this country. And yet, at moments like this, a little prevention goes a long way to making for a good night’s sleep.
This is also a reminder of why we counsel our clients to keep enough of their portfolio in cash and bonds to cover 5 to 7 years of planned withdrawals. If SVB is the beginning of something larger, that’s just the business cycle. Long-term discipline informed by a comprehensive financial plan gives Abacus clients the resiliency to weather any storm and to live their best lives – whatever part of the business cycle we may be in.
Note: Since writing this article, regulators have indicated that depositors of SVB and Signature, a second bank to fail within a matter of days, would have their full deposits protected.