Bank failures were big recurring news stories just over a decade ago.  The 2008 failure of Bear Stearns, then Lehman Brothers, signaled that the bubble in real estate had burst.  The effects began a long cascade of regulators closing banks, peaking with 157 financial institutions closed nationally in 2010, with another couple of hundred closed over the next four years. 

Georgia, with a system of small community based lenders focused on serving the real estate industry, was at the epicenter of the crisis.  By the time it was over, a quarter of Georgia’s banks had been shuttered.  There were complaints at the time that the bailout plans favored big banks over smaller ones, and the banks branded “too big to fail” grew stronger at the expense of community banking.

This is now old news, or at least it was until last week.  During the five years preceding this one, only 8 banks failed in the entire country.  No banks failed during 2021 or 2022.

Two weeks ago, Silvergate Capital announced it would voluntarily wind down its banking operations, with all depositors made whole.  The bank was the largest focused on the crypto-currency community, and the crash of various crypto coins in the aftermath of the FTX scandal seemed to have put the writing on the wall for Silvergate’s future.

In the last couple of weeks, financial concerns increased.  A run on California based Silicon Valley Bank caused a rare mid-week takeover of the institution, the second largest bank failure in history.  Over the ensuing weekend, regulators in New York seized Signature Bank, the other major bank focused on the crypto currency community.

What is unusual about all three failures is that none of them were caused primarily by making bad loans. As such, the failures are somewhat difficult for those who don’t follow financial news closely to understand.  

News networks that cater to their ideological bases were quick to blame “wokeism” or relaxed regulations, because – per standard operating procedure – when something happens that most people don’t understand, it’s important to blame your adversaries first.  By the time the boring facts are revealed, the masses have usually moved on to another ideological fight.

It’s important to know what did and didn’t happen here because, of course, those fighting their own partisan battles always demand policy actions that suit their ongoing interests. There are real issues here that need to be addressed, but addressing the wrong things the wrong way will only make things worse.

The failure of Silicon Valley Bank lies first at the feet of the management of the bank.  They were awash in cash deposits, exacerbated by all the money that flowed into technology startups during the pandemic in an environment of zero percent interest rates.  

They literally had more money than they could loan out.  Banks usually make money by taking in deposits at no or low interest rates, then loaning that money out at higher rates.  Because their customers had more cash than the need for loans that they could underwrite, they invested their excess deposits into bonds – specifically long dated US Treasury bonds.

There’s no problem there, right?  U.S. treasuries are backed by the full faith and credit of the government.

Except, the folks managing the capital for Silicon Valley Bank decided that the short term rates, near zero during the pandemic, didn’t give them the return they needed.  So they bought tens of billions of dollars in long dated treasuries.  

Then their head of risk management stepped down, in April of 2022. This was just weeks after the Federal Reserve began interest rates.  By the time a new person filled that role in January of this year, the Fed had increased interest rates 4% - an 800% increase.

As rates increased, the market value of those treasuries the bank held declined.  They’re still worth their face value at maturity, but a 10 year bond paying 1.4% isn’t going to be worth as much as a current 10 year bond paying above 4%.  Still, it wasn’t an immediate problem because banks aren’t required to mark the value of their bonds down.  …unless they have to sell them.

Rising interest rates also caused investment in tech startups to dry up.  Companies began burning through their cash, and found it difficult if not impossible to get new capital (that would have been deposited at Silicon Valley Bank) from new investors.  With their deposit base declining, Silicon Valley had to sell just over $20 billion in these bonds, recognizing a loss of over $2 billion.  

The failure of this bank was primarily due to taking too much risk in matching short term deposits against long term bonds paying little interest.  There’s also a failure of existing regulations, in that no one noticed that 9 months went by without a person in charge of risk management, nor did any regulator notice the liability created by such a concentration of long term bonds on the bank’s balance sheet.

There are policy consequences likely to come from this failure, as the short term panic it has caused has exposed liquidity issues within the entire global banking system yet again.  There’s not likely a bank in a similar position as was Silicon Valley Bank, but the new worry is that newly tightened financial conditions combined with historically high office vacancy rates may again pose loan loss problems for banks.

It’s not likely that this crisis will come anywhere close to the one that began fifteen years ago.  But when bubbles burst – whether they occur in real estate or technology – there are consequences.  We’re just now starting to figure those out.