In the past week 3 banks have failed (Silvergate Bank, Silicon Valley Bank(SVB) and Signature Bank). Silvergate was a crypto focused bank while Silicon and Signature were regional banks. I will focus on Silicon Valley Bank since we have the most information here.
WHAT SHOULD I KNOW:
· Investors, equity and bond holders in Silicon Valley Bank lose their investment (as they should for poor oversight & management). This is why it isn't a "bailout."
· Management will be fired
· Depositors (people/businesses with checking/savings accounts) have full access to their money (including depositors with more than $250,000 in FDIC insured accounts).
· No losses to the taxpayer
· Mass Bank Run (hopefully) avoided.
· More businesses may use the big 4 banks and concentrate power at the largest financial institutions.
· If you bank at a smaller/regional bank but have less than $250,000 in an FDIC insured bank, you should feel confident your funds are safe.
· If you have more than $250,000 in an FDIC insured account, you may want to consider spreading your bank risk.
· Should you change to a "big 4" bank? Probably not. While, the safest institutions are the largest banks because they are “too big to fail,” the trade-off is consolidating banking power, most likely earning lower yields and more unfavorable terms and most likely worse customer service.
WHAT HAPPENED (THE DETAILS): The collapse of Silicon Valley Bank (SVB) was the first FDIC-insured bank failure since 2020 and the second largest in history. This was followed two days later by the failure of Signature Bank, the third largest in history and preceded by Silvergate, a smaller bank active in the crypto industry.
This episode reveals that these particular banks grew too aggressively and with too little risk management as tech valuations rose and crypto prices rallied over the past several years. While this worked well in a bull market, the reversal of these trends in 2022 made these banks vulnerable to classic bank runs.
How do bank runs occur? A simplified description of the classic banking model is that customers – both businesses and individuals - deposit funds for safekeeping in checking/savings accounts. Banks then use these deposits to make loans or to buy high quality investment securities which they hope can generate profits until customers need their funds. This works well as long as these investment assets maintain or grow in value and customers trust that their deposits are safe. If either of these is not the case, a bank may not have the liquidity to meet its obligations. With this in mind, these recent failures were due to two related problems.
Banks accumulated unrealized losses on investment securities as rates spiked
First: After the pandemic, the US government spent trillions of dollars to keep the economy afloat. Many argued that too much was spent which led to a historic spike in inflation.
Last year the fed raised rates at the fastest pace in history in order to combat this inflation, which, as you may recall from the 1980's, can be devastating to the economy if it lasts too long. No one truly knew the unintended consequences that would result....until now.
Simply put, the bank took customer deposits it didn't think it would need, purchased bonds to earn a decent interest rate, but when rates went up, the value of the bonds went down. This wouldn't have been a problem if customers kept their funds in their checking/savings accounts, but...... Second: SVB's concentration of tech and startup customers made it vulnerable as conditions deteriorated for that sector. With higher rates, came higher borrowing costs for tech start-ups who rely on borrowed money to grow. As customers requested larger withdrawals than normal, SVB tried to plug this gap by raising fresh capital, but this backfired since it highlighted the liquidity and solvency issues it faced and spooked depositors. Like shouting "fire" in a crowded theater, once there is the perception of solvency problems, a classic bank run can occur swiftly, which can then become a self-fulfilling prophecy. Peter Thiel (famous founder of PayPal and other tech companies) urged his companies to move cash to other banks. Then, to a large extent, this played out publicly in twitter as many in the startup and VC communities urged companies to move their funds, thus creating a panic. Today, you can wire money with your fingertips and a smartphone which led to billions exiting the bank in mere hours.
SVB couldn't create enough cash by selling the bonds they just purchased because they were worth significantly less than what they purchased them for due to the rise in interest rates. $42 billion was withdrawn on Thursday or $4.2 billion per hour!
These bank failures are the largest since 2008 (BUT STILL VERY FEW FAILURES)
*Note that this FDIC data does not yet include Signature Bank
One reason that investors may be concerned is that, thankfully, there have been few bank failures in recent history, especially since banking legislation such as the Dodd-Frank Act was put into place after the 2008 financial crisis. According to the FDIC, there were only 8 bank failures from 2019 to 2022, far below the 322 experienced around the global financial crisis or the hundreds that regularly occurred in the 80s and 90s. That said, SVB is an outlier in that it had total deposits of $175 billion while the 8 from 2019 to 2022 had a combined $628 million. Naturally, there are also parallels being drawn to 2008 when the last wave of bank failures threatened the global financial system. It's important to keep in mind that, back then, the problem was not just that all banks held significant amounts of mortgage-backed securities and other housing-sensitive assets that ended up being worth only pennies on the dollar. Rather, significant amounts of leverage coupled with new financial instruments such as collateralized debt obligations allowed a housing crisis to turn into a financial meltdown. While it's unclear exactly how this episode will play out, many banks today are much better capitalized and do not primarily rely on tech or crypto deposits. Additionally, any economic spillover has so far been concentrated in the technology and venture capital industries which were already struggling with layoffs and a slowdown in demand.
Fortunately the Federal Reserve, White House and Treasury Department acted in a coordinated and decisive manner before the market opened on Monday. They helped prevent mass panic and instilled confidence in regional banks. WHAT SHOULD YOU DO?
· If you keep less than $250,000 in a regional or community bank, you don't need to do anything.
· If you hold more than $250,000 in an FDIC insured account, you want to consider spreading your risk across several banks and account types (feel free to call me to discuss).
· Should you move to a "big 4 bank?" Probably not - The safest institutions are the largest banks because they are “too big to fail,” however, the trade-off is consolidating banking power, most likely earning lower yields, more unfavorable loan terms and most likely much worse customer service. · This situation is still playing out but the risks to the overall market appear to be relatively minor, in fact, it may help the overall market in the short term.
· With the unintended consequences to the rapid rate increases out in the open, the Fed may slow the rate tightening cycle. Interest rates have dropped which has elevated bond prices. Stocks have been flat (except regional bank stocks). In the near-term the risks appear to be mitigated but we will be monitoring the data in the months to come.
· No drastic portfolio changes are needed as a result of this event.
The bottom line? While recent bank failures are problematic, parallels to 2008 are premature. Investors ought to stay diversified as the situation stabilizes, while focusing on the big picture rather than minute-by-minute speculation.
HOW CAN WE HELP?
Financial planning is not just about managing investment portfolios. More importantly, it is about having someone you trust to guide you when the unexpected occurs and to make sure your family has a trusted resource to rely on. If you have questions about whether this investment makes sense based on your unique circumstances, do not hesitate to call Steve at 443-812-5459. At Abel Financial Management, we are local, family-oriented, and truly independent financial planners with a mission to help you make smart decisions with your money. If you or someone you know faces decisions like these, we invite you to have a conversation with us.