So why exactly did Silicon Valley Bank collapse?
They had a lot of money in their current accounts parked at zero percent. All they had to do was invest it in Treasury Bills at say 0.25 percent.
They invested in long dated Mortgage Backed Securities, since they got more return, the exact number is not so important, so let's say 4 percent.
Now that's a big one. It needs some explanation. What is "long dated" , what is "mortgage backed" etc. etc.
But, before that, what is a bank? A bank is essentially an institution that takes on short term liabilities in the form of deposits, and lends out long term. They lend at a rate higher than what they borrow at thus making a "spread". This spread has to be enough to cover their costs, and bad debts, and yield a profit.
If they lend long term using money received from short term deposits, they have a problem. If ask the depositors ask for their money back, the bank does not have enough money to repay them.
Depositors will keep their money with the bank so long as they are assured that it is safe. The moment they feel that the bank is in trouble, they will rush to draw their money out. When more than a particular percentage of the depositors queue up outside the bank, the bank will collapse. Thus, rumour of a collapse becomes a self fulfilling prophecy.
No Bank in the world can survive a run on its deposits. And every bank lends long term against short term deposits.
The long term securities that SVB loaded up on to make more money on interest , were, from this prospective , thus ok.
However, they bought long dated government securities with fixed cash flows. Now here's the thing with long tenor bonds. They carry something called interest rate risk.
What is interest rate risk? Let's say you have a twenty year bond carrying an interest of one percent. And the Central Bank raises the interest rate from one to four percent. Anyone who is investing freshly has a choice. He can buy newly issued 4 percent bonds, or he can buy your bonds at such a price that the "yield" still works out to four percent. Obviously he will pay a lower price for your bonds.
So, when the Fed raises rates, the bonds that you hold drop in value. Every bank that holds these bonds needs to "mark down" the value of their bond holdings in their Balance Sheet. This is called mark to market.
Now, SVB had bought long dates Mortgage Backed Securities, which is an additional problem. The bonds in question were backed by interest payments received from housing loans. Now, when interest rates in the market go up, there is additional stress on people who have mortgages who find it difficult to repay their loans and they can do one of two things: increase their monthly EMI's, or keep their EMI's the same and increase the period of their loans. Obviously, they will mostly opt for the latter. That, in turn, increases the effective tenor of the underlying bonds, which in turn, increases the impact of interest rate increases, which in turn, reduces their price further.
Now, all banks have bonds on their Balance Sheet. They are listed as "Assets". They need to "mark to market" their bonds in the Balance Sheet daily, that is, change the asset values to reflect the current market value. If the value goes up, it's a profit, if the value goes down, it's a loss.
So, that's the background.
What did SVB do?
SVB had a lot of money parked in their current accounts by depositors at zero percent interest. They could have invested that in 0.25 percent Treasury Bills and their CEO and CFO could have continued playing golf and giving speeches on gender diversity, inclusion, sexual orientation, climate change and the Ukraine war. But what did they choose to do? They of course continued to give speeches on the above subjects - every good US citizen is supposed to do that - but they chose to invest their deposits in long dated mortgage backed securities.
So far, so good. Then...
Over the last few months the Fed raised interest rates rapidly. The value of the bonds in the SVB portfolio fell. In their case the fall was steeper since they were all MBS (not Mohammad Bin Salman that great prince villain whose opponents are known to mysteriously disappear, but, you got it, Mortgage Backed Securities).
Now, SVB needed money. So they sold a large part of their bond portfolio. At a huge loss. Plus of course, whether they sold it or not, the "mark to market" rule ensured that they "wrote down" their bond portfolio assets, and they suffered a huge loss. This huge loss wiped out their Reserves. They needed to get in additional funds. For which they had to raise equity. Now, they chose a bad time to announce that they needed to raise equity, when there was news in the market of another bank being in trouble. Or, it could merely be the fact that they announced it when the CFO had time between two of her golf matches. We don't know. In any case, the market heard the news, and what the market heard was "the bank is in trouble".
So people rushed to transfer their money elsewhere. The rumour spread. More people withdrew their money.
The share price plummeted - now, that is an entirely different angle, which introduces another dimension. And how the share price plummeted! From around 250 dollars to around 40 dollars. in a few hours.
Meanwhile, people realised they were not able to withdraw their money. Since the bank had no money.
Who are these people? A lot of them are CEO's of start-ups - start ups are a special kind of Ponzi Scheme which is a story for another day - who had parked their hardly earned VC money - oops, that is supposed to hard earned - in current accounts with SVB.
And the weekend comes. It is Friday evening and the bank people have placed a call to the Fed. The CEO's of the start-ups, are chewing their nails. Everyone is on tenterhooks.
Will the government do it or won't it do it? Do what? Rescue the bank by infusing funds. Whose funds? The taxpayer's funds, obviously.
We know the answer to that one. If 2008 is any indication. We also know who runs the US government. Wall Street does. As I am about to post this article, breaking news is that the US government has decided to step in and bail out the depositors of SVB Bank. But those who hold equity in the bank or have subscribed to its bonds will be wiped out. Totally.
The CEO's of the start-ups will therefore be able to service their payroll, and in general, continue to burn their VC's money. They are happy.
The CEO and CFO of SVB will no doubt, meanwhile, release a statement saying:
" We at SVB are a highly ethical bank committed to safeguarding the interests of our depositors and shareholders, and upholding gender diversity, inclusion, one hundred and twenty five sexual orientations, climate change and we support the government in the Ukraine war".
The headlines in the newspaper tomorrow will say "SVB Bank is not progressive. They support only 125 sexual orientations!"