Mar 14, 2023

The SVB bank failure, explained.

Why did the bank fail? And who is responsible?

I’m Isaac Saul, and this is Tangle: an independent, nonpartisan, subscriber-supported politics newsletter that summarizes the best arguments from across the political spectrum on the news of the day — then “my take.”

Are you new here? Get free emails to your inbox daily. Would you rather listen? You can find our podcast here.


Today's read: 12 minutes.

🚨
We're breaking down the SVB failure: Explaining how it happened, and sharing reactions from the right and left. 

From today's advertiser: In a perfect world, you would always have fresh veggies/fruits in a cooler ready to eat, but that would be a pain to prep and lug around. Most protein bars today aren’t great for your digestive health, cause bloating, and contain processed ingredients.

Meet Odyssey Snacks, a brand that combines prebiotics and protein all wrapped up into one, convenient bar to keep you thriving from the inside out. Whether you're headed to the gym or into the office, these protein bars will not only satisfy your taste buds but also benefit your gut.

  • Made with real ingredients like dates, kale, and spinach, their bars are packed with prebiotics that nourish your probiotics, the good bacteria in your gut.
  • Studies show that a healthy gut is linked to a stronger immune system, improved digestion, and even a better mood.

So say goodbye to useless ingredients and bloating caused by other protein bars. As a Tangle reader,  you get 20% off your first box.


Quick hits.

  1. The Consumer Price Index increased 6% in February compared to a year ago, down from 6.4% in January and about what economists expected. The inflation index rose about 0.4% on a monthly basis. (The numbers)
  2. The Biden administration approved an oil drilling project in Alaska while also issuing a rule restricting drilling on 16 million other acres of the National Petroleum Reserve and in the Beaufort Sea. (The deal)
  3. Meta, the owner of Facebook and Instagram, is planning to lay off another 10,000 employees after cutting some 11,000 workers in November.  (The layoffs)
  4. Senate Minority Leader Mitch McConnell (R-KY) was discharged from the hospital yesterday after suffering a concussion in a fall last week. He will spend time in an inpatient rehabilitation facility. (The facility)
  5. Russia signaled a willingness to extend its grain exportation from the Black Sea for 60 more days (The grain). Separately, the first arrest warrants from the International Criminal Court are being prepared against Russian officials over alleged war crimes in Ukraine. (The warrants)

Today's topic.

Silicon Valley Bank. Over the weekend, U.S. regulators took over Silicon Valley Bank (SVB) after it collapsed on Friday morning. In a matter of 48 hours, SVB experienced a bank run and capital crisis, becoming the second largest bank in U.S. history to go under. Over the weekend, panic spread among investors and economists who feared the failure of SVB could set off a national financial crisis, but those concerns were mostly allayed when U.S. regulators announced emergency measures to protect depositors.

What is a bank run? It's first important to understand what a bank is. Banks are essentially "borrowing short and lending long," as economist Noah Smith puts it. Your money in a checking account is money a bank is borrowing from you, but the bank has to give you that money whenever you ask for it. Banks use that capital to invest in long-term assets by offering other customers loans, like mortgages, which earn high returns but can't be quickly liquidated into cash. This is how banks make money: Long-term gains while holding short-term cash. But if a bunch of people all come asking for their money at once, a bank gets in trouble, because it can't simply liquidate its long-term investments to give people their money. This is what is called a bank run.

What is unusual here? SVB was a Federal Deposit Insurance Corporation (FDIC) insured bank, meaning that every depository account was insured for up to $250,000. However, most of SVB's capital was held in accounts that were over the $250,000 limit, because many of SVB's clients were startups — companies that are too young to have enough revenue to pay their bills, instead using money they raise from venture capitalist investors. A lot of these start-ups were storing the cash they raised with SVB, which billed itself as the “financial partner of the innovation economy,”  because it provided many services to start-up founders outside of simply being a bank, like helping early employees secure personal loans for homes.

Over the years, SVB has been pretty successful because so much venture capital money has been flowing to start-ups, due in part to a long span of historically low interest rates. However, it was still much smaller than the biggest banks: It had about $200 billion in assets, compared to JP Morgan Chase's $3.31 trillion.

So what happened? In a single day, about $42 billion of that $200 billion in assets was withdrawn. There are a few different theories about what caused the bank run, and the likely explanation is some combination of all of them. The initial event seems to have been SVB's parent company announcing it was going to sell billions of dollars of securities from its portfolio at a $2 billion loss, while also attempting to raise more money. SVB was aiming to clean up its balance sheet, but instead, the move signaled it had a cash crunch, which spooked its clients and the markets.

In response to the news, big name investors like Peter Thiel were telling their companies to withdraw their money from the bank while they could, sensing something was amiss. Those instructions, predictably, spread rapidly throughout the very insular venture capital and tech worlds. And because a bank run can sometimes be a self-fulfilling prophecy, the panic quickly compounded.

SVB’s very homogenous set of clients was a major contributor to the panic, but was not the only source of its financial vulnerability. Economic conditions for companies like SVB, which thrived in a climate of low interest rates, were already rocky. Since SVB invested in safe securities like U.S. bonds while holding its clients' cash, and rising interest rates make bonds worth less, SVB’s profit model became more and more vulnerable as interest rates continued to go up. At the same time, SVB was also getting hurt on the cash flow end, as rising interest rates also reduced investment in start-ups and business creation.

What's the big picture? SVB wasn't the only bank failure in the last week. Before SVB failed, Silvergate Bank, a cryptocurrency-centric bank, also failed. Signature Bank, a New York-based institution with deep ties to the crypto, real estate and legal industries, also suffered a failure over the weekend after the SVB episode scared its depositors into withdrawing their money, too. This became the third-largest bank failure in U.S. history. Signature had 40 branches and $110 billion in assets.

Since bank failures can be contagious, these failures prompted the U.S. government to step in and ensure all depositors would get their cash back and be made whole. That was an important step, because it ensured companies that used SVB to bank could still pay their employees. The government said bank fees and the newly formed Bank Term Funding Program (a fund banks pay into) will cover those losses rather than taxpayers' money, emphasizing the moves did not amount to a "bail out" similar to the government’s action after the 2008 crash. Stock prices of midsize and regional banks cratered nonetheless, despite President Biden assuring Americans they could have confidence in the U.S. banking system.

Today, we're going to take a look at some arguments from the left and right about why this happened and what to do next, then my take.


What the left is saying.

  • Many on the left pointed to a 2018 rollback of bank regulations under Trump and self-dealing of SVB that helped create this mess.
  • Some argued that the government reacted well to the crisis, and called for more oversight and regulation.
  • Others criticized conservative culture war arguments about why the bank failure happened.

In Mother Jones, Hannah Levintova pointed the finger at Donald Trump, SVB's president, and a lack of regulation for the failure.

"This precarious scenario... may not have been the case were it not for the work of SVB’s President Greg Becker, who eight years ago asked a Senate committee to relax regulations that would soon be applied to his own bank," Levintova wrote. "His appearance kicked off a half-a-million-dollar lobbying effort that led to a bill, signed by then-President Trump, undoing regulations precisely as SVB and other banks had asked for. At the 2015 Senate hearing, Becker had his sights set on chipping away at a portion of the Dodd-Frank Act, the sweeping Wall Street reform bill passed in the wake of the 2008 financial crisis... A key rule in the law required that 'Too Big To Fail' banks—which Dodd-Frank defined as those with more than $50 billion in assets—undergo stricter oversight, including higher capital ratio requirements designed to shore up the big banks’ ability to withstand financial shocks.

"Becker, along with several other banking executives, asked senators to raise the threshold for banks that should be subject to this expanded level of supervision from $50 billion in assets—a milestone his bank was quickly approaching—to $250 billion," Levintova said. "His testimony explained that the stricter risk checks would needlessly cost his banks millions, diverting resources from their ability to lend to 'small and growing businesses' that are 'job creation engines.' ... Following the hearing and three years of SVB lobbying lawmakers, Becker got his wish: In 2018, Trump signed a bill into law raising the threshold for stricter bank oversight to $250 billion in assets."

In CNN, Darrell Duffie said despite the failure, this isn't likely to morph into a larger crisis.

"Yes, there were failures of risk management and regulatory supervision. And there are likely some other banks whose balance sheets have been similarly weakened by the rapid increases in interest rates, which dramatically diminished the value of Treasuries and mortgage-backed securities. According to FDIC Chair Martin Gruenberg last week, banks have yet to recognize about $620 billion of losses in market value caused by rising interest rates," Duffie said. "Since the collapse of Lehman Brothers in 2008, the largest US banks have been forced by regulators to be much more resilient. They also rely far more heavily than SVB on retail depositors, who tend to have a greater share of their deposits covered by FDIC insurance and are less prone to run at the first sign of trouble.

"Of more immediate concern is the potentially systemic impact this will have on the tech sector, which has already seen mass layoffs and investments shrivel up in recent months. Close to half of all listed US venture-backed tech and health care firms were SVB customers and many of these companies were racing to line up funds to make payroll in the aftermath of the collapse," he wrote. "If a large fraction cannot survive, then it is in the US government’s own interests to step in. It can do that in a number of different ways. The SVB catastrophe could, for example, serve as a catalyst for the government to establish a new domestic industrial development bank, as proposed by Senator Chris Coons, which could provide bridge loans to the tech industry. For some tech startups, the Small Business Administration could step in with emergency loans, as was done when Covid hit in March 2020."

In The Atlantic, David Graham criticized some conservatives who were blaming "wokeness" for SVB's failures.

"A financial panic like the one that struck several U.S. banks over the past few days presents a dilemma for the committed partisan. You don’t want to side with the failed Silicon Valley Bank and other collapsing institutions and come across as coddling the rich, but you also don’t want to root for the bank to fail and end up being a cheerleader for broader economic collapse," Graham wrote. "This is especially tricky for Republicans, who spent the weekend looking for a way to criticize President Joe Biden’s handling of the crisis, even as they waited to see what his handling of the crisis would be. But a few prominent Republicans found a third way: Blame it all on wokeness. 'I mean, this bank, they’re so concerned with DEI and politics and all kinds of stuff. I think that really diverted from them focusing on their core mission,' said Florida Governor and presumptive presidential candidate Ron DeSantis.

"This is a clever maneuver, sidestepping messy questions about whether and how to rescue the failing banks by instead attaching the panic to an existing narrative about 'wokeness' in the Democratic Party. It also avoids the risk of appearing to be against entrepreneurs who might lose their shirts in bank collapses, or against the financial system that has historically backed Republicans," Graham added. "The only flaw is that the line of attack makes no sense. In reality, Silicon Valley Bank failed because it made some bad business bets. It invested deposits in long-term assets such as Treasury bonds. As the Federal Reserve raised interest rates, those investments lost value while simultaneously squeezing many of the depositors. The result was a bank run, complete with lines outside branches."


What the right is saying.

  • Many on the right also criticize government policy, though they point to monetary policy and the failure of Fed oversight.
  • Some argue this is not a bailout, and the depositors should be made whole.
  • Others suggest SVB made several huge management mistakes, and may have been distracted by DEI and other political worries.

The Wall Street Journal editorial board called it a "de facto bailout of the banking system."

"The unpleasant truth—which Washington will never admit—is that SVB’s failure is the bill coming due for years of monetary and regulatory mistakes," the board said. "The Federal Deposit Insurance Corp. closed SVB, and the cleanest solution would be for the agency to find a private buyer for the bank. This has been the first resort in most previous financial panics, and the FDIC was holding an auction that closed Sunday afternoon. But Rohit Chopra, the Elizabeth Warren acolyte on the FDIC board, is hostile to bank mergers on ideological grounds, and the purchase terms could be too onerous for some potential buyers. The biggest banks are now the safest, and deposits are flooding into them. J.P. Morgan can park that money at the Federal Reserve and earn interest on its reserves. Why take on a new political headache?

"SVB executives made mistakes, and they will pay for them, but they were encouraged by easy money and misguided regulation. As the Fed flooded the world with dollar liquidity, money flowed into venture startups that were SVB’s customer base," the board said. "The bank’s deposits soared—far beyond what it could safely lend. In a world of near-zero interest rates, SVB put the money in long duration fixed-income assets in search of a higher return. Regulators after the 2008 crisis had deemed these Treasury bonds and mortgage-backed securities nearly risk-free for the purpose of measuring bank capital. If regulators say they’re risk-free, banks and depositors may be less careful. But those securities declined in value as the Fed took interest rates up quickly to break the inflation it helped to cause."

In The Washington Examiner, Conn Carroll said SVB is not getting a bailout.

"The term 'bailout' is a dirty word, and rightly so. When taxpayers are forced to pay for the mistakes of corporate executives, and investors who were supposed to be monitoring those executives, bad incentives for risk-taking are created," Carroll wrote. "But this is not what is happening to Silicon Valley Bank. Silicon Valley Bank is not getting bailed out. It is dead. Its investors and bondholders have been completely wiped out, and the executives are now unemployed. The only people getting bailed out here are the depositors — the ones who put their hard-earned money in accounts with Silicon Valley Bank, including the companies that have bank accounts with them. So when Sen. Bernie Sanders (I-VT) says, 'Now is not the time for U.S. taxpayers to bail out Silicon Valley Bank,' he should be happy to know that Silicon Valley Bank is not getting a bailout — its depositors are. This is an important distinction.

"The executives who ran Silicon Valley Bank definitely made some big mistakes. They have been punished with the loss of their jobs. But they are not guilty of the same reckless behavior that caused the global financial crisis over a decade ago. In the run-up to the mortgage meltdown, financial firms were issuing predatory mortgage loans they knew were very risky and then engaging in highly questionable financial engineering (some would even say fraud) to sell those mortgages as safe investments," Carroll wrote. "Making bad predatory loans is not what caused Silicon Valley Bank to fail. Quite the opposite. If anything, Silicon Valley Bank didn’t make enough loans. Instead, it bought a bunch of ultrasafe low-yield Treasury bonds. In other words, it did exactly what people like Sen. Elizabeth Warren (D-MA) wanted it to do: It bought safe assets.”

In The Wall Street Journal, Andy Kessler pointed to management mistakes, DEI, and ignoring rising interest rates for SVB's mistakes.

"Everyone, except SVB management it seems, knew interest rates were heading up. Federal Reserve Chairman Jerome Powell has been shouting this from the mountain tops. Yet SVB froze and kept business as usual, borrowing short-term from depositors and lending long-term, without any interest-rate hedging," Kessler said. "The bear market started in January 2022, 14 months ago. Surely it shouldn’t have taken more than a year for management at SVB to figure out that credit would tighten and the IPO market would dry up... Was there regulatory failure? Perhaps. SVB was regulated like a bank but looked more like a money-market fund.

"Then there’s this: In its proxy statement, SVB notes that besides 91% of their board being independent and 45% women, they also have '1 Black,' '1 LGBTQ+' and '2 Veterans.' I’m not saying 12 white men would have avoided this mess, but the company may have been distracted by diversity demands," he wrote. "Management screwed up interest rates, underestimated customer withdrawals, hired the wrong people, and failed to sell equity. You’re really only allowed one mistake; more proved fatal. Was management hubristic, delusional or incompetent? Sometimes there’s no difference."


My take.

Reminder: "My take" is a section where I give myself space to share my own personal opinion. If you have feedback, criticism, or compliments, don't unsubscribe. You can reply to this email and write in. If you're a subscriber, you can also leave a comment.

  • This had nothing to do with wokeness or DEI, and it's not a bailout.
  • So many of the "smart people in the room" on both sides got big things very wrong.
  • We should all be a lot more skeptical about the tech industry and the venture capitalists propping it up.

Let me start with the easy stuff. First, no, this did not happen because of "wokeness" or "diversity" demands. Anyone making those claims is a partisan hack and should be discounted as such. If you think a bunch of conservative, anti-woke, straight white people would have avoided these errors, you'd have to be ignoring basically every other bank failure in U.S. history. Of course, I doubt SVB is that woke anyway. Maybe I'm just cynical, but I'd bet it wanted to project itself as a liberal institution more than anything else. The Bay Area is one of the liberal bastions of America, and SVB's limited attention to Diversity, Equity, and Inclusion was probably more about good business than any heartfelt devotion to DEI.

Second, this does not amount to a "bailout," and I think the rarely seen consensus between The Wall Street Journal's editorial board and Senator Bernie Sanders calling this a "de facto" bailout is wrong. SVB was not bailed out. Shareholders and bondholders are being wiped out, while depositors (who did nothing wrong but trust a bank) are being made whole. The money is coming from funds banks pay into and the government is not losing a bunch of taxpayer money by taking action. That is a decent outcome, all things considered.

Third, yes: It turns out the brilliant venture capitalists in Silicon Valley are not infallible geniuses. The tech sector has enjoyed so much positive press, so much hedonistic self-congratulation (remember when they were legitimately rallying around calls to secede?), that we somehow seem ready to believe everyone in the Bay Area is operating on a different wavelength than the rest of us. It turns out — if you look closely — the tech sector is actually having a rough one. They're in a wave of layoffs, facing huge crypto instability, struggling to hit profit expectations, and now we're seeing what happens when a bunch of low interest, essentially free money, starts to dry up. Things are likely just going to get worse.

What is interesting and perhaps most frightening about this entire episode is just how wrong all the "smartest" people in the room seem to have been. And that goes for folks on both sides of the political aisle.

Atop the blame pyramid is obviously the executives from Silicon Valley Bank. Andy Kessler (under "What the right is saying") rightfully got a lot of heat for his absurd mention of SVB's purported focus on DEI, but that was two sentences in his entire piece. His liberal critics are ignoring that he was right about pretty much everything else he wrote. This was not about one or two mistakes — it was about several that compounded each other’s effects. The bank was over-leveraged on U.S. bonds, reacted too slowly to changing conditions, and had a total blindspot about the people it was serving. They paid the ultimate price, and deservedly so.

Most of the other criticisms I saw about how this environment was created are right, too. Hannah Levintova (under "What the left is saying") nails it on bank oversight. SVB's president literally lobbied against regulations that could have stopped this. It doesn't get any more egregious than that. She's right, too, that President Trump's administration gave him exactly what he wanted.

The Wall Street Journal's editorial board (under "What the right is saying") is on the money that these "safe" investments in U.S. bonds are exactly the kind of investments progressive icons like Bernie Sanders and Elizabeth Warren wanted banks to make. Well, it turns out when the government spends a decade flooding the economy with interest-free cash and then has to turn the dial up to beat back inflation, there can be huge repercussions when the value of those bonds takes a hit. This is precisely the kind of thing the Journal's editorial board has been warning about for years.

Speaking of the government and regulators, where was the San Francisco Fed, who somehow missed the vulnerability of SVB? Aren't they the ones who are supposed to protect depositors from this kind of bank run?

Then, of course, everyone is right to mock the insular venture capitalists in the Valley, some of whom — and there is no polite way to put this — completely lost their heads in this meltdown.

Given that we know bank runs can be as contagious as a virus, one would think a focus on calm and reason would be at a premium. It's actually important to remember who kept their wits. Here was how entrepreneur Jason Calacanis, one of the most visible people in the start-up world, spent the weekend:

One startup founder told Vox that he got five calls in one single day from different VC investors telling him to pull his money out of SVB. Sam Altman, the CEO of OpenAI (the folks behind ChatGPT), ominously tweeted on Friday that investors should just start sending emergency cash to their startups — no questions asked.

Venture Capitalist Matt Harris summed up my reaction nicely:

A lot of people got a lot wrong.

For now, the good news is that the tide of bank failures seems to have momentarily slowed, and there isn't reason for any kind of major panic. A larger, and more concerning takeaway came from writers like Will Gottsegen, who said that Silicon Valley — which has at times been the engine driving the U.S. economy — is seemingly "just a house of cards.” For our sake, I hope he's wrong. But it's hard to be confident when everyone in the system — the regulators, the bank executives, the self-satisfied Silicon Valley smarties, and especially the venture capitalists — seemed to have gotten so much of this so wrong.

Want to share today's debate? You can share this on Twitter by clicking here or via email by clicking here.


Your questions, answered.

Explaining bank runs isn't easy. Today's main story took up a lot of space, so we're skipping our reader question today. Want to have a question answered in the newsletter? You can reply to this email (it goes straight to my inbox) or fill out this form.


Under the radar.

A California state appeals court has reversed a lower court ruling and upheld Proposition 22, reviving a ballot measure that allows app-based services like Uber to treat drivers as independent contractors rather than employees. The ruling is a major win for the industry, though it is expected to be challenged to the California Supreme Court. However, the appeals court did strike down a provision of Proposition 22 that limits the ability of gig workers to unionize. In 2020, roughly 60% of California voters approved Prop 22, which allows app-based transportation services to classify drivers as independent contractors so long as they are being paid minimum wage and receiving expense reimbursement and health subsidies. Reuters has the story.


Numbers.

  • 16th. SVB's rank, in size of assets, among all U.S. banks.
  • $160 billion. The amount of value SVB lost in just 24 hours.
  • $3.6 million. The amount of company stock SVB CEO Greg Becker sold two weeks before the firm disclosed its extensive losses.
  • $209 billion. The amount of assets SVB had at the time of its failure.
  • $175.4 billion. The amount of deposits SVB had at the time of its failure.

The extras.

  • One year ago today, we were writing about the fighter jets Poland wanted to send to Ukraine.
  • The most clicked link in yesterday's newsletter: My "new favorite card game," called Kemps (apparently also known as Canes, Cash and Kent).
  • Divided: 42% of Tangle readers said they felt somewhat or mostly positive about Biden's budget proposal; 38% said they felt somewhat or mostly negative.
  • Nothing to do with politics: Happy Pi Day. You can celebrate by reading about the guy who memorized 111,700 digits of pi.  
  • Take the poll: Did SVB’s failure make you worry about your own bank? Let us know.

Have a nice day.

Good news for Tangle’s business model! A new research paper published in the journal Nature Human Behaviour suggests party loyalty and partisan motivation may be interfering less with Americans’ thinking than previously believed. The study, done by MIT behavioral researchers, suggests both Democrats and Republicans are more open to being challenged than previously thought. “Our results are clear and unequivocal: Learning the in-party leader’s position on an issue certainly did influence partisans’ attitudes — but it did not cause the partisans to ignore or discount arguments and evidence that ran counter to the leader’s position,” David Rand, who was involved in the study, said. You can read more about the study here.


Don't forget...

We have a small team, no investors, and — because we don't use sensationalist, divisive, or misleading narratives — a harder time getting people's attention.

In order to spread the word about our work, we rely heavily on readers like you. Here are some ways to help us...

📣  Share Tangle on Twitter here, Facebook here, or LinkedIn here.

💵  If you like our newsletter, drop some love in our tip jar.

🎉 Want to reach 58,000+ people? Fill out this form to advertise with us.

😄 Share https://readtangle.com/give and every time someone signs up at that URL, we'll donate $1 to charity.

📫  Forward this to a friend and tell them to subscribe (hint: it's here).

🎧  Rather listen? Check out our podcast here.

🛍  Love clothes, stickers and mugs? Go to our merch store!

Subscribe to Tangle

Join 50,000+ people getting Tangle directly to their inbox!