Layman's explanation: Bank failures of Silvergate, SVB and Signature (2024)

This last weekend has been eventful to say the least. I'm writing this in an effort to both explain and understand what happened to the three banks that failed, Silvergate Bank, Silicon Valley Bank (SVB) and Signature Bank. Consider this a layman's perspective and feel free to let me know if I've gotten something wrong.

Our story begins with the announcement by Silvergate Bank on Wednesday March 8th that it will be winding down operations and liquidating all assets. Apparently, Silvergate, a bank with $11bil of assets, had been struggling for months. In boom times with interest rates at near 0%, Silvergate heavily invested in US treasuries or bonds. For the uninitiated, when you buy a US treasury bond, you are making a loan to the US government who in turn agrees to pay you interest. US treasuries are backed by the "full faith and credit of the United States government". Even though bonds don't make much money, they are low risk and can be easily converted into cash, so it is entirely reasonable that banks invest customer deposits into bonds. Except it isn't.

From 2009 to 2022, Federal Reserve interest rates were hovering near zero. The Federal Reserve ("the Fed") is the US version of a national central bank. Starting Q2 of 2022, interest rates began rising and are currently at around 5%. Since the financial crisis of 2009, the Fed has kept interest rates low to stimulate consumer spending in an endless game of "dodge-recession". The pinnacle of the game came during COVID when the Fed, at the behest of the US government, printed trillions of dollars that were distributed as COVID relief funds. As the dust settled, it became clear that people had too much money to spend and were driving prices up, so the game switched to "dodge-inflation". In an effort to fight inflation, the Fed started raising interest rates. The theory is that higher interest rates make borrowing more expensive and people will spend less money since they won't borrow to spend. In addition, higher interest rates also means that all newly issued US treasury bonds were now paying more interest than older bonds, encouraging people to save.

To understand bonds, let's use an example. Let's say you have paid a $1 par value for a bond paying 0.5% per year for 10 years. You will receive interest payments on the bond for 10 years. After 10 years, you will be able to redeem the bond for the original $1, but if you tried to redeem the bond earlier than that, you would be hit by heavy penalties and may only get back $0.60 or less. However, if you simply hold on to the bond and not try to redeem it, then you would not lose any money since you will get back the original $1 when the 10 years is up. Even though you cannot redeem the bond prematurely without taking heavy losses, the bond is still considered liquid because you can sell the bond to someone else. The new bond owner would then receive the remaining interest and be able to redeem the bond at expiration. In a market where interest rates were steady and all the bonds paid out at the same interest rate, you would be able to sell your bonds at close to the original $1 par value, which means that your bonds are as good as cash. However, if interest rates rise, your bonds would lose value. Newly issued bonds would pay much higher interest payments so why would anyone pay the same for bonds that were paying out lower amounts?

Back to Silvergate. FTX, the centralized crypto-exchange that went kaput, was a key customer of Silvergate. As people withdrew their money from FTX amidst the FTX meltdown in late 2022, that money was also coming out of Silvergate. By the end of 2022, Silvergate's customer deposits had declined 68% from $11.9bil to $3.8bil. Since their customer deposits were invested in bonds, Silvergate had to sell its bonds in order to pay back customers. And of course, it had to sell its bonds at a loss. Silvergate announced a $1bil net loss in Q4 of 2022. By this time, Silvergate executives saw the writing on the wall. The realized that things were only going to get worse and they still wanted their annual bonuses. So they took the prudent step of announcing a voluntary wind down and liquidation in a plan that would ensure that all depositors would be repaid in full over time. This was Wednesday, March 8th.

That very same day, Silicon Valley Bank announced a $1.8bil loss on the sale of their bonds and a plan to raise $2bil through stock sales to shore up their balance sheet. SVB was the 16th largest bank in the US with $210bil in assets. This sent a chill up the collective spine of financial market analysts and the word on the street was that SVB was running out of cash. It is important to note that SVB customers were mainly venture capitalists and startups, a highly networked group where news travels fast. VCs began withdrawing their funds and encouraged their portfolio companies to do the same. SVB CEO Greg Becker tells his VC and startup friends not to panic. By Friday, March 10th, the bank run became a self-fulfilling prophecy and the Federal Deposit Insurance Corporation (FDIC) stepped in and took over SVB to protect depositors. The FDIC is the agency that insures all bank deposits up to $250,000. Deposits above $250,000 are not insured. By end of business Friday, barely 3 days after their unfortunate announcement, SVB is declared a failed bank.

Over the weekend, the Fed and FDIC worked to "stem the contagion". Nervous pundits were already pointing out other banks that were taking losses on their bond portfolios. Doomsayers were predicting the end of the banking system as we know it. Predictably, on Sunday, March 12th, the Fed steps in to calm the markets and announced that they will backstop all SVB deposits, meaning they will pay out all customers who have deposited funds in SVB regardless of amounts. The Fed made a point to note that no losses from the backstopping of customer deposits would be borne by the taxpayer. So if they're not taking from tax payer money, which is money that has already been printed and exists in the system, that can only mean that they will print new money to pay for this. So much for dodge-inflation. And in the same breath, they announce the closure of Signature Bank by the New York State authorities, citing "systemic risk". Signature Bank has $110bil of assets.

Now, Signature Bank is a curious case. They are one of the top crypto-friendly banks in the US. According to one of its board members, customers withdrew more than $10bil in deposits on Friday, spooked by the SVB collapse. While these withdrawals were unusually high, there were no outward signs of distress from the bank and liquidity appeared to be high. Nonetheless, in a pre-emptive move, New York regulators shut down the bank and the FDIC took over. This reminds me of World Trade Center building 7, which collapsed due to fires caused by debris from the North and South buildings that were hit by planes (too controversial?). Signature Bank was shut down on contagion fears, not on actual bank fundamentals or liquidity issues. Signature Bank board member and former U.S. Rep. Barney Frank, coauthor of the Dodd-Frank Act that increased government oversight of banks following the 2008 financial crisis, said about the bank shutdown: “This was just a way to tell people, ‘We don’t want you dealing with crypto."

Yesterday, the consumer price index (CPI), a number that measures inflation, was announced to be 6%, meaning prices went up by 6% over last year. Bitcoin and crypto prices shot up, supposedly in reaction to the news. Seems the Fed's preemptive strike against crypto didn't work. It's now Wednesday March 15th, a week after our story begins and I'm buying bitcoin, what about you?