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What in the World?

Silicon Valley Bank collapse is not a sign of new financial crisis

Mar 16, 2023

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In the wake of the stunning collapse of Silicon Valley Bank, President Biden is calling for tougher regulations on banks. The move comes as the White House and the Federal Reserve work to restore confidence in the U.S. banking system after a $42 billion bank run wiped out SVB.

Signature Bank, based in New York, has gone under, as well. Straight Arrow News contributor Peter Zeihan urges calm, saying that while these bank failures are bad news, the U.S. is not facing another bank crisis.

Excerpted from Peter’s Mar. 15 “Zeihan on Geopolitics” newsletter:

No, we’re not headed for another financial crisis…although, to those with more than 250k in one of the three failing banks, it may seem like we are. Silicon Valley Bank is the largest of the three, but it’s still only the 16th largest in the nation.

The problem for Silicon Valley Bank and the smaller Silvergate and Signature Bank is that they all took on a questionable amount of exposure to illiquid assets. For SVB, it was a variety of long-term bonds and securities with long durations. Then interest rates started to go up — way up. And SVB was not left with many tools to manage interest rate risk it had not hedged for. When its primary customers — the tech industry — found out, they sounded the alarm. Being the tech world, they’re all relatively well-connected and active on social media, triggering a stampede of customers wanting to pull their cash out more or less simultaneously, or what we’d call a good old-fashioned bank run.

The real thread connecting all of these banking mishaps, however, is one that’s not going to go away anytime soon. Rising capital costs. Many of these banks and their customers have been operating in a world where money has been as close to free as it has ever been in human history. Over the past year, we’ve seen interest rates rise — sharply — and there’s little reason to believe that we’re anywhere near done yet. The fundamental operating paradigm for banks and the financial paradigm of the past decade and a half is shifting, and we’re going to see which financial institutions are able to deal with the change and which ones won’t be able to keep up.

The Biden administration has now stated that the FDIC will make all depositors whole. That’s great for ending any potential bank runs, but those CFOs who thought it was a good idea to put all of their company’s capital into one bank won’t be learning their lesson this time around.

Hey everybody, Peter Zeihan here coming to you from … Bloomington, Illinois. Sorry, I forgot where I was there for a second. It is the 14th of March, Tuesday. And for those of you who have been following the news, you of course know that the United States is facing a little bit of a banking hiccup right now. Over the course of the last few days, three banks of note, Silvergate, Signature, and Silicon Valley have either been closed by regulators or just simply collapsed. And this is something that honestly, I don’t think anyone should really overly worry about. 

The biggest of them, Silicon Valley, is like number 16 in the country, so this is nothing like the financial crisis of 2007 when all of our big 10 banks were in trouble all at the same time. Now, normally, when you have a financial crisis, it’s because of a problem with loans. Whenever the business cycle turns, the cost of capital goes up and loans that may have made sense in the past don’t anymore. 

So in 2007, the issue was subprime. We had, based on how you measure the math, somewhere between half a trillion and two and a half trillion dollars of questionable loans in the real estate market. And that meant it touched almost every single bank within the entire system. So when the real estate market turned, and we realized that a lot of these people were baristas who had no incomes and had qualified for 100% mortgages on million-dollar homes and those loans went bad, we had problems across the entire space. Nothing like that is going on this time.

We’ve had some very strong expansion and certainly, capital’s probably been overly cheap, and there is some rot in the system that does need to be worked out. And what basically what’s going on is, the financial system is going through the process of taking out the crap trash right now.

You would expect some banks to go down; that’s not necessarily a signal of a broader contagion, systemic risk sort of thing. In addition, the United States has something called the FDIC, the Federal Deposit Insurance Corporation, which is a system by where all banks pay a monthly fee into the system in order to get insurance for their depositors. So as long as your deposit is under a quarter of a million dollars, you are federally guaranteed to get your money back without the federal government having to do anything.

That system has kicked in and depositors will be made whole. It makes sense that these three banks are the ones that went under first. They won’t be the last probably, although that doesn’t mean I’m concerned about something like eating through the entire system like a cancer. It’s just that they’re all related to tech and tech tends to be a capital-intensive industry. And especially when you’re talking about newer firms and startup firms and research firms, which are what these banks cater to, you’re talking about institutions and companies that don’t make money today. They’re hoping to make money next year, or the year after, the year after that or invest in the next big thing. So they tend to be more prospective, they don’t have to all have any income. 

And so when capital costs go up, they fix problems. And so these banks are the ones that are facing the issues. So there’s nothing about this that is any more than a run-of-the-mill bank failure, but matches most of our understanding is about macroeconomic trends. I don’t want to say it’s nothing to worry about. But I’m really not concerned about an overall national bank contagion or a broad bank run. And I think what the stock markets have done in discounting all things financial is a gross overreaction. So there’s that. 

Now, there are three reasons why this time, it is a little bit different. First of all, Tech has been on a tear for the last several years. And not just because capital has been cheap, but because of COVID. When we all found ourselves living and working at home, we needed better cameras, we needed ring lights, we needed computers, we need to update our phones, and so in the year 2020, and 2021, and to a lesser degree in 2022, we were all buying all kinds of tech-related products generating a bit of a boom. Well, once you buy the newest and greatest computer and phone, you probably are going to wait before you get the next one. And so we were always going to have a little bit of a tech bust independent of what was happening with the overall economy. So that’s one. 

Number two, this is a little atypical for a bank run or a bank crash because normally the problem is on the loan side. It really isn’t this time, it’s not that there hasn’t been a capital crunch. But in the tech startup space, these companies usually don’t go to like, the Small Business Administration to get a business loan. They get their capital directly from a venture capitalist. And it’s the venture capitalists who are finding themselves with less capital to throw at situations. So they’re not as able as they have been to throw money at these small startups. And so the startups have been drawing down on their cash, which means the problem from the bank’s point of view hasn’t been with the money that they’ve lent out. They don’t lend out very much it’s been with the money that they thought they had. So as deposits have been drawn down, they haven’t had enough operating capital to continue normal operations. 

Now, this is mostly good news because it means the overall exposure to the financial sector, which is normally what how happens when you sell loans among banks, just isn’t there. But it’s a very big problem for the tech sector. And then we get to our third problem, which is how the Biden Administration has chosen to deal with it. 

Now, if you’re dealing with a deposit that’s under a quarter of a million dollars, the federal government doesn’t have to lift a finger because the FDIC will take care of it. But a lot of these small startups, they put all of their money into individual banks, most notably Silicon Valley Bank. So it was a lot more than a quarter of a million. Now more than a quarter million is not insured, so what the federal government has done to the Biden Administration is step in and say that all depositors will be made whole by the FDIC. 

What will happen is, banks will have to pay a little bit higher all banks into the FDIC system in order to ultimately make up for this so that taxpayers don’t have to pay for the actual bailout. Now, this does put a hard stop on any risk of a bank run, so it’s definitely the right tool for the job there. But what it does is, is it encourages companies that have done stupid things like this to continue doing them, because now all of us have to pay through lower bank interests or more difficult loan conditions, for a handful of startup companies who had CFOs who were just too dumb to realize that there was a limit to the deposit insurance system. And so this has injected a permanent level of stupidity into the financial system that was really not necessary. 

And by backing all depositors, the federal government, the Biden Administration, specifically has chosen to introduce what we call moral hazard into the system at the base level, which in my opinion, was really not a great idea, although it definitely does put a bit of a backstop on the financial maybe/kinda/sort of/itty-bitty crisis. 

Okay, I’d like to give a little shout-out here to Marcy Roussel who is an economist that I actually just saw on stage who is fantastic. So if you ever have a chance to see her in person, she is definitely an entertaining show, and will constantly give you new things to challenge your assumptions and thinking new directions. Alright, that’s it for me. See you guys next time.

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