Silicon Valley Bank
The tech industry's lender, insolvent
This just in: Silicon Valley Bank, one of the largest banks in America, shutdown yesterday. The bank declared earlier this week that they were looking to raise $2.25 billion in funding to take care of a massive debt hole on its balance sheet. Coming from a commercial bank, this triggered just the kind of reaction you’d expect: doubt, panic, and bearishness. Today, we’re going to be looking at the largest bank failure in US history since Washington Mutual during the 2008 financial crisis, and how gradually deteriorating financials simply blew up in less than a week.
What is Silicon Valley Bank?
Founded in 1983 in Santa Clara, California, Silicon Valley Bank (SVB) thought of itself as the “financial partner of the innovation economy.” Being less than a 15 minute drive from the world’s technology hub, SVB rose to be a major player in the financing of the technology industry, particularly with startups and venture capital, with some of their early hits including Cisco Systems and Bay Networks.
Following the dot-com bubble burst, SVB focused on expanding their private banking (financial services for high-net-worth individuals) affairs as well as their international outreach. In 2004, they opened offices in India and London, and later Beijing and Israel.
SVB’s uniqueness came from their focus on startups (by the company’s estimate, SVB served 65% of all startups in 2015). New firms generate little revenue in their first few years and are generally riskier investments from a bank’s point of view. SVB’s way around this, however, is essentially keeping a tight leash with their debtors. By continuously monitoring the financial conditions of their clients and adjusting the funding accordingly, SVB was able to establish themselves in an area Wall Street has historically avoided.
SVB also worked with private equity and venture capitalist firms that specialize in high-tech startups, further building their influence in the technology industry.
A bank run, plain and simple
In short, too many clients demanded their money back and SVB couldn’t pay it all back – the hallmark of a bank run. But this begs the question, what caused the calamity? Why did people suddenly want to withdraw their funds?
In addition to providing loans to startups, SVB also used depositor funds to buy Treasury bonds. These are generally considered some of, if not the safest assets out there, so it would seem logical to do so. In fact, it’s very common for mutual funds, pension funds, and insurance companies to hold US Treasury bonds – these companies have a low risk tolerance for investment, so T-bonds are their best bet.
However, bond prices are in no way fixed. When Federal Reserve Chairman Jerome Powell declared that more rate hikes will be necessary to quell inflation, bond yield rates increased. There are 3 key components of bonds: the bond price, yield, and percent yield. The yield (in terms of actual dollars) is fixed, and the price and percent yield revolve around it so to speak. When investors anticipate higher interest rates, the bond percent yield also increases.
But because the percent yield and price move inversely, a higher percent yield decreases the bond’s value. The Fed’s hawkish sentiment with respect to monetary policy is reflected in the recently increasing bond yields:
(On a side note, that hefty drop at the end is actually because of SVB’s collapse, as investors flocked to safer assets! More demand for bonds = higher price = lower percent yields.)
For SVB, the bond price drop was catastrophic. But why couldn’t they just wait for the bonds to mature, even if they completely collapsed in value? First off, because a lot of them mature in several years (think 10, 20, and 30 year bonds) and SVB, being a bank, must have immediate liquidity to satsify depositor demands. Long-term bonds therefore won’t meet the bank’s short-term financial needs. This is called a maturity mismatch: when a company’s short-term liabilities are greater than their short-term assets.
Secondly, the bond price drop wasn’t a one-off event, but represented an overall trend that didn’t look good for SVB; soaring interest rates not only decrease bond prices but also venture capital investments. When funds aren’t as easily available, there’s little reason for investors to put their money into startups of all things. Not only is the cost of capital higher (thereby making it more expensive for VCs to finance their investments), but investors recognize that high interest rates aren’t ideal for startups, as reduced aggregate demand poses a challenge for new firms wanting to get off the ground.
What this means for SVB is that young firms – their clients – will have to turn to their deposits to continue operations. From 2021 to 2022, SVB’S deposits lost $16 billion. But liquidity needed to somehow be maintained, and so SVB sold their Treasury bonds at a $1.8 billion loss. And the rest is just history: SVB offers to sell $2.25 billion in shares to cover up their loss, markets panic, a bank run ensues, and before you know it the California Department of Financial Protection and Innovation closes the bank and hands it over to the Federal Deposit Insurance Corporation. Silicon Valley Bank had more than $200 billion in assets before it all came crashing down.
Implications
The general consensus on the matter is that SVB’s rapid collapse was because of their deep ties in the tech startup sector. A bank putting more than half of their business in a single industry yields greater rewards when that sector does well, but if and only if that sector does well. As soon as things start to dwindle, things can quickly turn sour for said bank.
SVB was deeply concentrated in technology venture capital, which began to subside in the wake of tighter monetary conditions. So that’s the first lesson: if you're a bank, diversify your business.
As for the broader financial system, it’s unlikely we’ll see anything catastrophic. Most of America’s bigger names such as JPMorgan and Goldman Sachs have a diversified collection of investments and an abundance of deposits. Keep in mind that although these banks have also likely incurred losses on their Treasury bond holdings, they can be offset with assets that perform well in a high interest rate environment – such as loans, which most banks have plenty of under their belt.
Econ IRL
Does anybody remember Toys R Us? The once-sensationalized toy store seems to hardly exist nowadays. From a massive debt burden created in a leveraged buyout (when a company uses borrowed money to buy another company) to a Chapter 11 bankruptcy in 2017, things haven’t been looking too good for them lately. One particular factor that hampered their growth was their lag to online retail, which proved devastating with the rise of Amazon.
This week’s paper focuses on just that; the relationship between Amazon and Toys R Us as economic competitors, and how that impacted the price of toys. The main question is whether or not Amazon uses increases in market power to their advantage, and the authors approach this inquiry by looking at how Amazon’s US toy prices changed (relative to other products as well as the toys on Amazon’s Canadian sites) in the wake of Toys R Us’s 2017 bankruptcy announcement. This event is called an exogenous change: a change in a variable outside of a system’s control.
The authors find that for the most popular products, prices rose by 5.3%. But how do we know this is driven by market power, and not other supply-side factors? Despite higher prices, the sales also increased. Moreover, Amazon’s price increases were long-lasting, whereas other stores only hiked their prices temporarily.
‘Till next time,
SoBasically