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Risk. It's tricky. Try to avoid one set of risks, you can just end up exposing yourself to another. That's what happened to Silicon Valley Bank.
"Silicon Valley Bank was a very good bank... until it wasn't," says Mark Williams, professor of finance at Boston University and a former bank examiner for the Federal Reserve.
A victim of its own success
Williams says the problem at Silicon Valley Bank really started with its wild success. Many of its tech company customers were raking in money during the early pandemic.
"Silicon Valley Bank was just flush," he says. "Its deposit base tripled between 2020 and 2022, with billions and billions of dollars flowing in."
A lot of those billions had come from all of the risks the bank took, lending money to start-ups and companies that couldn't get loans at other banks. Those risks paid off.
And Silicon Valley Bank took all of those billions it earned from taking those risks and stowed them into what is supposed to be the least risky investment around: US government bonds.
Bonds: The Riskless Asset
Bonds are like a little loan you give the government for 3 months, 1 year, 10 years etc., depending on which bond you buy.
At the end of that time, the government will pay you back for that loan, plus a little interest. US bonds are considered to be the safest investment on the planet. The U.S. always pays back its debts. They are often called a riskless asset.
The downside? Government bonds don't pay out a lot. Super safe, not super profitable. But some of these bonds are slightly more profitable than others.
Longer term bonds (like 10 year bonds) typically pay out more at the end than the 3 month or 1 year bonds, which makes sense: Long term bonds mean you agree to lend the government your money for years. You get more yield - a bigger payoff - for that wait.
"Basically what happened was Silicon Valley Bank wanted a bigger payout," says Alexis Leondis, who writes about bonds for Bloomberg. "So they basically wanted to reach for longer term bonds, because, I think, they felt like what they would get from shorter term bonds was kind of a joke."
Risky business
Silicon Valley Bank locked billions of dollars away into 10 year bonds. But there were risks it wasn't seeing.
Risk #1: Access. Those billions were now locked up for years. It wouldn't be easy to get that money in an emergency.
Risk #2: Interest rates. When interest rates started going up, the market value of Silicon Valley Bank's bonds went down.
That's because the bank bought its government bonds before interest rates started going up. The price you get from bonds is directly tied to interest rates. When interest rates go up, the market price of older bonds goes down because new bonds pay out higher interest rates.
When rates started climbing quickly, the price of Silicon Valley Bank's bonds tumbled.
Risk #3: Really, really rich customers. When rumors started up about the bank, customers panicked and and started pulling their money out. Because they were rich individuals and companies, that meant multi-million, even multi-billion dollar accounts cashing out all at once.
Silicon Valley Bank needed a lot of cash fast. But, of course, a lot of its cash was locked up in 10 year bonds. Now it had to try and sell those now to get cash.
Government Bond Fire Sale
That's where the interest rate risk bit Silicon Valley Bank: Trying sell those second hand, low interest rate bonds at a moment when all the new bonds being issued paid out far more was not easy.
"Now, that same bond and the yield would be about 20 times higher," says Mark Williams. "So, to encourage investors to even think about your old bond, you would have to discount it."
Discount as in, a fire sale.
Silicon Valley Bank took huge losses selling off its bonds, and more investors panicked and pulled out their money. Williams says it was a bank run on a scale the U.S. hadn't seen since the Great Depression.
"In a single day last week, depositors knocked on the door and pulled 41 billion depositor dollars out," says Williams. "That's about a quarter of their total deposits. No bank, no matter how strong, could ever survive that sort of withdrawal... that sort of run on the bank."
The rest of Silicon Valley Bank depositors were bailed out.
Guilt by association
Mark Williams says even though Silicon Valley Bank made a bunch of very specific mistakes, people all over the country got scared and started yanking money out of smaller banks.
"That means these smaller, regional banks are getting potentially destabilized," says Williams.
Where are these nervous investors putting their money? Williams says a lot of it is getting deposited into big banks that customers see as safer. Also, a lot of people are putting their money into U.S. government bonds.
Demand has spiked all week for the riskless asset.
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Transcript :
AYESHA RASCOE, HOST:
It's been a wild week for the banking industry - the main culprit, Silicon Valley Bank, which failed after customers pulled out billions of dollars in a modern-day bank run. But one of the most interesting parts of this story is how the bank got into trouble. Plot twist - the bank may have played it too safe. NPR's Stacey Vanek Smith reports.
STACEY VANEK SMITH, BYLINE: Risk - it is tricky. Try to avoid one set of risks, and you just end up exposing yourself to another.
MARK WILLIAMS: SVB was a very good bank until it wasn't. You know, almost overnight it failed. And the question is, you know, why did it fail?
SMITH: Mark Williams is a professor of finance at Boston University. He has also worked as a bank examiner for the Federal Reserve. He says the problem at Silicon Valley Bank really started with its wild success. Many of its tech company customers were raking in money during the early pandemic.
WILLIAMS: Yeah, SVB was just flush. Its deposit base tripled between 2020 and really 2022 with billions and billions of dollars flowing in.
SMITH: Silicon Valley Bank took all of those billions and stowed them into what is supposed to be the safest investment around - U.S. government bonds. So bonds are like a little loan you give the government for three months, a year, 10 years, depending on which kind of bonds you buy. And at the end of that time, the government will pay you back for that loan, plus a little interest. And U.S. bonds are considered to be the safest investment on the planet. They are often called a riskless asset. The downside - government bonds do not pay out a lot - super safe, not super profitable.
ALEXIS LEONDIS: The culprit here were the long-term bonds.
SMITH: Alexis Leondis writes about the bond market for Bloomberg. She says longer-term bonds, like 10-year bonds, will typically pay out more in the end than a three-month or a one-year bond, which makes sense - right? - because long-term bonds mean you agree to lend the government your money for years, and you get a bigger payout for that long wait.
LEONDIS: Basically, what happened was SVB wanted a bigger payout, so they basically wanted to reach for longer-term bonds, I think because it felt like what it would get from shorter-term bonds was kind of a joke.
SMITH: So Silicon Valley Bank locked billions of dollars away into 10-year bonds, supposedly the safest investment on earth. But there were risks it wasn't seeing. Risk No. 1 - access. Those billions were now locked up for years. It would not be easy to get that money in an emergency. Risk No. 2 - interest rates. So when interest rates started going up, the market value of Silicon Valley Bank's bonds went down because they had bought those bonds before interest rates started going up. So their bonds paid out less than the new bonds on the market, says Mark Williams.
WILLIAMS: So you bought, unfortunately, in 2020 or 2021 when interest rates were almost zero.
SMITH: Which brings us to risk No. 3 - really, really rich customers. So when rumors started up about the bank, customers panicked and started pulling their money out. And because they were so rich, that meant multimillion, even multibillion dollar accounts cashing out. Suddenly, Silicon Valley Bank needed a lot of cash fast. But remember, a lot of its money was locked up in these 10-year bonds, and it now had to try to sell those to get cash. And this is where the interest rate risk bit the bank. Trying to sell those secondhand low interest rate bonds was not easy, says Williams.
WILLIAMS: Now the same investor in 2022 or 2023 could buy that same bond and the yield would be about 20 times higher. So to encourage investors to even think about your old bond, you have to discount it.
SMITH: Discount as in fire sale - Silicon Valley Bank took huge losses. And as word of this got out, more investors panicked and pulled out their money. Mark Williams says this was a bank run on a scale the U.S. had not seen since the Great Depression.
WILLIAMS: A single day last week, depositors knocked on the door and pulled 41 billion depositor dollars out. No bank, no matter how strong, could ever survive that sort of withdrawal - you know, run on the bank.
SMITH: The rest of Silicon Valley Bank depositors were bailed out. And Mark Williams says even though the bank made a bunch of very specific mistakes, investors are scared. And they started yanking money out of smaller banks.
WILLIAMS: Which means then that, you know, these smaller regionals are getting potentially destabilized.
SMITH: Where's the money going? Williams says a lot of it is getting deposited into big banks that customers see as more likely to get a bailout if troubles happen. And a lot of people are investing in U.S. government bonds. Demand has been spiking for the riskless asset.
Stacey Vanek Smith, NPR News. Transcript provided by NPR, Copyright NPR.