More details have come out on what was going on late last week and over the weekend with Silicon Valley Bank (SVB) and the DC officials dealing with the fallout.  And as more information comes to light, we can more thoughtfully reflect on who might be to blame.  We also look at all of the investigations that have been announced as a result to hold the appropriate people accountable and address flaws in regulation/supervision.  Finally, we take a look at the other banks swept up in the frenzy.  

The Feds to the Rescue

SVB’s situation was not news to the Federal Reserve last week. They had reportedly been concerned about the drop in value of the bank’s portfolio as interest rates increased. The FDIC was concerned about the customer base being so concentrated in the venture capital/tech start-up space. Both organizations were deeply into the situation Thursday. SVB attempted to raise funds using Federal Home Loan Bank advances first, which is commonly used to fund needs. They also used the Fed’s discount window. The Fed provides temporary loans to banks, and the banks pledge collateral in support. It is used less frequently because of the stigma that only banks in trouble come to the discount window. One of the questions that remain is why SVB sold those securities at a loss rather than use them as collateral at the discount window. In my view, selling securities at a loss is a stronger negative signal than going to the discount window, and apparently the depositors did as well.

(for an excellent explanation of the Fed's discount window as well as the take up of the new Fed lending facility, 

The conversations in Washington DC between Jerome Powell (Chairman of the Federals Reserve), Lael Brainard (White House National Economic Council Director), Martin Gruenberg (FDIC Chairman), and Treasury Secretary Janet Yellen boiled down to determining if the run on SVB justified the use of a special law, “the systemic risk exception,” which allows the FDIC to guarantee deposits over the $250,000 threshold. The outflows from Signature Bank on Friday and data showing outflows from other midsize banks on Saturday led them to conclude “yes” by Sunday. Concurrently, the Federal Reserve Bank offered a special lending program to all banks to provide credit as needed.

Martin Gruenberg was reportedly the holdout. He was well aware of the potential downside of guaranteeing all deposits. If the government will keep your depositors whole, what incentive would a bank have to stick to sound risk management practices? (See this WSJ article for more—subscription may be required.)

This accessible article from the Bank Policy Institute does an excellent job of explaining the Fed's discount window and how much money is moving in and out of the discount window and the new facilities created by the Fed over the weekend.  

Whose Fault Was It?

Initially, folks were looking for someone to blame for this.   One group blamed the easing of Dodd-Frank era regulations that kept SVB from being subject to the Fed “Stress Tests.” Regardless of your view of how big a bank needs to be to be “too big to fail,” the truth is that the Stress Test as it is currently configured would NOT have raised any red flags with SVB. It was solvent. The issue was liquidity, not solvency.

Should the Stress Tests be revamped? In light of the new environment of rising interest rates (remember the interest rate environment when the tests were developed was very different,) I would suggest the answer is ‘yes.’

The Fed was the also the target of blame, both for keeping interest rates low for so long, which resulted in more aggressive risk taking as investors and venture capitalists were looking for bigger returns, and then for raising interest rates so much in a relatively short period of time.

Are the venture capitalists to blame? First for pumping so much money into so many businesses (many of which, in higher interest rate scenarios, would not have been funded.) Then for telling the startups they funded to pull their cash out of SVB.

No one is contesting that SVB management bears the bulk of responsibility. An accounting rule allowed them to keep their long-term bonds and mortgage-backed securities on their balance sheet at par because they intended to hold them to maturity. If they had “marked them to market,” reflecting their loss in value due to interest rate increases, they would have wiped out all of the bank’s equity, and then some. They needed to raise capital much sooner than when they attempted to do so. The timing of insider sales of stock suggests that perhaps management knew what might happen (see next section.)

And what about the auditors and regulators? KPMG’s review weeks before the crisis revealed no indication of any issue. Regulators are the people that write the rules.  Rules may need to be changed after this episode. Supervisors are the people that enforce the rules. The Federal Reserve Bank announced that it will review its supervision of the bank as the SVB situation should have raised red flags. (see next section.)

For more on the blame game, check out this article from Irrelevant Investor.

Investigations

Agencies may be tripping over each other as they investigate what happened at Sillicon Valley Bank. (The Hill)

• The Department of Justice has launched an investigation, suggesting they are suspicious there may be criminal wrongdoing in the (mis)management of the bank.

• The SEC also announced they would launch an investigation as they are responsible for protecting investor interests and will be looking to see if any federal securities laws had been broken.

• The Federal Reserve will be conducting an internal investigation to see if/where their supervisory processes may have broken down and need to be revamped.

• Federal authorities will be looking into insider stock trading by SVB executives in the weeks just before the failure. (Reuters)

Signature Bank, Credit Suisse and New Republic Bank

Signature Bank was the second bank to be seized by state regulators last week. This happened two days after SVB was seized and after a $10 billion drain of deposits. The bank was heavily invested in New York City real estate, and between that and their crypto position, depositors got concerned. To read more about the bank, try this WSJ article (subscription may be required).

Credit Suisse and First Republic Banks were also facing potential failure this week. For Credit Suisse, the Bank of Switzerland came through with funding to keep it afloat for now. (NPR) For First Republic, a group of larger US banks pooled $30 billion of funding to rescue it. (AP) Rumors abound about a possible sale of the bank.

More NGPF Resources on SVB

• Podcasts in the Classroom: Explaining Silicon Valley Bank Crisis (with ready-to-use worksheet)
• EconExtra Blog post: Silicon Valley Bank—A Traditional Bank Run but not a Traditional Bank Failure
• WSJ explainer video: How Silicon Valley Bank Collapsed in 36 Hours: What Went Wrong?

• FinCap Friday "A Bank Run is No Fun"
• Podcast from Virtual PD "Understanding the Silicon Valley Bank Crisis"

Lesson Idea/Discussion Questions

Use one of the first four NGPF resources to introduce the topic if you haven’t yet discussed the events with the class. The class could be split into three groups, each assigned to one of the first three sections of this post, or select one section for the entire class to tackle. Students can read the section of the blog and the linked article.

Group 1: Students can take on the role of the four key players in DC last weekend to determine what should be done to avert a full-on crisis.

Would they have come up with the same decision (protect depositors but not the bank’s investors or management), or something different?

What potential issues could arise if they decided to go further (bail out the banks themselves) or decided to do nothing?

Group 2: Students can debate and discuss which parties might be to blame for the crisis, going down the list in the article.

Are there any points the students think were missed in the article to either support or contradict the conclusions?

Group 3: These students might need to do dig a little deeper here for information about the regulations and laws that might have been broken.

Students should end up with a list of potential parties and violations that might come out of the investigations.

Regarding the Federal Reserve, the focus should be on the role of bank supervisors, and whether or not they should have seen what was coming. For anyone truly interested in pursuing this line, here is a link to the Manual for commercial bank examinations.

About the Author

Beth Tallman

Beth Tallman entered the working world armed with an MBA in finance and thoroughly enjoyed her first career working in manufacturing and telecommunications, including a stint overseas. She took advantage of an involuntary separation to try teaching high school math, something she had always dreamed of doing. When fate stepped in once again, Beth jumped on the opportunity to combine her passion for numbers, money, and education to develop curriculum and teach personal finance at Oberlin College. Beth now spends her time writing on personal finance and financial education, conducts student workshops, and develops finance curricula and educational content. She is also the Treasurer of Ohio Jump$tart Coalition for Personal Financial Literacy.

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