Mar 17, 2023

Podcasts

The failure of the 16th largest bank in a matter of days last week has shaken confidence. Find out what was behind the bank's fall and what it might mean for the banking industry moving forward through this conversation between NGPF Co-Founder Tim Ranzetta and Director of Educational Outreach Yanely Esipnal. Note: This live Virtual PD Session will be offered again on Wednesday.

Resources:

• Clickable Slide Deck with links to resources from the Virtual PD Session
• Collab Board from the Virtual PD with ideas on how to explain this current event to your students. 
• 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

Timestamps and Transcript:

[00:00:00] Introduction 

Tim Ranzetta: Hey, it's me, Tim Ranzetta, a co-founder of Next Gen Personal Finance. And thank you for tuning in to this NGPF podcast. What a week it has been. So we're gonna try something new with the podcast this week. Yes, it was about a week ago, Silicon Bank, the 16th largest bank in the country, had a run on it and within 24 hours the bank was out of business. A lot of people, including teachers are trying to make sense of this. How did this happen?

So the NGPF team, including Amanda, Yanely, and myself, created a pop-up virtual PD to try and explain what happened at Silicon Valley Bank. We hit the record button, and that's what you're gonna hear following this with some expert editing from Ren. But we felt it was really important to get the information out to educators and think about how to frame this in the classroom. What are the key issues that should be covered from the structure of the banking system to the impact of interest rates on bond portfolios to behavioral economics, namely loss aversion, sprinkled with some social media, and how that really just accelerates things like bank runs? 

Without further ado, it's Tim and Yanely on the fall of Silicon Valley Bank. 

[00:01:25] Background on Silicon Valley Bank

Tim Ranzetta: Welcome to this NGPF Virtual Professional Development on Understanding the Silicon Valley Bank crisis and its aftermath. This is groundbreaking news, right? This all happened within the course of a week. In fact, a week ago, Silicon Valley Bank was generally regarded as the top bank in Silicon Valley. Obviously, it had a tech focus, it was the bank that venture capitalists invest in these startup companies when they made their investments, they would introduce the startups to Silicon Valley Bank and they would do all their banking business there. So it's a little bit different in terms of it really being more of a bank made up of whose customers tend to be large, multimillion dollars in terms of the account holdings, principally companies as well as high net worth individuals. So I think that's important, this isn't your run-of-the-mill retail bank here, this is the kind of a bank that's catering to companies as well as investors who invest in those companies as well as executives that work at those companies.

This is not meant to be financial advice. It's really all about information, content, and materials. 

And I know Amanda Voltz has thought a lot about this, and I can, I wanted to thank her. There's nothing better than when you have a Virtual PD scheduled, you go to bed at night thinking, okay, I gotta produce a deck. And you look at your inbox and you, and Amanda's already created it. So want to thank her for really thinking through how best to deliver what is, you know, not, not a simple story to tell.

So we started with, with who is Silicon Valley Bank? Yanely, I was talking specifically about this is a bit of a different kind of bank. In that really it was the banker to Silicon Valley companies. Silicon Valley investors, Silicon Valley executives. 

Yanely Espinal: That's right. I think that's one of the reasons why it's important not to panic and you know, when you think about this particular bank, it's not your typical bank, right? It's really catering to a different clientele than your typical bank of this size or similar size. So, great point. 

Tim Ranzetta: Yeah. So again, 16th largest bank in America, with over 200 billion in deposits.

So not diversified from an industry perspective, but also not diversified from a geographical perspective. And I think that's kind of another key point. Most of its customers, it did have offices kind of throughout the US and I think some international offices, but most of the assets were held by companies, investors, executives, in probably, I don't know, a 50, 60-mile radius. 

Yanely Espinal: It's really important to note that a good chunk, not all of them, but like a good large chunk, almost all were uninsured, and a very small amount were insured. The reason why is because of Tim's point earlier. Who does this bank serve? Well, it serves a lot of investors, big venture capitalists and startups.

These are companies that have to pay for a lot of expenses on a day-to-day and week-to-week basis. And we're not talking about expenses like my electric bill, which is 150 bucks a month. We're talking about a massive payroll and massive bills and, you know, company events that they pay for all of their tech employees, right?

So we're talking millions of dollars. And so that is why it's really hard for these types of clients to meet the bar for ensuring funds, which is $250,000 insured by FDIC. But when you have a business like this, of this size, you're using millions a week. You can't just have $250,000 cash in the bank. You need to be able to pay your bills, which are millions of dollars, weekly and monthly. 

Tim Ranzetta: Yeah, so almost a direct flow here, right? So imagine the left-hand side, that's venture capital. These people are investing in startups. So they write a 10 million check to maybe help get a company started. Believe it or not, that tends to be like a seed round.

So 10 million going to a company. When they give the money to the company, they say, Hey, let me introduce you to the banker at Silicon Valley Bank. They're gonna be your banker. And so you saw a tremendous influx of dollars. And then 2022 is not a really good year for venture capital. And so now you see deposits at Silicon Valley Bank decline.

So what's happening there is there are no more fund flows, very minimal fund flows coming from venture capital companies. And so then startups do what startups do, which is they burn capital, right? Startups don't come out of the gate making money. 

So Silicon Valley Bank is a problem on its hands. Their deposit base has grown almost four times, from 50 billion to 200 billion. So they got two choices as a bank. You can invest in securities like bonds. Banks like to invest in low-risk bonds, like maybe some treasury bonds or maybe some mortgage-backed securities. What happened here is because Silicon Valley had so much money coming in the door, they didn't have enough demand for loans to be made, so they said, oh, we gotta invest that money. So they took about a hundred billion dollars and they invested in bonds and not only did they invest in bonds, they tended to be longer-term bonds 10, 20, 30 year they were safe, right? They're treasury bonds and mortgage-backed securities. So looks to be pretty low-risk investments. That's another key important point to keep in mind here. A lot of them, those deposits the bank invested in long-term bonds. What could possibly go wrong in Yanely?

[00:06:59] What Went Wrong?

Yanely Espinal: A quick plug for the Investing Certification Course because we actually went through what happens when you invest in a bond if it's a long-term bond and you are investing in it at a low-interest rate?

Well, the nice thing is that you're guaranteeing yourself this, or you know, very likely to be able to continue to get this fixed amount of interest every year over that 10-year or 20-year term. However, when interest rates change at the Federal Reserve, it's going to impact the value of those bonds. And so when you have changes, like the recent changes that the Fed has announced, increasing interest rates, that has a seesaw, an inverse effect, right?

It's the opposite of the direction in that the value of the bonds will move in. So interest rates go up. The value of the existing bonds that you have is now gonna go down. Because why would anybody wanna lock in a one-point-something percent bond that you have, that you're trying to sell when newly issued bonds are now at the higher rates set by the Fed, 3.7, 3.8%?

I'd rather get those bonds that are newly issued at a much higher rate than buy a lower interest rate bond that you locked in two, three years ago. So they become less valuable on the bonds, when interest rates go up. And as we know, interest rates recently went up and they were locked into those bonds at Silicon Valley Bank because as Tim mentioned, they were 10, 20, 30 year long-term bonds means if you wanna get rid of them and cash them out, you have to now sell them.

But try to find someone who's gonna wanna buy a locked-in one-point something rate when they could get a three-point something rate instead. So the only way that they could get these bonds out of their hands is and get them to liquidate and get cash for them is if they sold them at a loss. Sell them at a discount, essentially being able to offer them at a lower price than what they initially paid, which is where they lost a lot of that money.

Yeah. So actually, so again, the story is flooded with deposits. Banks make money on something called net interest. And so what that means is Silicon Valley Bank at the time was paying 0.0% for deposits. So if you had an account at, Silicon Valley Bank, whatever balance you had in your account was earning zero.

So they take a hundred billion of the free capital they were getting and they were putting it into 10, 20, 30-year bonds earning 1.6%. That's their profit. They're sitting there saying, I'm taking, Tim Ranzetta, I'm taking your money for nothing. I'm giving you nothing in return, but I'm taking it and I'm investing it for 1.63.

A ton of pressure on companies to maximize their short-term profits. So they're just thinking to themselves, oh, interest rates are gonna be low forever. Tim's gonna continue to give me his money at 0% and I'm gonna make 1.63%. It doesn't seem, to Yanely's point, that seems like a really low return to make, but it was the best they could do at the time.

And so that's, it's called hunting for yield. They were trying to get the highest interest rates they could from their depositors, and so they were willing to take that risk thinking, okay, interest rates are gonna be low for a long period of time. So really bad timing in that. They put most of this a hundred billion dollars to work in the lowest interest rate environment ever.

[00:10:19] How Bond Rating Works

Yanely Espinal: That's a great segue to act two. 

Tim Ranzetta: Moody's gets moody. You guys like that? 

Yanely Espinal: That's a good one, Tim. Honestly, it's funny if you know what Moody's is.

Moody's is a bond rating agency. When you actually are going to invest in bonds, you have to really know what type of bonds you wanna invest in because there are many different types of bonds. There are corporate bonds, there are government bonds, and even within corporate or government bonds, you now have these different classifications.

So some are gonna be rated really well and some are gonna be rated very poorly. Similar to how we go when we wanna borrow money from a car lender or a bank and they wanna check our credit score first. Cause they wanna know, are we high credit score rating or are we low credit score rating. Because if we have a low credit score, they're gonna charge us higher interest rates for our car loan and for our mortgage.

But if we have really excellent credit rating or credit score, then we're gonna get a really low-interest rate on that mortgage loan or that car loan. Similar thing with bonds. Bonds are rated based on all of the history of their past payments to their bondholders. Have they paid that interest and those original principal balances that were lent to them?

On time and in full, just like us paying our bills on time and in full to get a good credit score. So these bond issuers are rated with a credit score, but it's called the credit rating. And who creates those credit ratings while it's not TransUnion, Equifax, and Experian. It's Moody's, Fitch, and S&P these are the bond rating agencies that create those grades, those ratings they get.

Tim Ranzetta: It's probably fun people to be around at a cocktail party, right? So I think it was either Tuesday or Wednesday of last week. Moody's downgrades, Silicon Valley Bank. It wasn't a big drop, it was like a really, it was like one letter grade lower. They used letters like A, B, C and really confusing, cause sometimes there are numbers and each of the rating agencies has different symbols, but they downgrade it one little notch.

And so people ask, why would you sell bonds at a loss? And clearly, there was pressure, right? Somebody wanted their money out of the bank. There weren't deposits coming in and startups were withdrawing money. That's what startups do. They tend to lose money for a long number of years, and so they sell it, but then at the same time, losing 2 billion on what they sold they go out and say, don't worry, don't worry regulators, we're gonna go raise 2 billion in equity. We're gonna sell our shares. We're gonna sell our stock. We got these buyers coming in, so we're gonna lose 2 billion when we sell all these bonds. But don't worry, we're gonna fill that hole with 2 billion of equity capital we're gonna sell to sell our stock and bring this money in.

Yanely Espinal: I was just about to say, who is closely monitoring raising capital? Who else is raising capital? Well, the entire raising capital space is venture capital. So the clientele that they serve, these venture capitalists, and all of the startups that they have in their portfolios are obviously gonna find out that they're raising capital because this is what they do.

So they found out that the bank was raising capital, and that was a huge red flag to these venture capitalists who thought, oh no, this is not a good look. And we need to let the companies in our portfolios know that this is not a good look. And that if all the money that they have in Silicon Valley Bank, that it's probably at risk right now because Silicon Valley Bank is out there desperately trying to raise $2 billion by selling shares.

And so this is probably a good time to move their money out of Silicon Valley Bank. But you know, as Tim mentioned before, we're talking about a 60-mile radius. Like once a few venture capitalists get wind, then a couple more get wind. Then they tell a few of the companies in their portfolio. Now, these founders are texting all their founder friends and soon it goes from a small community concerned to full-on like outrage within all of the people who have accounts at SVB and they run into Silicon Valley Bank.

Now, back in the day, you would have to physically run to the bank and get in line and bang on the door, but now it's so much faster to be able to move your money. So I'll pass it back to you, Tim, to talk about how that accelerated all of this because you can move your money digitally in seconds versus waiting in line for hours to get your money how you used to have to do.

[00:14:47] How FDIC Insures Deposits

Tim Ranzetta: So we're on to act three. So again, this is all in a matter of hours, if not days. So we got a modern-day bank run. There's a behavioral element to this. Do you remember the chart we showed where 90% of the bank's deposits were uninsured? 

Yanely Espinal: Uninsured, over $250,000. And we're not talking about by a couple of tens of thousands. We're talking about multiple millions, hundreds of millions in those very small number of cases.

Tim Ranzetta: I remember the first thing I did when this story broke was I googled what is FDIC insurance for corporations and was shocked to see, what is it, Yanely?

Yanely Espinal: It's exactly the same as the FDIC insurance for an individual like you and me, $250,000, regardless if you're an individual or if you're a corporate entity.

Tim Ranzetta: So not really realistic for a typical company that's gonna need millions of dollars, you know, to pay payroll, to pay vendors, just you kind of want enough funds. So that was kind of a surprise number one. So this loss of version behavior anybody's taken behavioral economics, loss of version like we feel losses twice as much as we enjoy gains. The potential of losing the money you have in the bank and 90% of the funds were in excess of the FDIC requirement. Like that's scary. Like that's really scary to wake up one day and realize, oh, the FDIC, I'm not gonna get bailed out because I have a million dollars in this account and only 250 thousand guaranteed.

And then the point Yanely made social media. Things move at the speed of sound. These days we tweet, so this is Jason Calcanis, he's a leader in kind of the tech industry. And so all caps, you should absolutely, you should be absolutely terrified right now. That is the proper reaction to a bank run and contagion. And so another leader kind of in the investing world here is a guy named Peter Thiel

The story is that he apparently started the whole thing. So imagine this, right? You're an investor in all these startups. You're concerned about the health of the bank. You've invested all this money in these startups. You're getting on the phone and calling all your startups and saying, get the heck out.

Because guess what? When they run outta deposits, there's a risk. You're only gonna get your $250,000. So that's kind of loss aversion, social media, networking.

Yanely Espinal: I think that I, I just wanna point out that I think there's a bit of reason behind this because it's coming from within the clientele.

Now, imagine you're the clientele. Imagine you are the creator of a new startup company and you wake up one day and you don't have the ability to pay your employees, and you don't have the ability to pay your bills. I mean, I, personally, if it were me, I would probably tweet. I'm panicking right now. I can't pay, and I can't process my payroll.

You're hearing that the FDIC is taking over the bank. You don't know what to do. So you go to Twitter and you post this, you know. I just want us to kind of frame this as like, why, why would they do something like this? But what else could they really do? They feel that they had much control over the situation.

[00:18:03] The Bank Run

Tim Ranzetta: Here comes act four, the day the money died. So by Friday the bank was dead. Regulators stepped in and took over the bank. 40 depositors tried to withdraw or did withdraw 42 billion dollars. So again, seems like a lot, but there were a lot of really large accounts.

Yanely Espinal: So all of the management team got fired. 

Tim Ranzetta: So actually you also noted something I think that's important. You may have, some folks may have seen the headlines that bonuses were paid out on Friday. So again, this was the day the company was seized by federal regulators. What was going on with those bonus payments?

Yanely Espinal: So, according to a CNBC piece, there was an interview with some of the folks in the Santa Clara base, right where the headquarters for Silicon Valley Bank, they claim that they have historically always paid their employee bonuses on the second Friday of the month of March. It's really important for us to get as much information, really keep searching for more facts, really keep looking for the full context of the situation.

Because if we, if we are overly simplistic with the way that we perceive or the way that we receive the information or jump to conclusions, there could be puzzle pieces missing. So this is something to consider, again, still suspicious, but something to consider.

Tim Ranzetta: Yeah, I think the other thing I read was the CEO sold 3.5 million in stock during that week. That's another thing, there are plans that executives put in place to avoid any suspicion of insider trading. They're called 10b5-1 trading plans. Like they put these plans in place to avoid lawsuits. 

Yanely Espinal: So there's been this pattern of constant sales of shares, which Tim referenced dating back to 2021.

Tim Ranzetta: Okay. What happened to shareholders? 

Yanely Espinal: All the shareholders lost anything that they had invested. It's all gone, all the money. 

Tim Ranzetta: And unsecured borrowers. So people, you know, bondholders? 

Yanely Espinal: Yep. So money's lost if you held bonds and they lost value, you have those losses. It's so important to understand the difference between shares and bonds if a company is busted the bondholders will receive any money first in line before shareholders because shareholders are taking risks as owners. Bondholders are actually debt collectors. So they have to pay their debt before they can share the profits with their co-owners. 

Tim Ranzetta: So, depositors who had $250,000 and less, they were told on Friday they could sleep well over the weekend because they were gonna get access to their money on Monday.

How about depositors? Who had uninsured deposits? Yanely, where did they stand on Friday and where'd they end up on Monday? 

Yanely Espinal: So it was, it was unclear. And then over the weekend, there was a big announcement that said, no worries, including the depositors who had up to $250,000. They're all covered by the insurance, but including anybody who had over $250,000, every depositor who had money at Silicon Valley Bank will receive full their full money back.

Tim Ranzetta: So basically what that says to folks is, you know, that FDIC insurance of $250,000, it's now unlimited. So it's gonna be interesting to see how this plays out. I'll just kind of give you my perspective, and this is my opinion, had they not stepped in and guaranteed all depositors, here's what would've happened on Monday, every CFO at a company that had more than $250,000 at a bank, would've had the job to take all the funds in excess of $250,000 and get them out of that bank and spread it around. It would have been chaos because suddenly people were gonna see risk in a lot of different places. And this is the second-largest bank failure ever. And again, it's a regional bank, so it's not one of the big four, but I would say $200 billion is a pretty darn big bank. So 16th, largest, second largest failure ever. If they had not guaranteed those deposits on Monday, I don't want to think about what the financial system would've looked like because there would've been a run on regional banks.

Yanely Espinal: That's right. Now, Tim, there's gonna be an immediate question that comes up from almost everyone. Where's that money gonna come from? 

Tim Ranzetta: Silicon Valley Bank has a lot of assets still. They still have these mortgages. They still have these bonds. They still have these securities, right? They're worth less money. But 200 billion dollars didn't vaporize. It's just they couldn't get access to the money fast enough to deliver it to depositors who wanted their money out. So basically you have the Federal Reserve step in and say, we have an unlimited bank account, so we're gonna meet people's withdrawals.

You wanna take your money out of Silicon Valley Bank? We're gonna give it to you. But they still, the government still owns all of the assets. Silicon Valley Bank still has assets. There's a timing issue, right? Deposits can come and go. There's short-term money, but investments are long-term and locked up in terms of like 10, 20, 30-year bonds.

And you don't wanna liquidate the entire portfolio because, you know, you take a 17, 18 billion hit right out of the gate. And so it's a mismatch in what's called duration, which is deposits are short term. People can put it in and take it out whenever they want. And we're investing for the long term cause we want to earn a return on that money.

Yanely Espinal: If everybody was to panic and run to the bank right after our zoom call ends tonight and everyone does it at the same time, that would create instability in our financial system because we've all lost trust and lost confidence in the system. When we lose trust, we lose confidence it loses stability and that seems precarious because it is. Right? And, and so, and these are just facts, but the more we remain confident in the system and allow it to work the way it is designed to work, then it will continue to work. 

Tim Ranzetta: Why would they put all of their portfolios in one, in only one bank? I think I think we often lack imagination. I think the idea of the 16th largest bank disappearing in two days is just outside. If someone had told you that sometimes this could happen, you'd hard to believe, right?

And it wasn't. We're always thinking about the last crisis too. This wasn't about mortgage-backed securities, it wasn't about no-doc home loans. It was like a bad investment in bonds when interest rates were so low because they were trying to chase the next quarter's earnings. And they showed a loss in bonds. They were gonna raise money. They weren't successful at raising money. And then everybody lost confidence and it happened so quickly. And I think that's why there's still a lot of unease in the market. 

Yanely Espinal: It's also something that is just a behavioral bias. Like, it's like most people do this.

Like I was just talking to my family and friends this weekend. They're like, well, what do you think about this? What should I do? And I'm like, the only thing to do if you feel any. Type of anxiety around it is to diversify your bank accounts. Most people have all of their savings at one bank or one credit union.

Most people have the same bank for their checking account that they have for their savings account. They don't put those in different institutions. And so this is something that I think it's just a simple takeaway for everyday people, not just those VCs in the tech industry, but are we diversifying in the ways that we can where we have control and power, even if we don't have $250,000, it's still important to make sure that we are diversified in where we're port, where we're putting our money.

Tim Ranzetta: So obviously my concern is, yeah, it's not taxpayer dollars that are gonna fund this, but ultimately it's gonna fall on US consumers because guess what? When banks pay higher fees for FDIC insurance, how are they gonna make it up? You can probably guess you're gonna see fees go up for consumers. 

Well, banks are gonna have to pay higher fees. They ought to, they ought to cap bank fees for customers. Because that's how they're gonna make it up. You know, you're gonna see maintenance fees, you know that monthly little maintenance fee. If you don't have a balance at a certain level, those are gonna get jacked up.

Maybe we'll see overdraft protection come back. I mean, banks have to make money. That's kind of what the commitment they make to shareholders. So that's always the worry, is that ultimately it's gonna hit, it's gonna come back. 

[00:26:48] Conclusion

Tim Ranzetta: We'll try and package this into somewhat of a coherent podcast. But, thank you all for showing up. What a crowd on such short notice. Hopefully we helped you understand this situation a little bit better. Maybe we'll do a recap in a couple of months to see how the banking industry changes.

Lots of great resources were mentioned during this podcast. We wanna make sure we share those. You'll find those in this show notes at www.ngpf.org/podcast. Better yet, subscribe. Now that you've listened to an NGF podcast, subscribe on iTunes, Sound Cloud, Stitcher, or ever you get your podcast. I wanna thank Ren Makino. He produces the podcast. This one was done on very short notice so we could get this timely information to you. Thank you, Ren. Also wanna thank again Amanda and Yanely for helping put together this virtual PD on extremely short notice. So on behalf of Yanely and myself, I wanna thank you again for tuning into this NGPF podcast.

Have a wonderful week. 

 

About the Authors

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

More posts by Tim

Yanely Espinal

Born and raised by Dominican, immigrant parents in Brooklyn, Yanely is a proud product of NYC public schools. She graduated from Fiorello H. LaGuardia High School in 2007 before going on to receive her bachelor's degree at Brown University in 2011. As a Teach For America corps member, Yanely taught third and fourth grade in Canarsie, Brooklyn. She received her master's degree from Relay Graduate School of Education in 2013. She spends her spare time making YouTube videos about personal finance on her channel, MissBeHelpful. Yanely also loves to dance, sew, paint, listen to podcasts, and babysit her 10 nieces and nephews!

More posts by Yanely

Ren Makino

Ren started interning at NGPF in 2014, and worked part-time through high school and college. With his knowledge growing alongside NGPF, he joined the team to work full-time after graduating from college in 2020. He is also the producer of the NGPF podcast. During his free time, he likes to try out coffees from different roasters across the world.

More posts by Ren