When trouble hit, Silicon Valley Bank had to sell US government bonds at a loss. : NPR
TIMOTHY A. CLARY/AFP via Getty Images
Risk. That is difficult. Try to avoid one set of risks, you may end up exposing yourself to another. That’s what happened with Silicon Valley Bank.
“Silicon Valley Bank was a very good bank… until it wasn’t,” said Mark Williams, a professor of finance at Boston University and a former Federal Reserve banking ombudsman.
A victim of its own success
Williams said the problem at Silicon Valley Bank really started with its huge success. Many of their tech clients made money in the early part of the pandemic.
“The Silicon Valley bank just went out,” he said. “Its deposit base tripled between 2020 and 2022, with billions of dollars flowing in.”
A lot of those billions of dollars came from all the risks banks took on, to startups and companies that couldn’t get a loan from other banks. Those risks have paid off.
And Silicon Valley Bank took all the billions of dollars it made from taking those risks and stashed them in what was arguably the least risky investment: U.S. government bonds.
Bonds: Risk-Free Assets
A bond is like a small loan that you lend to the government for 3 months, 1 year, 10 years, etc., depending on the type of bond you buy.
At the end of that period, the government will pay you back on that loan, plus a little interest. US bonds are considered the safest investment on the planet. America always pays its debts. They are often referred to as risk-free assets.
Defect? Government bonds don’t pay much. Super safe, not super profitable. But some of these bonds are slightly more profitable than others.
Bonds with longer maturities (such as 10-year bonds) typically pay more at the end of the term than 3-month or 1-year bonds, which makes sense: A long-term bond means you agree to the government borrowed its money for many years. You get more profit – a bigger sum – for that wait.
“Essentially what happened was the Silicon Valley Bank wanted a bigger payout,” said Alexis Leondis, who writes on bonds for Bloomberg. “So they basically want to get to the longer-term bonds, because, I think, they feel like what they’re going to get out of the short-term bonds is a joke.”
Silicon Valley Banks have locked billions of dollars into 10-year bonds. But there are risks it doesn’t see.
Risk #1: Access. Those billions are now locked up for years. It won’t be easy to get that money in an emergency.
Risk #2: Interest rate. As interest rates began to rise, the market value of Silicon Valley Bank bonds dropped.
That’s because banks bought government bonds before interest rates started to rise. The price you get from the bond is directly tied to the interest rate. As interest rates rise, the market price of the old bond falls because the new bond pays a higher interest rate.
As interest rates began to escalate rapidly, Silicon Valley Bank bond prices tumbled.
Risk #3: Really, really wealthy customers. When there is a rumor about the bank, customers panic and start withdrawing money. Because they are wealthy individuals and companies, that means millions, even billions of dollars worth of accounts are drawn out all at once.
Silicon Valley banks need a lot of cash fast. But, of course, a lot of its cash was locked up in 10-year bonds. Now it has to try to sell those things now for cash.
Selling government bonds on fire
That’s where interest rate risk comes in. Silicon Valley Bank: Trying to sell old, low-yield bonds at a time when all new bonds are being issued are paying much higher interest rates.
“Now, the same bond and yields will be about 20 times higher,” said Mark Williams. “So to encourage investors to think about your old bond, you would have to discount it.”
Discount as in, sold out.
The Silicon Valley Bank took a heavy loss selling its bonds, and many investors panicked and withdrew their money. Williams said it was a bank run on a scale the United States hasn’t seen since the Great Depression.
“In just one day last week, depositors knocked on the door and withdrew $41 billion of depositors,” Williams said. “That’s about a quarter of their total deposits. No bank, no matter how strong, can survive that kind of withdrawal… that kind of withdrawal.”
The rest of Silicon Valley Bank’s depositors were bailed out.
Sin by the association
Mark Williams said that although Silicon Valley Bank made a very specific series of mistakes, people across the country got scared and started pulling money out of smaller banks.
“That means these smaller regional banks are potentially destabilizing,” Williams said.
Where are these nervous investors putting their money? Williams said a lot of that is being deposited in big banks that customers consider safer. Also, a lot of people are putting their money in US government bonds.
Demand has spiked all week for the risk-free asset.