As Warren Buffet once famously said, “Only when the tide goes out do you learn who has been swimming naked.” And last week, that turned out to be the Silicon Valley Bank, whose customers include tech startups, venture-capital firms, and Napa Valley wineries.
SVB’s leadership certainly deserves their fair share of the blame. Bankers, more than anyone else, knew that an aggressive interest rate tightening cycle lay ahead. Federal Reserve officials had made no secret of their plans. Interest rates had remained at unsustainably low levels for over a decade. Still, losing sight of possible short term cash needs, management chased the higher yields offered by longer term securities.
As interest rates rose, the prices of bonds and other debt instruments in their investment portfolio fell. This wouldn’t have been a problem if these investments were held until maturity, in which case they would receive the face value of the bond. But, forced as they were to liquidate their positions early to meet unexpected withdrawal demand, SVB realized a $1.8 billion loss. Following the disclosure of this loss, depositors raced to withdraw funds, triggering a good, old fashioned run on the bank. At the same time, shareholders raced for the exits driving the price of its stock down 60% in one day.
Although SVB tried to raise additional capital, and even find a corporate buyer, the bank was shut down by regulators on Friday and taken over by the Federal Deposit Insurance Corporation. SVB’s collapse was the second largest in U.S. banking history and the first bank failure since the 2008 financial crisis.
On Sunday, the Treasury Department, the Federal Reserve, and the Federal Deposit Insurance Corporation released a joint statement which said that SVB’s depositors will have access to all of their funds on Monday morning, even those that exceed the FDIC’s current threshold of $250,000. This action was taken to calm depositors and to avoid runs on other regional banks.
The statement also announced the shutdown of Signature Bank, a New York-based bank that serves cryptocurrency companies.
The Federal Reserve’s latest tightening cycle has taken the federal funds target rate range (the rate at which banks lend to each other overnight) from 0.25% to 0.50% on March 17, 2022 to 4.50% to 4.75% on Feb. 1. That’s an increase of over 4 points in less than one year.
The Consumer Price Index reached a peak of 9.1% in June 2022, a level not seen in over 40 years. Although the CPI has shown signs of cooling, it still remains at 6.4%, year-over-year (January CPI).
In remarks to the Senate Banking Committee last week, Federal Reserve Chairman Jerome Powell indicated that interest rates will be moving higher still. Citing persistent inflation and strong employment data, he said: “The process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy. The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.”
But let’s not lose sight of why the Fed’s aggressive tightening schedule was necessary: the Biden administration’s profligate spending had driven inflation to record high levels.
The central bank has been trying to tame the red-hot inflation ignited by trillions of dollars of reckless and unnecessary spending. There was a reason why Republicans warned the administration to put the brakes on their spending plans two years ago. Actions have consequences.
The effects of the one-two punch to the U.S. economy of roaring inflation and a steep rise in interest rates have touched the lives of every American and affected every sector of the economy.
Business for SVB’s client base had already begun to suffer ahead of the collapse.
Rising interest rates and an uncertain stock market have made it difficult for startups to raise capital. There’s been a major slowdown in the initial public offering market in the last year even for larger, more established companies. Citing high inflation and rising interest rates, CNBC reported that the IPO market fell “off a cliff in 2022.”
Following the release of Friday’s employment report which showed 311,000 jobs had been added to the economy in February vs. the 225,000 expected, President Joe Biden said, “And I think all this matters. It’s no accident. It means our economic plan is working.”
He then proceeded to tout his new budget that calls for an additional $6.9 trillion in spending.
So, oblivious to the fact that his administration’s out of control spending is the catalyst for the persistent inflation that prompted the Fed’s aggressive interest rate hikes that are killing the economy and hurting Americans, he plans to double down.
The SVB collapse did not happen in a vacuum. If the government doesn’t rein in spending, SVB will be only the first of many dominoes to fall.
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