No Atheists In Foxholes. Or Libertarians In Bank Runs
by Jean-Louis Gassée
Silicon Valley Bank (SVB) made and lost chancy bets on long-term bonds. This concerned depositors who in turn worried other depositors, starting a chain reaction, a massive exit of funds. SVB didn’t have enough liquidities, became insolvent and is now in the hands of the FDIC (Federal Deposits Insurance Corporation).
Bank runs are an old phenomenon. According to Wikipedia, the first known bank runs go back to the 16th century, followed by the Tulip Manias, the South Sea Bubble, the French Mississippi Company, and many more over the ages. I won’t venture to say bank runs are part of the normal order of business but, like pandemics, they’re bound to happen. This no exaggeration, on its site, the FDIC lists 562 bank failures (not all are Bank Runs) between 2001 and 2023.
How does a bank run happen? If you’re a learned Monday Note reader versed in the arcana of finance, you may want to avert their eyes as I indulge in an oversimplification.
A bank may provide services such as disbursing or accepting transactions on your behalf, but its primary function is safe storage for your money.
But banks don’t simply let your money sleep, safe and sound. They put your funds to works by lending to people who pay interest for the service — that’s how your bank makes money and stays in business.
For example, Sheetmetal Co. needs to pay its vendor before its customers can settle their bills, so the bank lends some of your money to the company. But what if you need your money before Sheetmetal Co. can pay back the loan? No problem, the bank has many other customers and will be able to return your money.
The bank has many depositors like you and many borrowers like Sheetmetal Co, and the flow of money is harmonious and smooth…unless depositors suddenly, en masse, decide to take all of their money out. Unfortunately, the money isn’t all there, some of it has been lent to the bank’s borrowers. This leaves the bank unable to return depositors’ money. Bank run!
But why would depositors suddenly, collectively lose faith in their bank? It starts with objective data that shows that the bank is in trouble, and snowballs through herd mentality: Depositors run because they see other depositors run.
Instructed by history, banks avoid runs by following two lines of conduct. First, they strive to always look respectable: big buildings; seasoned, well-behaved people at the helm; regular proclamations of good financial health. Second, they carefully weigh the risk they take in lending your money to others. This means only lending a reasonable portion of deposits to carefully qualified borrowers that are sure to pay their loan fully and on the time.
But how do you define reasonable? Human nature, which always wins, intervenes and corrodes judgment. Greed leads banks to lend more money and to take more risk, which is why fine connoisseurs of the human soul called bank regulators establish rules that protect depositors and govern the level of risk banks can take. Of course, for every regulator we have scores of bank lobbyists who push our elected officials to loosen those pesky rules — as they did in May 2018, during the Trump administration.
Things get more complicated when we realize that banks can go to Wall Street, issue stock, and acquire shareholders. The bank is no longer just in the business of making loans — with your money — to reputable people and businesses. In order to please their shareholders, bank executives included, banks must search for higher returns from the money that they’re allowed to lend — a word that has acquired broader meaning than supporting Sheetmetal Co.’s on going business.
The financial jungle ecosystem is rich in opportunities to lend. For example, buying Municipal Bonds is a way to lend money to the bond issuer and get interest payments. This is more flexible than lending to Sheetmetal Co. because bonds are tradable, you can buy and sell them at will, and bond prices vary as buyers and sellers weigh their interest payments and dates against other bonds with different timing and interest numbers.
(For this unschooled mortal, bond trading is an inscrutable topic that brings fond memories of HP’s now vintage HP 80 financial pocket calculator with specific functions for Bond Price and Yield.)
The bank at the beginning of this essay has become a business with many masters and divided loyalties. Does it exist as a service to society, to depositors, to businesses needing cash lubrication? Or does it serve its shareholders on Wall Street and company executives?
We can now turn to the Silicon Valley Bank (SVB) collapse.
Founded in 1983, SVB is a pillar of Silicon Valley. The 16th largest US bank with $212B in assets and $342B in client funds, SVB served venture capital companies and startups alike, holding their funds, fielding loans, processing payrolls. A success story, a valued character of Valley Lore.
But in 2022, SVB took chances. In a search for bigger returns, the bank made unusually large investments in long-term bonds that quickly lost value as interest rates went against their assumptions. Billions were lost. Since SVB is a publicly-traded company, the losses couldn’t be hidden and depositors started to worry. Venture firms pulled their funds and told their startups to do the same.
SVB management tried to talk reason, saying things would be manageable if everyone simply stayed calm, but to no avail. Some quick-thinking SVB depositors managed to withdraw $42B this past Thursday, others weren’t so lucky as SVB became insolvent. The Bank Run was on and the FDIC took control in the biggest US bank failure since Washington Mutual in 2008.
The consequences could be dire for companies that couldn’t get their funds out before the collapse. How will they make payroll, how will some of their employees living paycheck-to-paycheck cope? Creative greed offers a possible if costly out: Some investors have offered to buy startup deposits stuck at SVB for as little as 60% on the dollar. Call that a sort of Down Round financing. For some startups, it’s that or death.
Perhaps more encouraging, we see a group of venture investors coming up with this proclamation:
Hopeful…but no money attached. And, as Kara Swisher pointed out, large funds such as Founders Fund, Andreessen Horowitz, and Sequoia are notable by their absence.
Just as there are no atheists in foxholes, there are no libertarians in a bank run. We now see appeals for more government intervention using taxpayers funds:
The idea is to avoid a free-fall into an epidemic of insolvency. This worked during the 2007–2008 crisis when, incidentally, the federal government injected $235M into SVB under the Troubled Asset Relief Program (TARP). Fifteen years later, billions might be required to forestall further contamination of our treasured “free market” systems.
To be continued when we know more about the FDIC’s plan to right the ship and avoid large scale devastation…
— jlg@gassee.com
