Due to my professional history as a banker and bank examiner as well as my positions on the House Financial Services and Small Business Committees, I have received countless questions and comments about the bank failures that occurred last weekend and the government’s response. The first thing I would say is that these are banks with extremely risky business models, one investing in a weakening tech industry and the other with deep ties to crypto currencies. The American banking sector as a whole is strong and banks here in Missouri remain sound.

In today’s bulletin, I’m going to do my best to explain what happened without making your eyelids heavy or causing your blood to boil - hopefully!

Over the past several years, Silicon Valley Bank has nearly tripled in size. That occurred in part because of the amount of money that has been injected into the economy by the government and the historic low interest rates that have been in place. The bank’s customers, which are largely venture capital firms and technology companies, had been heavily investing in new, startup companies that also bank at Silicon Valley. That created a massive amount of customer (business and individual) deposits being held at the bank. Banks are required to hold a certain amount of cash (or “capital”) on hand to ensure they have enough money available if a customer wants to make a withdrawal. Most banks also invest a portion of customer deposits in low-risk investments like Treasury bonds. In fact, regulators encourage holding deposits in Treasury bonds because they are so safe, they offer a set rate of interest, and banks can quickly sell them if and when their customers need cash. Silicon Valley Bank held a significant amount of customer deposits in Treasury bonds and other long-term, “safe” investments.

There was a plethora of technical factors that played a role in the bank’s failure. The two primary reasons were 1) the tech industry, which is the bank’s largest customer base, has been experiencing a large number of job cuts and closures and 2) the Treasury bonds the bank held dropped in value and the bank was far too slow to react. 

During the pandemic when people were stuck in their homes, the tech industry experienced a massive boom. For example, think about how many home delivery apps popped up over that time. The industry’s growth lead to hundreds of new tech companies and tens of thousands (if not hundreds of thousands) of new tech jobs in 2020 and 2021. Many of those companies opened bank accounts at Silicon Valley Bank. As the pandemic ended and people reentered the regular world, many of those startups closed and hundreds of thousands of tech jobs were lost.  According to a CNBC article, large tech companies laid off more than 95,000 employees in 2022. With many of its tech customers losing money, the bank began getting a large number of withdrawals. Basically, companies were not making money so they needed their money back from the bank to stay afloat.

In order to have enough cash to satisfy its customers’ withdrawals, the bank had to sell some of the Treasury bonds that were holding customer deposits. This is where the bank’s lack of diversification and slow reaction to interest rate hikes came back to bite them. We’ve all heard about the Fed raising interest rates over the last year. Well, those rate increases lead to higher interest rates on new Treasury bonds. The problem for Silicon Valley Bank is that it bought the vast majority of its bonds before the interest rates went up. So the bonds they owned paid an average of less than two percent, while newly issued bonds were paying almost four percent. When it came time for the bank to sell their bonds, there were very few people who wanted them because the interest rate was less than half of what a newly issued Treasury bond pays (think of it like this: would you rather have a savings account that pays two percent or four percent?). So, in order to sell the bonds and get the cash it needed, Silicon Valley Bank had to sell them at a lower price than what they bought them for, which resulted them in taking a $1.8 billion dollar loss. The news of the bank having to sell bonds at a massive loss in order to meet its customers’ withdrawal requests spread quickly across the internet – we’re talking about Silicon Valley after all. This led to more of their customers worrying about the safety of their own money and withdrawing massive amounts out of fear of the bank’s survival. This is the classic definition of a bank run.

By midday last Friday, California state bank regulators and the Federal Deposit Insurance Corporation (FDIC) believed the bank did not have enough money to meet customer withdrawal demands and decided to shut down the bank, which is standard procedure for a bank failure. Typically, when a bank fails the regulators hope another bank will purchase it. That way, people with accounts don’t lose their money or ability to operate their business. For reasons that have not yet been disclosed, the regulators could not finalize a sale over the weekend. On Sunday night, the FDIC, the Treasury Department, and the Federal Reserve announced that the FDIC’s Deposit Insurance Fund will insure all deposits held at the Silicon Valley Bank and Signature Bank in New York (which also failed for similar reasons) are going to be repaid in full. The Federal Reserve also announced a new program to help banks that are holding a high number of bonds, similar to those held by Silicon Valley Bank, access cash for customer withdrawals without suffering a massive loss.

FDIC insurance is only designed to cover deposits up to $250,000 per account. That means most of us never have to worry about the safety of our bank accounts, regardless of the bank we use. While it is not unprecedented – similar actions were taken in the wake of the financial crisis of 2008 – the decision to cover all deposits, even those worth hundreds of millions of dollars, was surprising. It is important to note that banks are charged a quarterly fee to fund the Deposit Insurance Fund, so taxpayer funds are not being used to cover those losses. However, banks will likely have to pay increased fees to replenish the fund due to the FDIC’s decision, which could have a trickledown effect to their customers – us. I am hopeful that the impact of that will be minimal on account holders, but we won’t know for sure until we know how much the Deposit Insurance Fund needs to recoup.

Many people have called what the regulators did a bail out. It is not. These banks are closing, their management has been fired, and their executives are being investigated - as they should. To be so heavily invested in one industry is as reckless and negligent as it gets. On top of that, the shareholders of the banks will lose most if not all of their money – that’s what happens when you invest in a poorly run business. However, that does not mean the regulators did everything right. They most certainly did not. Banks of that size are under constant supervision by federal and state regulators. By constant I mean there are regulators who go to the bank every day to ensure they’re functioning properly. Obviously, those people failed, and they too must be held accountable.

If you read this far you understand there is a lot to consider and uncover when it comes to the operation and regulation of these banks. The Fed has already announced an investigation and Congress will be doing our own assessments. The bright side is that under great stress the overwhelming majority of banks remain healthy, particularly here in Missouri. I will continue working to hold the bad actors in our economy to account while using the past week as an opportunity to review and strengthen the weaknesses in the regulators’ approach to bank supervision.