The Downfall of Silicon Valley Bank: Risky Investments and the Federal Reserve’s Role

By Amoli Deshpande — Correspondent

On March 10, a crucial part of our nation’s tech hub, Silicon Valley, crashed, causing great fallout across our economy and banking system that our nation is still feeling the consequences of. As new details emerged, the causes of its demise began to paint a bigger picture of how the bank crashed.

The Silicon Valley Bank’s services were curated to the financial services of the tech industry and soon became the go-to bank for tech startups in the area. The bank ended up crashing after depositors withdrew their money leading to its collapse and seizure by the California Department of Financial Protection and Innovation.

One of the largest reasons for the bank’s downfall was the types of bonds that Silicon Valley Bank (SVB) invested in and how the Federal Reserve’s hike in interest rates impacted them. According to Thomas Sanborn, an economics teacher at Sharon high school, when the Federal Reserve increased interest rates, this decreased the value of their investment in bonds. “The Fed has been raising interest rates to combat inflation, which causes savings to be more profitable than bonds and a reduction in the value of bonds. Medium banks like SVB have been investing heavily in long-term bonds with their deposits. And the decrease in bond price makes their investment to devalue,” said Sanborn.  

Experts also believe that the Fed’s hike in interest rates causes other banks to be at risk. In a report for the Social Science Research Network, some economists believe that the decline in value caused by increased interest rates makes the banking system more fragile to uninsured bank runs. “The recent declines in bank asset values very significantly increased the fragility of the U.S. banking system to uninsured depositor runs,” said the report. 

The long-term bonds that Sanborn mentioned are known for being risky, but attracted by the potential of higher returns and blindly trusted the stability of theU.S. financial system, SVB still decided to invest heavily in them. Things took a turn for the worst when depositors failed to take out their deposits because they were locked away in these longer-term bonds. 

Sanborn says that these insecure investments are appealing to banks because they can use the money from those returns to buy loans, assets, or securities. “They take that money and it doesn’t just sit there in the bank, they loan it out, buy assets, or buy securities. If the government is gonna cover all the reserves if things go wrong, the banks are gonna invest all that money. They seek higher risks ‘cause they can make more money,” said Sanborn.

 These risky investments come at a detriment to taxpayers. Sanborn says that the money that is used to save banks when they do risky investments is coming from taxpayers’ wallets, while not reaping any sort of benefits for them. “Basically taxpayers are gonna be borrowing and essentially support risk-taking by banks. But we – the taxpayers – don’t get the benefits if the bank’s bets go well, they just cover their losses,” said Sanborn. 

After the collapse of SVB, the Federal Reserve had to do crisis management when it came to making sure that depositors got back their money. In a joint statement on the collapse of the bank by Secretary of the Treasury Janet L. Yellen, Federal Reserve Board Chair Jerome H. Powell, and FDIC Chairman Martin J. Gruenberg say that the Federal Reserve will aid banks in recuperating depositors’ losses. “Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law,” said the statement.

The statement also says that it will help banks in recuperating these losses.  “Finally, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors,” said the statement. 

Sanborn believes that when the federal reserve helps these banks during a collapse, it allows for other banks to continue making such risky investments. “When the Fed protects banks like SVB from losing money, it is signaling other banks that they can continue making risky investments and they are likely also to be saved by the bank if their investment goes awry. I think the Fed might have made a blunder here,” said Sanborn. 

Sanborn furthers that the collapse of SVB has major consequences on how the Federal Reserve deals with inflation as its collapse would prevent the Federal Reserve from raising interest rates to combat inflation. “The Fed will now worry about raising interest rates ‘cause they’re gonna cause more silicon valley bank situations. Which is another problem because it means the Fed is less likely to fight inflation effectively,” said Sanborn.

 During the height of the collapse there was a death of a 24 billion dollar equity deal between Goldman and Sachs, an investment management firm, and SVB.  This equity deal was crucial for SVB to gain money and decrease its debt. This would have meant that it could have prevented a decrease in debt ratings from Moody’s, a rating agency that was threatening to do so. Following the death of this equity deal and the collapse of Silvergate, the SVB stock started to plummet rapidly until 8 pm on the following Thursday. This also jumpstarted multiple downgrades from different agencies, including Moody’s, which ended up downgrading the bank by one notch. Amidst this crisis, Goldman and Sachs were still able to somewhat salvage this deal, but Goldman and Sachs couldn’t give the money to the bank and SVB couldn’t accept it because of the bank’s financial state. Their financial state was poor which resulted in SVB having to essentially tell investors that nothing had changed monetarily in the company’s financial status since they had agreed to do the deal. This is because since the deal had been announced on March 9th, approximately 45 billion dollars worth of deposits had left the bank, which made the bank’s financial status abominable. 

Another cause of the collapse was SVB’s inability to pay back deposits properly. Sanborn says that since SVB wasn’t able to fully pay back the initial money from the deposits, depositors were losing money. “If the bank sells those bonds at 80% of their initial value, then the banks lose 20% of their money on those bonds, so then they can only pay their depositors back like 80% of what their deposits are. So the depositors are losing money. If that happens people are gonna lose confidence in the bank and all will want their money out,” said Sanborn.

SVB’s problems further intensified after SVB was running low on money to pay back these same depositors, as their bonds decreased in value due to rising interest rates. Sanborn says that SVB was short on money to cover deposits because their bonds were not as valuable anymore. “They traded bonds with a bunch of people including Goldman and Sachs, sure and they bought US government bonds and then those interest rates went up and the bonds became less valuable and they became concerned they didn’t have enough like reserves to cover the deposits,” said Sanborn. 

“If people took the money out of their deposits they would run out of money and have this problem where they would have to sell these bonds at a lower price and run out of money. So they asked their depositors for some more money,” Sanborn added. 

He furthers by saying that the bank run that occurred during the collapse of SVB was due to depositors being unsure about the status of their money and how much money they will get back in interest. “The depositors were like we don’t want to wait around for that, we’re gonna lose money so they pulled their money out which sort of made the bank’s problem intensify,” said Sanborn. 

One of the most serious consequences of the bank’s deteriorating financial status was insider trading. Experts believe that insider trading has been occurring since 2021 at the bank, with top executives making $84 million from selling stocks over the past two years. On top of this, SVB’s CEO, Greg Becker, sold nearly $30 million of stock since 2021. He also sold 3.6 million dollars worth of shares just days before the bank had announced a big loss that triggered the collapse of its stocks. Ro Khanna, the representative of the congressional district that includes Silicon Valley, tweeted that the 3.6 million dollars that Becker took should be returned to depositors and Becker’s motives should be sought.  “Whatever his motives, and we should find out the motives , that $3.6 million should go to depositors,” said Khanna. These reports of Insider trading at SVB have also sparked investigations from the Justice Department and the Securities and Exchange commission. 

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