The Breakdown - The 2nd Biggest Bank Failure In American History: Silicon Valley Bank Is No More

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is produced and distributed by CoinDest. What's going on, guys? It is Friday, March 10th, and today we are staring down the barrel of the second biggest bank failure in American history. Before we get into all that, though, if you are enjoying the breakdown, please go subscribe to it. Give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pot. All right, well, friends, it is moments like this that the news comes so fast that even a daily

Starting point is 00:00:47 podcast can barely keep up. As I mentioned yesterday, I'm using YouTube to try to fill in the gaps with some faster content. So if you were interested in that, search Breakdown NLW or Nathania Whittemore and you will find it. Now, to give you a sense of just how crazy things are right now, a hearing led by Republicans whose main thrust was to ask whether there is collusion, in the government's attack on crypto is not our main story. Neither is the New York Attorney General asserting in a lawsuit against exchange co-coin that Ethereum is a security. And if you had asked me, if there could be a day where the U.S. government or a representative

Starting point is 00:01:21 thereof decides to go after Ethereum as a security and it wouldn't be the thing to cover, I might not have believed you. However, here we are, and it turns out that the potential for the systemic failure of the banking sector trumps just about everything else. So for those of you who missed yesterday's show, this week, Silvergate Bank threw in the towel after a brutal last few months. The narrative for people who were outside of crypto was that this was just the inevitable consequence of being involved with such a risky, suspect industry. For folks in the crypto industry, the same people who were saying that previous argument needed to share a big part of the blame, especially Elizabeth Warren and a set of other senators with her who kept a barrage of angry public pressure on Silvergate,

Starting point is 00:01:59 undermining confidence in it along the way. However, there was another piece of the bank's failure that was more serious. structural. And that had to do with a mismatch between the liabilities of the bank, which were largely crypto company depositors, and the assets of the bank, which were held in a variety of fairly standard securities, including treasuries, municipal bonds, and mortgage-backed securities. The problem was that in a high interest rate environment, most of those assets were now worth less than they had been a year ago. That's the nature of the beast when interest rates rise and people can park money and higher yielding quote-unquote risk-free assets. Now, even this wouldn't necessarily be a problem if the

Starting point is 00:02:32 assets were allowed to be held to maturity. The problem in this situation arises when the asset holder, Silvergate in this case, is forced to sell at a loss before those assets reach maturity. This is what happens when there's a bank run, and unfortunately, it is a painfully self-reinforcing reflexive cycle. For example, when Silvergate quarterly results showed a huge loss from having to sell assets to cover outflows, it further undermined confidence in Silvergate, which led to lower stock prices and further outflows, and you see where this goes from there. Now, there is a whole other question in the case of Silvergate of a $4.3 billion FHLB loan that they received, but which was called back shortly after, and which forced them to liquidate even more in January and

Starting point is 00:03:12 February to pay it back. There hasn't yet been any explanation given as to why this loan was called so shortly after being made, but it's quite clear that it was the straw that broke the camel's back. However, for the purposes of our conversation today, the key dynamic in Silvergate that we want to think about is this idea of a duration mismatch between short-term deposits and long-term loans. It is also worth noting at this point that banks having that sort of duration mismatch isn't necessarily them acting badly. It is fundamentally what fractional reserve banking does. Joe Wisenthal from Bloomberg tweeted,

Starting point is 00:03:42 Every time a bank gets into trouble, people are like, they took short-term deposits and made long-term loans, what were they thinking? As if that's not the business model of every bank ever. All of which gets us to Silicon Valley Bank. For the TLDR in this situation, I'm going to turn to a great little explainer from investor Jamie Quint. Jamie writes, in 2021, SVB saw a mass influx in deposits, which jumped from $62 billion or so at the end of 2019 to around $190 billion at the end of 2021. As deposits grew, SVB could not grow their loan book fast enough to generate the yield they wanted to see on this capital.

Starting point is 00:04:17 As a result, they purchased a large amount over $80 billion in mortgage-backed securities with these deposits for their hold-to-matured portfolio. 97% of these mortgage-backed securities were 10-plus-year duration, with a weighted average yield of $1.1.5%. point five six percent. The issue is that as the Fed raised interest rates in 2022 and continued to do so through 2023, the value of SVB's mortgage-backed securities plummeted. This is because investors can now purchase long-duration, quote-unquote, risk-free bonds from the Fed at a 2.5x higher yield. This is not a liquidity issue as long as SVB maintains their deposits, since these securities will pay out more than they cost eventually. However, yesterday afternoon, SVB announced that they had sold 21 billion of their available for sales securities at a $1.8 billion loss,

Starting point is 00:05:01 and were raising another $2.25 billion in equity in debt. This came as a surprise to investors, who were under the impression that SVB had enough liquidity to avoid selling their AFS portfolio, end quote. So as you can see, here we again have the same structural problem faced by the assets in Silvergate's portfolio. Those assets had unrealized losses because interest rate increases in the wider environment had made them less valuable relative to government. government bonds, which wouldn't have been an issue unless they were forced to sell, but boom, all of a sudden, they were forced to sell. Now, one of the other things that Silvergate and Silicon Valley Bank share is a high concentration of depositors from a specific industry. For Silvergate,

Starting point is 00:05:38 that's obviously crypto and the concentration was extremely high, like 90% plus. For Silicon Valley Bank, it was tech more broadly, and while it wasn't nearly that concentrated, there's no denying that SVB has historically been the bank for the tech industry. SVB's own website claims that 44% of US VC-backed companies with an IPO in 2022 were SVB clients, and that number is probably a lot higher than that for startups. One difference, however, is the precise nature of the bank runs that Silvergate and SVB faced. The run on Silvergate initially wasn't really a run on Silvergate, but instead, a run on crypto exchanges in the industry more broadly. However, because so many of those institutions banked with Silvergate, they experienced a run by proxy. The point, in other words,

Starting point is 00:06:19 is that initially, at least, it wasn't a loss of confidence in Silvergate that precipit the huge amount of outflows. That loss of confidence came later and was aided and abetted by Elizabeth Warren at all. Meanwhile, Silicon Valley Bank was a bit different. They had been dealing with challenges posed by an impaired customer base, i.e. their tech customers, and so had to sell assets before maturity. When they reported this, alongside the fact that they were raising more money, it totally spooked the market. This wasn't helped by genuinely some of the most ill-advised comments from a CEO I've ever seen, who said in an investor call to stay calm, not to panic, told everyone that the only way there would be an issue is if everyone told everyone else there

Starting point is 00:06:56 was going to be an issue. What he seemed to have missed is that Silicon Valley is maybe the most communications dense professional network in the world. And what's more, despite their attempt to portray themselves as all contrarians, many VCs are inherently trend following Lemmings who listen to the big guys in their space. On top of that, every tech founder is friends with every other tech founder that they went through Y Combinator with, etc., etc., etc., etc. And so, when yesterday afternoon some VCs like Union Square Ventures started advising their companies, To try to get money out of Silicon Valley Bank, the message flew around like absolute wildfire. Reporters, VC influencers, everyone was on Twitter by the evening East Coast time saying that everyone they knew was trying to get their money out of Silicon Valley Bank to various levels of success.

Starting point is 00:07:40 Completely outside of this podcast, my Instagram feed, WhatsApp, Telegram, were all literally just full of founders and investor friends, either trying to get their money out or trying to help companies they work with get their money out. Now, this wasn't the only reaction. Prominent investor Mark Suster was notable in trying to quell the comm. He wrote, more in the VC community need to speak out publicly to quell the panic about SVB. I believe their CEO when he says they are solvent and not in violation of any banking ratios and goal was to raise and strengthen balance sheet. I believe the biggest risks to startups and VCs end to SVB would be a mass panic.

Starting point is 00:08:12 Classic runs on the bank hurt our entire ecosystem. People are making jokes about this. It's not a joke. This is serious stuff. Please treat it as such. I believe SVB is one of the 20 largest banks in the U.S. I do not believe the U.S. government would like to see them fail. I know some have already withdrawn money.

Starting point is 00:08:27 I know some are advising this. I know it's scary. More VCs need to speak up. It doesn't matter exactly what banking solutions are chosen. What matters is that we don't have or create mass hysteria. Now, I think Mark here was right in that, one, this is a deadly serious issue and not something to joke about. And that, two, to the extent cooler, calmer heads could prevail, it would be good.

Starting point is 00:08:46 But the damnable thing about bank runs is that if you would, have a fiduciary duty, like you do if you're a startup founder or CEO. And there is a reasonable chance that your bank is going to fail. You have an absolute obligation to try to get your money out of there, even if you doing so marginally increases the chance that the bank fails because of it. This is brutal but true and why this sort of contagion can spread so fast. Join CoinDesk's Consensus 2023, the most important conversation in crypto and Web 3. happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse.

Starting point is 00:09:30 Immerse yourself in all that blockchain technology has to offer creators, builders, founders, founders, brand leaders, entrepreneurs, and more. Use code Breakdown to get 15% off your paths. Visit Consensus.com or check the link in the show notes. Now, there was one other subplot here, which is that some VCs were accusing other VCs of inciting the chaos to benefit their neobank portfolio companies who are competing with SVB. To the veracity of this, it is definitely the case that as startups are trying to get out of SVB, Neobanks like Mercury and others are scooping up depositors.

Starting point is 00:10:06 But does that mean that investors are actively trying to incite the run to help those portfolio companies? I don't know, man. I haven't seen any evidence that it seems like a pretty stupid idea to me. But of course, that doesn't mean it's not happening on some small level. By and large, however, I think that the bank run is being driven by startups who don't want to get caught with their assets locked, which unfortunately for those recognizing that bank runs are really, really bad, is a super rational thing for them to do. Certainly when we woke up this morning, it was clear that markets had not gotten the memo to stay calm and not panic. SVB began the day down 60% overnight and had its stock trading almost immediately halted.

Starting point is 00:10:40 The big blaring headline from CNBC, Silicon Valley Bank Financial in talks to sell itself after attempts to raise capital have failed. Senator Bloomberg report, Silicon Valley Bank tells employees there are conversations to determine next steps for the bank. Staff should work home until further notice. Now, the main speculated buyer has been JPMorgan, who some see as having long coveted the sort of tech clients that SVB has. This was aided and abetted by a JPM analyst note this morning, which said, we will be buyers of SIVB shares at this highly attractive valuation. SVB is a world-class and highly valuable global franchise, and the option to purchase the shares below TBV, we believe more than adequately compensates investors for the risk being taken. However, even that isn't looking super

Starting point is 00:11:22 solid at the moment. At 10 a.m., Fox News Charles Gasparino tweeted, Scoop, investment banker with direct knowledge of the SVB Bankrun says the firm is for sale, but a complicating factor is mandatory Federal Reserve approval, which means it narrows the potential buyers dramatically, possibly to the big banks like J.P. Morgan and Bank of America, both of which might be hesitant to buy something and inherit its liability given their financial crisis experiences. As another banker involved, told me buyers are circling, but sale is, quote, looking tough. And by the way, it's not like other banks are doing great today. Bank stocks, especially those of smaller community banks or regional banks, are in full-on crisis mode. First, Republic Bank is down 50%, Western Alliance Bank

Starting point is 00:12:01 Corporation is down 23%. Signature bank is down more than 20%, and so on and so forth. Indeed, volatility is so high that trading on a number of these stocks has been halted, and others are seeing shorting restrictions as well. So yeah, it's a bit of a fever pitch out there. And I think in many ways the attention is now turning to what happens if Silicon Valley Bank fails. Bill Bill Ackman writes, The failure of SVB could destroy an important long-term driver of the economy, as VC-backed companies rely on SVB for loans and holding their operating cash. If private capital can't provide a solution,

Starting point is 00:12:35 a highly dilutive government-preferred bailout should be considered. After what the feds did to J.P. Morgan after it bailed out Bear Stearns, I don't see another bank stepping in to help SVB. The government could also guarantee deposits in exchange for a dilutive warrant, issuance, and other covenants and protections. If Silicon Valley Bank is indeed solvent, this would buy time to enable SVB to restore the franchise and raise new private capital. To be clear, a bailout should be designed to protect SVB depositors, not equity holders or management. We should not reward poor risk management or protect shareholders from risks,

Starting point is 00:13:03 they knowingly assumed. The risk of failure and deposit losses here is that the next, least well-capitalized bank faces a run and fails, and the dominoes continue to fall. That is why government intervention should be considered. Former Treasury Secretary Larry Summers on Bloomberg TV said, What is absolutely imperative is that however this gets resolved, depositors be paid back and paid back in full. I don't see this if this is handled reasonably, and I have every reason to think that it will be,

Starting point is 00:13:28 that this will be a source of systemic risk. It's worth pointing out at this point that literally, two days ago, we had senators like Elizabeth Warren and Sherrod Brown high on their own shot in Freud, tweeting in a not so subtly gleeful way about the failure of Silvergate after it experienced a bank, run. Two days later, you have a former Treasury secretary going on Bloomberg to say that as long as depositors are taking care of, the second biggest bank failure in American history wouldn't be a

Starting point is 00:13:56 source of systemic risk. Life comes at you fast. Now, it is a heady, scary time out there, and I think it's worth also quoting Lynn Alden, who says, I'm going to interrupt today's schedule doom and gloom and say most banks will be fine. The ones facing problems have an industry specific in this volatile deposit base, or an unusually high ratio of security. on their book. For deposit safety, big and diversified banks. At the heart, it's a duration problem rather than a solvency problem. The bank's deposit base as a whole can't really go anywhere, so the widespread unrealized losses won't be marked to market. But deposits can move around, so for weak areas, that's exactly what's happening. Now, I am hoping Lynn's right. I'm hoping

Starting point is 00:14:34 SVB finds a buyer. I'm hoping markets calm down. I'm hoping that regional banks and community banks, which play an incredibly important role in this country, recover as the market's worst fears are quilt. I want, in other words, for all of us to be able to be not scared for long enough to start to be angry. And when we do, I think it's going to be a hell of a sight to see. I tweeted earlier, the only reason people aren't angrier at the Fed for causing a banking crisis with the fastest tightening cycle in 40 years after a year of screwing the pooch with transitory is that crypto and tech are punching bags right now. At some point, that anger is going to shift. And I genuinely believe that to be the case. The Fed has talked continuously about how it hadn't broken anything yet,

Starting point is 00:15:16 well, here you go, you broke it. And indeed, we are starting to see some of that anger emerge even through all the fear. Former CFTC Commissioner Brian Quintin's rights, so the Federal Reserve hikes rates by 400 basis points in 12 months, sending all asset prices into a tailspin, and inverts the yield curve the most since 1980, causing large regional banks like Key Corp to raise alarm bells on funding costs, and crypto is the problem? Of course, the speculation is now running rampant about when the Fed will be forced to step in and reverse course to provide liquidity to the system. Scott Melko writes, now a 25 basis point rate hike is being priced in by the predictive markets.

Starting point is 00:15:48 Again, I continue to remind you that people have no fucking idea what is going on. And making financial decisions based on spastic human predictions that change daily is a really bad idea. So there you have it. We are in the middle of it. I'm sure that by the time this gets to your ears, it will be out of date, but hopefully it helps explain what's going on a little bit. Like I said, check out my YouTube for more up-to-date information. I'm trying to keep that posted a little bit more frequently.

Starting point is 00:16:12 Until tomorrow, guys, be safe and take care of each other. Wait a second. I'm still here? Yep. As soon as I finished recording, I logged back on to Twitter to see that it was done. Silicon Valley Bank has been closed by the FDIC. It is no more. The FDIC released a press release this morning that says FDIC creates a deposit insurance

Starting point is 00:16:35 national bank of Santa Clara to protect insured depositors of Silicon Valley Bank in Santa Clara, California. Silicon Valley Bank was closed today by the California Department of Financial Protection and Innovation, which appointed the FDIC as receiver. All insured depositors will have full access to their insured deposits no later than Monday morning. The FDIC will pay uninsured depositors and advance dividend within the next week. So there you have it, folks. SVB has failed. More on what the hell that means coming soon.

The Breakdown - The 2nd Biggest Bank Failure In American History: Silicon Valley Bank Is No More

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