I doubt that anyone but Wall Street short-sellers were happy about the problems with Silicon Valley Bank and Signature Bank. The broad problem for each of these banks has been discussed, but what about the linkage? Is there a reason why both banks, with different exposure to different risks, failed in a period of less than a week? What does this tell us, what must we learn, to protect not only tech and startups, but economic health overall.
SVB’s problem was that unlike most banks, it didn’t really do a lot of short-term lending. Tech companies stockpiled their cash there, cash from VC funding rounds, IPOs, and operations, and the bank held the cash in bonds rather than lending it out. When the Fed started raising interest rates, the price of bonds dropped because the bonds’ own interest payments were less attractive given the new rates. That meant that the bank’s reserves fell. Had they loaned out more of the money, the higher interest rates set by the Fed could have given them more money, not less. In addition, the tech sector and startups and VCs that largely create it were pressured by the same rise in rates, borrowing less and pulling money from their accounts. When the bank had to sell some assets at a loss, the run started. The perfect storm.
Signature Bank’s problem was crypto. Almost a quarter of the bank’s deposits came from the crypto sector, which even at the end of 2022 was showing some warning signs. As a result, the bank announced it would shrink the share of deposits represented by the crypto space in 2023. However, that had apparently not gone far enough when fears of bank problems were raised by the SVB problem’s emergence. The SVB weekend closure meant a stablecoin lost access to what backed it, and suddenly there was no stability in crypto anywhere.
In both cases, the banks suffered both a confidence crisis among depositors and among investors. This in turn caused regulators to step in. Bank failures aren’t unusual; there are usually a dozen or so in a given year, but it was hoped that regulations put in place after the 2008 crisis would prevent them in the future. It has worked so far among the major banks, but smaller regional and specialized banks like SVB and Signature have continued to be vulnerable.
Given that the “cause” of the two takeovers were very different, why did we see them almost one on top of the other? Part of the reason is the contagion created by publicity. Depositors who have more in a bank than the FDIC insurance would cover were fearful after SVB, the great majority of whose depositors were largely unprotected until March 13th, when the government stepped in with guarantees. Short-sellers jumped on every bank stock to make money, and some investors were fearful and joined them in selling. But while these were also “causes” of the problems, what started the perfect storm? Speculation, meaning bubbles. One thing that’s been true of the financial industry for at least a century is that it loves bubbles, loves to speculate and leverage to gain more.
Crypto is a self-contained bubble; there is no real foundation of value behind it, only the “technical” buy/sell relationship of the market. Even “stablecoins” that are supposed to be pegged to assets like the US dollar are really bubbles. Why would you invest in something that’s pegged to something else? Answer, you hope that the value appreciates despite the peg but that the peg protects the downside. Well, one stablecoin was temporarily caught in the SVB mess, and it may not be out of the woods. That’s because nobody reserves 100%; if enough people bail on a stablecoin, it fails too.
The tech VC world is also, I would argue, a bubble. For decades, the VC community funded multiple startups in the same space to create “buzz”, the media attention that tended to make the space seem hot and induce established firms to buy up the startups or be left out. The current focus is on social-media startups, despite the fact that ad sponsorship is a zero-sum game. What you do is to raise money, spend a bit on cloud resources to host your startup, spend more to promote it, and then try to “flip” it quickly. We’ll see AI playing along these lines shortly, and in great volume.
Banking once was regulated enough to prevent most bubbles, but those regulations were weakened in 2018. The real problem, though, was Wall Street’s appetite for more risk, and their search for new bubble opportunities. Even dot-com bubble and the credit-default-swap bubble didn’t stimulate addressing the systemic risk of bubbles, just minimal local ways of reducing their impact. As a result, banks were exposed to problems that really existed outside banking…what might be called “inherited bubbles”. While there are banks that want to issue crypto, the majority who are at risk there are at risk because they’ve banked crypto firms’ assets. SVB banked startup assets, tech assets. Both held reserves in bonds, reserves required by law, and at the same time the Fed was taking steps to make the bonds worth less.
The global economy has a bunch of moving parts, but they’re not separate parts. Instead, they all move in a complex way, and so something that distorts one segment will almost inevitably bite you in a segment that seems on the surface to be totally unrelated. Should the Fed have asked what the impact of higher rates would be on bonds and those who hold bond reserves? Surely, but if they did, it didn’t show. They left it to the market, and the market loves bubbles, until they burst.
There are a lot of reasons why it’s said that the US is losing its top spot in tech innovation, but I think the biggest reason is one that’s not talked about at all. It’s bubbles. Startups that are actually aimed at creating a real, new, value have almost disappeared in the VC bubble. The thing about bubbles, including startup bubbles, is that they enrich capital and not labor. You don’t need many real engineers to launch a social-media bubble, far fewer than you’d need to start a company that was going to build a product and employ real people. Bubbles have enriched the wealthy rather than creating jobs for the average worker, and it’s real stuff that advances technology, and pretty much everything else.