Strange Things Volume III: The Dying Banks and the Singularity

A new financial crisis is brewing. Last month, 4 major banks collapsed or were shut down, and this past weekend First Republic Bank was seized by the FDIC and sold in a fire sale to JP Morgan Chase. There is an accelerating withdrawal of money throughout the entire system. The cracks are widening, and Strange Things are going on in the world of banking. The gravitational fields made by the Fed to avoid prior crises are now creating a new crisis. Anything will be done to paper up the disemboweled banks bleeding from the latest hiking cycle.

Welcome to the Singularity.

Silicon Valley Bank (SVB) was a commercial bank that provided financial services to technology and life science companies, as well as venture capital and private equity firms. Founded in 1983 in Santa Clara, California, the bank had expanded to serve clients in major innovation hubs across the world, including New York, Boston, London, and China. Silicon Valley Bank was known for its expertise in the technology and life science industries, providing tailored solutions to help companies and investors navigate complex financial landscapes. To incentivize companies to stay with them, SVB would offer a range of financial products, and include bonus “gifts” such as free subscriptions to many of the essential SaaS services that startups need (Salesforce, for example.) More insidiously, however, the bank offered to help firms raise additional capital if they stayed with the bank, and kept this money in their account.

This is eerily reminiscent of Mafia rackets, where businesses were given incentives to keep a gang as their business partner in a money laundering scheme. As a result of these policies, Silicon Valley Bank had a unique customer base- almost entirely high end VC, PE and startup clients who held millions of dollars in each deposit. 

Silicon Valley Bank, like any bank, is constrained by a variety of regulations that limit the types of investments it can make- loans and bonds, especially “Tier 1” HQLA (High Quality Liquid Assets), would make up the majority of its balance sheet. During 2021 and the first quarter of 2022, the Fed had been plowing $120B a month into the market via QE, and interest rates were suppressed near the zero bound. This created a massive influx of capital- deposits ballooned from $61bn at the end of 2019, to a peak of $174bn at the end of 2022.

With limited places to put these funds, SVB had poured them all into Treasuries and MBS in hopes of remaining compliant with federal regulations. We can see their balance sheet below:

However, this would soon come back to haunt them. 

While digging through their financials, I found something startling. Their assets were segregated into two different types: AFS and HTM. AFS stood for Available for Sale, these were assets that were liquid, marked to market (meaning that if there were losses, they would be counted as unrealized losses on the BS). HTM stood for Hold to Maturity- these were bonds and MBS that would be held until the maturity date of the instrument. Strikingly, HTM securities were not hedged for interest rate risk, and did NOT have to be marked to market. They assumed that the risk profile for these bonds was ZERO.