Tag Archives: SVB

Don’t put all your money into bonds, a message for SVB

So remember a while ago I wrote a post about how you should diversify your investing, not just put all your money into bonds? I just realized that if SVB had listened to me they wouldn’t have been in this mess. I talked about how rising interest rates make old bonds worth less than you payed for them, and how you’d take a loss if you needed to sell them in a hurry. That’s exactly what caused SVB’s collapse, they were sitting on assets (bonds) that had lost tons of value due to rising interest rates. That triggered fears of insolvency which triggered a bank run.

If anyone knows a dumb bank that needs to hire a smart guy like me to do risk assessment, I’m always looking for a new job. Just email theusernamewhichismine@gmail.com.

It’s not a bailout unless it comes from the bailout region of DC

America is bailing out the banks again, but like Josh Barro writes, we don’t want to say we are. When the government hands billions of dollars to Silicon Valley hedge funds by guaranteeing their deposits, it makes us wonder why they can’t hand billions of dollars to those of us struggling with inflation. Maybe they can guarantee our rents? But this totally isn’t a bailout, just ask Biden.

For those who don’t know what I’m talking about, Silicon Valley Bank (SVB) was a bank holding deposits from hedge-fund backed startups and using them to make very risky plays. Those risks cased them to crash and burned due to rising interest rates. So the government had to bail them out, but it doesn’t want to call it a bailout.

So why isn’t this bailout really a bailout? Well, only the depositors will be getting all their money back, the bond and equity holders of SVB will be getting little to nothing. This has led some to even applaud this bailout as being re-distributive: money is going from the wealthy to the poor.

Let’s get one thing straight, this is a bailout of the rich. Depositors are ALREADY guaranteed to get their money back p to $250,000. The FDIC already made sure anyone with less than $250,000 in the bank got their money back. But what about the poor hedge funds and VCs with millions, even billions of dollars locked in the bank? Well normally they would get back $250,000, but it’s not fair that rich people lose money so that’s what this bailout is supposed to cover.

The wealthy depositors will be made whole at the expense of bond and equity holders of course. But that’s just moving money from the rich, politically connected people to the rich, not-so-connected, it’s classic graft of making sure your boys get the best from the government.

More to the point, the money may not come from the government per se but it is coming from the people, or at least the people with bank accounts. FDIC is the insurance that is paid by every bank account, and it in turn pays to cover all bank accounts up to 250,000 dollars should their be a bank run. The fact that the FDIC will now be covering more, potentially up to billions in dollars, means that money has to come from somewhere. It will come from all the other people with FDIC ensured bank accounts, all the people with a few hundred or thousand dollars in the bank.

The FDIC isn’t a line item you’ll see in your bank statement, it’s an invisible insurance policy to most people. But make no mistake it is paid by the account holders. If FDIC insurance did not exist, the bank would give you a higher interest rate on your savings account because they wouldn’t need to pay insurance on your bank account. Instead, interest on deposits is likely to be lower than expected as the FDIC will have to drawn on the insurance premiums from every small account in order to cover the billions of dollars they’ve pledged to rich hedge fund managers. Poor people with small bank accounts will be made tangibly more poor in order to ensure hedge funds get all their money back.

Not only that, there is a definite moral hazard with bailout out the rich in this manner. When a bank goes under, there is supposed to be a protocol of who gets what. Depositors up to 250,000 dollars will be covered by FDIC no matter what, everything else including bond holders, equity holders, and large depositors is fair game depending on the results of the bankruptcy.

Instead, it is know going to be assumed that depositors will always be bailed out at the expense of bond holders. People who want to make low interest money have a few options: they can give it to the bank and get interest, or they can buy a bond and get the coupon. They know that if their money is large, both of these carry risks. The deposit and interest are only covered up the 250,000 while bonds can be defaulted on or banks can go bankrupt. However now, the calculus changes. Deposits will always be bailed out by the FDIC at the expense of bonds, meaning that they are now much safer and bonds are much riskier. This could even make it worse for some banks as they will find they cannot raise money through bonds as easy as they used to. Who will buy your bond if a high-yield savings account gives roughly the same interest rate and is guaranteed zero risk by the FDIC no matter how much money you put in?

So this is a bailout that isn’t a bailout, it gives money to the rich at the expense of the poor.

Quick Post: WTF happened with Silicon Valley Bank

So I’m really only making this post so I can link to it in another post, but while there have been plenty of explainers going around about what happened with Silicon Valley Bank (SVB) I wanted to get all the facts as I know them in one place.

Basically, Silicon Valley Bank had a bank run and needed a bailout. Why?

When you deposit your money into a bank, the bank pays you interest on the money. You are giving what is essentially a loan to the bank, and they in turn use that money to give loans to other people. The assumption is that the interest they get on their loans is more than the interest they pay you for your money, so the bank can always stay profitable.

Banks have their best relationships with the people who deposit money into them, so those tend to be the ones they reach out to and offer loans. Whatever bank you deposit your paycheck into is likely going to be the one that offers you a car or a house loan. But SVB was taking deposits from Tech startups and Silicon Valley hedge funds. Those guys don’t need or want loans. They raise money through equity, not loans. So while lots of deposits flowed into SVB, far fewer loans flowed out.

So how could SVB make money without loans? They bought bonds instead. Government bonds are just a loan you give to the government after all, and SVB thought that using their deposits to buy bonds was a surefire strategy because the government will never default. Remember that banks don’t ever just sit on loads of cash, they have to sell assets if they want “liquidity” (finance speak for cash). But if depositors want their money back, SVB can just sell bonds and give them cash, while if depositors hand them more money, SVB will use that money to buy government bonds.

But then inflation came, and brought with it interest rates. We’ve discussed before about how when interest rates rise, the price of an old bond falls. If you bought a bond paying 0.25% and interest rates have gone up to 5%, no one will buy your bond without a heavy discount. So 3 years ago a tech startup deposited $100 dollars into SVB, and SVB bought 100$ worth of bonds. Now the startup wants its money back but the 100$ bond SVB has bought has given them almost no interest (0.25%!) and has collapsed in price. When SVB sells its bond, it gets back WAY less than 100$.

So when interest rates rose, SVB’s bonds were all worth a lot less, but they were obligated to sell them to pay back their depositors. That would be fine if only a few depositors wanted their money, SVB can take a loss and make back the difference with profit elsewhere. But if ALL their depositors want their money back, SVB cannot cover.

And the depositors did want their money back. Startups backed by hedge funds get piles of money by selling stock, IPO’ing, and selling equity. Then they handed that money to SVB. Stock prices collapsed in part due to rising interest rates, the flow of cheap money stopped. Because of that, startups needed to take their money back out of SVB to keep the lights on. Money was flowing out but nothing was flowing in.

So SVB had a massive interest rates risk on both sides of its balance sheet. Interest rates decreased the amount of money going in (by tanking the stock market and making IPOs and share selling less common) while also decreasing the value of the assets SVB held (by making their government bonds worth less). Add onto that that inflation increased the amount of money flowing out (since startups needed to pay more for everything) and SVB was primed for a bank run. Depositors realized SVB didn’t have enough cash to cover everyone’s deposits, and so they all rushed to take all their money out before it collapsed.

And so collapse it did, and the government handed it a bailout. I’ll write more about that tomorrow.