Over the weekend between September 12th and September 15th, 2008, investment bank Lehman Brothers went out of business. Investment bank Bear Stearns failed earlier in the year on March 16th. Washington Mutual, the 6th largest bank in the US, failed 10 days later on September 28th. The financial crisis worsened steadily through the fall, and over the next four years, 440 US banks were taken over by regulators.

Despite this disastrous situation, bank depositors did not actually lose their deposits.  In principal, any bank deposit over $250K is not covered by FDIC insurance.  In practice, when the FDIC take over a bank, the assets of the bank (deposits) are merged into a healthier bank.  Depositors may not have access to their money for a week or two, but then financing operations resume as normal when the new bank takes over.

When a bank goes bankrupt, share-holders generally experience a 100% loss on their investment.  Bond-holders experience a partial or complete loss on their investment depending how how successful the FDIC is at selling off bank assets, which are comprised of loan portfolios, holdings of treasury bonds and real estate owned by the bank for offices and branches.

All the banks that failed between 2008-2013 made the same mistake – purchasing low quality mortgage backed securities with borrowed money.  This trade was VERY profitable form 2002-7 given the interest rate spread between borrowed money and money invested in MBS.  The same trade was poison from 2009 forward as the value of the MBS collapsed as the housing bubble burst.

Managed Accounts Inna Rosputnia

Want your money to grow?

See how I can help you to make your money work for you

Managed Investment Accounts – unlock the power of professional asset management. Let me make you money while you enjoy your life.

Send Request

Since 2010, bank regulators have fiercely regulated how much risk a bank can assume  In 2018, 2021 and 2022, there were no bank failures.  4 banks failed each year in 2019 and 2020.  Silicon Valley bank is the first bank to fail since October 2020.

Does the failure of Silicon Valley Bank presage problems for other US banks?

Most banks take in deposits from a wide variety of sources, and make loans to a diverse group of borrowers, which can include commercial lending and mortgage loans to home owners.  The age long risk to a bank is that deposits are short assets that can be withdrawn at any time, while loans are long term liabilities that must be funded by a fluctuating pool of deposits.

To smooth out the risk of the liability-asset mismatch, banks must hold a certain percentage (historically 10% of liabilities) in highly liquid securities such as treasury bonds, notes and bills, or deposit excess funds with the US Federal Reserve.  In a crisis, a bank CAN borrow funds from the Federal Reserve, but this action will trigger a visit by bank examiners.

Silicon Valley Bank had a different business model that most banks and focused exclusively on serving the banking needs of California venture capital firms and California startup companies in technology and healthcare.

Generally, the VC firms would raise capital from investors, deposit those funds with SVB.  Then, as the VC firms funded various startup companies, the investment funds would be transferred to accounts of the startups, also with SVB.  Startup companies are precluded from borrowing with most banks because startups have no collateral for loans, and no income to support payments.  SVB was about the ONLY bank that would lend to startups.

Startups actually need little cash, so deposits just sat in the bank as SVB did not have a broader clientele of borrowers.  To cover deposit interest payments, SVB invested much of its deposits in long dated treasury bonds, which generated enough return to cover deposit interest and pay a profit to the bank.

All was good until 2022, when the Federal Reserve drove rates from 0% to 4.7%, which dropped the value of long dated treasury bonds by about 15%. Earlier this week, SVB announced a plan to raise additional $1.75 billion to replace the capital lost in the bond portfolio.

Unfortunately the venture capital firms that enabled SVB’s growth over the previous four decades interpreted this routine process as evidence that the bank was in trouble, panicked, yanked deposited funds out of the VC accounts and told their portfolio companies to do the same.

Ironically, the social media platforms that SVB had funded over the years became an echo chamber amplifying the loudest (and dumbest) voices.  In barely 12 hours, the bank was wiped out.

So is SVP the next Lehman Brothers?  The reason why the 2008-9 financial crisis was so contagious was that ALL banks were pursuing the same risky trade.  There was a moment during the week of September 15th, 2008 when the entire US banking system was insolvent.

That crisis was resolved by the Federal Reserve lending freely and without restrictions to any bank that needed short term funds.  (There was a similar liquidity crisis following the October 1987 stock market crash that was resolved in the same fashion.)

SVP has such a unique business model that we don’t see ANY threat to other banks.  Still, investors overreacted with banks stocks dropping 12% for the week (and created a nice opportunity for other investors who don’t panic.)

The broader US stock market was up 6% by the end of January, gave back all but 0.58% of YTD returns through yesterday, and remains 14% undervalued by our favorite Morningstar Fair Market Value.

Silicon Valley Bank is not Lehman Brothers

Wishing you a great week!

Want to make your trading more profitable?

Subscribe to get free research, trading lessons, and more insights.

(We do not share your data with anybody, and only use it for its intended purpose)