SVB – Won’t somebody spare a thought for the ultra-wealthy?

How does the rich guy bank fail first?

Photo by Madhur Chadha on Unsplash

One of the reasons why I write about finance is because its ridiculously easy and simple to understand. People who were seemingly conceived wearing Armani suits and a prenatal cocaine habit will try to make it sound complicated so that you don’t look too deeply into how they can afford 4 beach houses, but its really just a bunch of small, simple factors that anyone could understand.
The problem is, none of these factors happen on their own, none happen in clear chronological order, people often hide if they’re happening or misdiagnose what factor is occurring, and many factors just look the same until a disaster has already happened, at which point smug know-it-all’s will have had time to settle into their armchairs and explained why everything happened exactly how they predicted in their blog four years ago… which of course no one read...

…Somebody please read it.

Did I say simple? I meant finance is a complete clusterfuck.

SVB was the second largest bank to collapse in history. So how did it happen? Avarice? Hubris? Idiocy?
I would love to say yes, because that would make for a damn compelling story of corporate conspiracy, but the real answer is just a near infinite number of interconnecting factors that made risks near impossible to predict.

What we’re going to do today is look at 4 of the factors and how they tangled themselves into a knot that even a contortionist would struggle with.

1.       Fractional Reserve Banking

I already took a stab are explaining this to you HERE, but you’re attention span has rotted away due to those productive hours you spend on TikTok, so lets try this again:

When you put your money in a bank deposit account, it doesn’t just sit in big hessian sacks with “$” signs on them, waiting to be stolen by the kind of minor league criminal that you see at the start of a superhero movie. For the most part, the banks use your money to do something productive, like lending out as part of a business loan, or purchasing assets.
The banks don’t tell you this explicitly, and your savings account still says the money is all there, but in theory, much of it is not available to you.
But very few people ask for all their life savings at once, unless they need to pay off a ransom, or are a SoundCloud rapper trying to show off in a music video. Banks know this, and so know they actually don’t need have all your money on hand at any given time. Banks only keep a fraction of your deposit (5%, 10%, 20%, depending on the regulations in your country and how risky the bank decides to be) in reserve, in order to pay out the few people that ask for money today. The government sets minimum amounts for banks to keep in reserve, but it’s a balancing act. If the bank keeps too much in reserve, they aren’t lending enough, don’t make a profit and they go bankrupt. If they don’t keep enough in reserve, people take their money out of the bank and the bank is forced to sell all their assets… and they go bankrupt. You need to Goldilocks it to get the reserve balance just right.  

2.       Federal Deposit Insurance Corporation (FDIC)

In the USA, where our tale is being told, the FDIC insures money in each persons bank account, up to $250k. To pay for this insurance, banks are forced to pay fees. This is literally the same as you taking out home insurance to make sure you don’t burn the house down, which given your talents in the kitchen, is a real possibility.

If a bank fails, anyone who keeps their money in the bank can get up to $250k back out, without worrying. This is to stop everyone freaking out and pulling all their life savings every time Tucker Carlson comes up with a new reason why America is going to collapse, like unsexy confectionary mascots. Any money in a bank account that is over $250k is considered ‘uninsured’ which means the FDIC doesn’t have to pay you if everything goes tits up.

“Why not just insure all deposits” I hear you whine. Sure, they could, but that would require higher premiums, in the same way the insurance on your 2004 Honda Accord is not quite as high as the latest Maserati. Would you really want your bank to charge you more so that the CEO of Optus can be assured that his money is safe? Didn’t think so. Theoretically, rich people take a big risk by leaving their money in banks.

3.       “Sophisticated Investors”

If you ever thought rich people were treated differently, you’d be right. In the financial world, if you make a certain amount of money, you are known as a ‘Sophisticated Investor’, letting them access things like hedge funds and Pre-IPO investments.

I’ve always hated this term, because its only one step away from describing normal people as ‘fucking plebs”, but the idea is that these people make enough money that the normal safety nets that the government is meant to offer us normies doesn’t apply to them. More importantly to our story, these absolute pillars of society act in very different ways to the rest of us. Chances are, you aren’t spending your days analysing the risk profiles of the various banks to hedge against some theoretical cashflow risk, keeping a google alert every time the stock price dips more that .04%... but these Ubermen do… or at least hire analysts to do it for them.

Sophisticated investors might have a lot of money, but they are unpredictable because they don’t treat banks the same way the fucking plebs do.

4.       Safe Assets are dangerous

Bonds are about as boring as you can get without legally being declared comatose, but the one thing people agree on is that they’re safe. Government bonds in 1^st world countries rarely default and are usually the first to be paid back when things go wrong. They don’t pay much compared to riskier assets, but if you want a safe bank to store your money, you want one that has a lot of safe assets, right?
Wrong, that’s stupid and so are you. How dumb you look; you must be so embarrassed.

There is one risk that bonds have that affects them more than others and that’s interest rate risk. After all, if you buy something with a guaranteed small pay out, but then interest rates go up, you’re bonds don’t pay as much as the newer ones.  
You buy a 30-year bond in 2021 when the interest rate is low, you might get 2% a year for it. You buy one now that the central banks have increased the interest rate, you’ll get one for 5 or 6%. Why would anyone buy the old one off you?

Suddenly, the only way you can convince someone to buy your bond instead of a new, better bond, is if you sell it at a huge discount.

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A lot of Silicon Valley Banks depositors were rich people. There was $13 billion of deposits between just 10 accounts, meaning SVB had a much larger proportion of ‘Sophisticated Investors’ than normal. When the Federal Reserve started increasing interest rates, the ‘sophisticated rich people’ started pulling all their money out at once. By regulation, SVB had kept some money in reserve for such an occasion, but they didn’t have enough for such a huge wave of requests, so they had to start selling assets. This should be fine because as long as the as the assets were worth as much as they were bought for. Since SVB was a good little multi-billion dollar bank, a large proportion of their assets were safe bonds, but as interest rates rose, the value of the bonds declined meaning that SVB had to sell more of them than expected to pay back the rich investors. Bad news for SVB, because more rich people realised what was happening and because they knew that anything over $250k was not insured by FDIC in the case of a bank run, they all rushed to pull their money out of the bank as well, hoping to get out before the bank collapsed, and effectively ensuring that it will collapse. To stay afloat, SVB had to sell all of its other assets, but by this stage there was too many people asking for money and not enough shitty bonds to pay for it, so the bank had to be shut down.

The hope was that the Federal Reserve would step in and buy the bonds at a higher price, allowing the bank to pay everyone back, but the Federal Reserve thought about it for a minute, said ‘Lol… no’, and ignored the cries of the poor little silicon valley billionaires.

This led to a problem for the FDIC. They would pay back deposits up to 250K, making sure that the average American who was unfortunate enough to bank with SVB was protected, but what would they do about the uninsured funds? Would those people get their money back?
On the one hand, FDIC didn’t have to pay them back, and if you have ever dealt with an insurance company, you know that finding a way to not give you money gives them a feeling of pleasure bordering on the sexual. But on the other, if rich people who kept their money at other banks found out they were not insured, there was a risk that they would all start pulling their money out, leading to more bank collapses and FDIC having to pay back bankruptcy insurance more and more times. So, they decided to pay back all uninsured funds, to avoid a panic.

That was the big controversy and where you may have heard the term ‘bailout’ being thrown around. It wasn’t the bankers or even the shareholders that got saved, but the people who had their money sitting in the bank, who didn’t do anything to cause the massive crash in the first place. The issue with this, of course being that if there were more bank runs, FDIC might not have enough money on hand to pay back all the 250K or less depositors, and that in the future they will have to increase premiums on all banks to make up for this decision.

This isn’t the same as 2008. For one thing, Flo-Rider and T-Pain aren’t culturally significant anymore. For another, the collapse of this bank isn’t necessarily indicative of a complete collapse of our financial world, because most banks don’t have half as many sophisticated investors and they better diversify the assets that they hold. For another another, the ‘bailout’ was not of the ultrawealthy shareholders and banking elite, but of the simple, every day, down-to-earth depositors that had their money sitting in the bank… who in this case just so happen to also be ultrawealthy…

… The trick is to not think about it too much.