Is There Contagion Risk From Silicon Valley Bank’s Implosion?
The final and perhaps most key question is, does this matter beyond the narrow confines of this bank?
Or, to step back for a second, could this be the event that ends the US economy's surprising resilience and tips the country into a deep and prolonged recession?
It is very unlikely but also sort of besides the point. The real damage is perhaps not that bank runs will spread. The real damages are the VERY thorny questions this sorry episode has raised not just for the US government and regulators but for the broader economy.
First, on the basic contagion question:
Events are both moving very quickly so this is a bit risky to say but it is unlikely that whatever the issues are with Silicon Valley Bank will spread. It had some unique issues and occupied a unique position in a stressed part of the economy.
We have procedures and policies in place to deal with exactly this outcome. Furthermore, overall the banking system is both very well capitalized and this should not spiral into a Lehman-type credit crunch.
There is also the fact that SVB was very much an outlier in terms of its business model and its loan-to-deposit ratio. There are some real idiosyncrasies to their business model and also just how the Bay Area works.
The bank had a high level of loans in addition to securities as a percentage of overall deposits while also a very low reliance on stickier retail deposits as a share of total deposits.
Not a great outcome, as the chart makes clear.
The problem is this won't necessarily matter.
The difficulty is that it can be very hard to stop a bank run. This weekend will be both very welcome and be a key opportunity for regulators and banks themselves to come up with a plan and make clear that Silicon Valley Bank's very real problems are not their own.
Second, what now happens to the depositors:
Apparently, over 97% of depositors have more than the FDIC cap of $250,000 at SVB.
See here:
It is all fine and well to say that these depositors should pay for their mistake but the knock on effects of that decision will likely be very serious.
For instance, many assets (one-third) in this country are in small banks and most of them are uninsured. Think about all those depositors waking up tomorrow just having had a profound lesson in their foolishness.
This is the problem with bank runs. It puts the government and regulators in a very, very tough position.
(to be clear about our own financial position: Pebble Finance and its founders have zero capital at Silicon Valley Bank and never have. For reasons we won't go into here, we have long disliked using them - for business reasons)
To add some further context, it has been reported that over 1,000 Y-Combinator companies have been impacted by this event. Y Combinator is a famous (and prolific) start up accelerator that funds hundreds of companies every year. As the YC CEO said on Friday "This is an extinction level event for startups."
It isn't just startups either. It is also venture capital firms. It is also established companies and many other people besides. For the first time in many years, there were lines of worried people outside banks and the problem is, people driving by will start to think about where their own money is deposited....
That may very well be the case and has led to a rising tide of calls for bailouts from everyone from Larry Summers to many prominent venture capitalists to prominent hedge fund and online personality, Bill Ackman etc. etc.
By bailout they mean: make all depositors whole. i.e.: they get all their cash back, no matter the size of their (uninsured) account.
The very real problem because it would be a terrible precedent to set. Banks do fail and there is a limit that the government guarantees for a reason. But the problem is if you do that and make depositors hole then how can you say no the next time and if you can't then you have just fundamentally placed a US government backstop behind the entire US banking system.
It is a bit more complicated and nuanced than that but not by much.
This is a VERY tough tension to resolve and will be the source of furious discussion, debate, lobbying and doubt. The contagion risk is in many ways secondary to whatever gets decided there. They will likely fudge it but it will be difficult to keep whatever gets decided from being tested in the future.
The biggest problem might be simply that, regardless of what happens today and tomorrow, millions of people and companies are going to wake up and switch their deposits, or a large proportion of them, to large and systemically important banks that they will feel safe in thinking are backed by the government.
Big is back! And that is a terrible sign for business overall and especially the intrepid risk takers of Silicon Valley and the startup ecosystem everywhere.
The last question we urge you think about is:
Does this change the Fed's plans in a few weeks time?
For months it has been expected that they would raise by a very slim 25 basis points. Then, over the last month or so that has shifted to expecting 50 basis points instead.
Here is how the odds of a 50 basis point hike shifted this week:
Monday: 23%
Tuesday: 62%
Wednesday: 71%
Thursday: 54%
Friday: 38%
Quite the swing.
I suspect they will still hike but not by 50 basis points. I also think this will be a consensus view by midday Monday or, at latest, Tuesday of this week.
More importantly still, the two-day 45 basis point plunge in the US 2-year Treasury note yield is the bond market’s way of telling Powell “You ain’t going 50!”
The real shame of this, besides the billions and billions, is that many small and very enterprising companies stored their precious capital at the Bank.
Longer term, this could cast a further blast of frozen air over the world of technology, venture capital and start up companies that have already been severely challenged by shifting credit conditions and the cost of capital.
The Bay Area and tech-startup scene has had a tough 14 months or so. It looks likely that it will get far tougher still in the months ahead.
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