As readers are aware, Silicon Valley Bank’s (SVB) recent failure, along with that of Signature Bank, still has many people fearing the situation will result in a contagion of bank failures due to weakness in the banking system with widespread failures across the US and the World.
Recently, Moody’s rating agency (one of the three big rating agencies) downgraded the entire banking system, which was largely expected because rating agencies tend to make changes when sentiment has already shifted, so this should be viewed as a statement about sentiment, not the health of the banking system.
First, SVB’s problems were unique and mostly misunderstood. Most public commentary about SVB is somewhat true, but not entirely. SVB’s “available for sale portfolio” (portfolio of assets a bank usually uses) to cover unusually large withdrawals we’re elongated bonds. So, when long-term interest rates went up tied to earlier 2023 inflation fears, prices dropped, and SVB had to take unrealized losses bigger than Wall Street wanted to see.
Additionally, SVB couldn’t cover all the incoming requests for withdrawals. But make no mistake, although true, it’s a misnomer because the real problem was that SVB received too many requests for withdrawals because the VC world turned against them, creating the collapse. The VC world turning on SVB happened so quickly and ruthlessly because SVB, unlike almost any bank in the US, has extraordinarily concentrated depositors. SVB’s depositors are predominately venture capital firms, those venture capital firms’ portfolio companies, the employees of the venture capital firms, and the venture capital firm’s employees’ families and friends. So, on Wednesday, March 8th, and Thursday, March 9th, before the shutdown, VC firms doing business with SVB started phoning their portfolio companies and demanding they yank money out of SVB before others do. This action created an extraordinary run on the bank, different from other similarly sized banks with more diverse portfolios of donors.
For example, First Republic has a similar and reasonably overlapping geography at almost the same size and a similar balance sheet as SVB. The most significant difference is that First Republic does not have a concentrated VC depositor base. Having a diversified depositor base helped First Republic withstand withdrawal requests as family and friends demanded to take out money. It also allowed First Republic to accommodate withdrawals more easily because they have a diverse customer base, and the base depositors didn’t request large withdrawals all at once.
The other thing about Silicon Valley Bank that created fear (a false fear) was the media fanning the false notion that this was the second biggest bank failure ever. Along with this, the New York-based Signature Bank, which failed with a concentration in crypto, was the third largest failure, both failing within days of each other, Friday, March 10th, and Sunday, March 12th. This information is correct in one unimportant way. SVB was about twice as big on an absolute deposit value ($211 billion) as the New York-based Bank of the United States in 1931, but that’s not an accurate way to measure the failures. Scaling matters. So, if you take SVB’s $211 billion and compare it to the size of the entire US economy versus the size of other banks that have failed before, tied to the size of the US economy, then Silicon Valley Bank is not even close to the biggest bank failure.
In 1931 the New York-based Bank of the United States, not a federal entity, just a commercial bank with that name, failed and was the largest bank failure of 1931 and credited with starting the Great Depression. SVB, with $211 billion versus the size of our economy in 2023, is only about four percent as significant as the New York-based Bank of the United States was in 1931 relative to its size in the US economy. Proper scaling is often difficult for people to wrap their heads around, but it’s true. The Bank of the United States in 1931 held a little over $200 million in deposits. The difference is almost 100 Years of inflation and US economic growth (about 2500%). That is a phenomenon people don’t consider. So, the Bank of the United States was hugely more important to the economy and more detrimental to the States.
Furthermore, if you take the 1984 Continental Illinois bank failure, it would have been even more significant than Signature Bank and SVB together adjusted relative to the size of the economy didn’t cause a recession (1), didn’t cause a bear market (2), didn’t cause a contagion (3), and didn’t cause other banks to fail (4). Those first two things and the third one are essential when thinking about today’s environment in the proper framework.
As a reminder, the basic measure of a bank’s solvency is its total loans compared to the size of its deposits. This capital-to-assets ratio makes sense because the depositors will be the ones who pull money out. So, if you’ve got plenty of government bonds, mortgages, and other assets relative to deposits getting pulled out, you can cover the deposits by easily selling liquid assets. Fundamentally, that’s what banking’s all about. When we look at all banks in the States today, small bank balance sheets are a smidge worse in that way than big banks because, after 2007-2010, big banks were forced by the Federal Reserve (particularly in the aftermath of the Dodd-Frank legislation) to strengthen their balance sheets. During that time, the Fed focused on forcing the big banks (too big to fail banks) into ensuring their balance sheets were stronger than ever before. Even today, the banking system as a whole, based on loans to deposits, is almost as strong as it’s ever been. The fact is, if you just look at a chart of that function, it keeps improving. It isn’t quite as high as it was a little while ago, but it is higher than it was 5 years ago, 10 years ago, 15 years ago, 20 years ago, 30 years ago, and 50 years ago, which tells you the banking system is in good shape which is one of the reasons why the fears of contagion and downgrading banks aren’t correct.
In closing, you should know that there might be other banks that fail. They will likely be smaller banks, but the same principle will apply; it won’t spread, it’s not a systemic problem, and therefore as I continually state, the fear of a false factor is a bullish sign.