The Fed claims its first victim.
- A combination of aggressive Federal Reserve policy and poor management has led to the collapse of Silicon Valley Bank causing all sorts of problems for start-up companies and putting much of the start-up and early-stage ecosystem in great peril.
- Silicon Valley Bank (SVB) has been taken over by the Federal Deposit Insurance Corporation as a run on its deposits left it unable to meet demands for withdrawals.
- The problem is relatively simple in that it took lots of deposits from its clients in 2021 which its clients could withdraw at any time and then invested those deposits in the longer-dated US government bond market (treasuries). ‘
- Ordinarily, this would not be a problem because even the longer-dated treasuries are deeply liquid and can be quickly sold at any time but when the Federal Reserve started raising interest rates, this became a bomb waiting to go off.
- This is because when the base rate of interest increases, the price of a bond will decline in order to give anyone who purchases it the higher return that the market is now demanding.
- For example, a bond trading at 100 with a coupon of 1% will decline materially in price when interest rates rise to 5% in order to offer 5% over the life of the bond as a mixture of the $1 coupon and the capital gain made at maturity when the full 100 is returned.
- Under normal conditions, SVB should have been able to wait for the maturity of the treasuries to get its 100 back but the sudden spike in withdrawals meant that it needed cash immediately.
- Unfortunately, it had to raise money to pay depositors immediately which meant selling bonds for less than it had paid for them rather than waiting for the bonds to mature.
- This is known as a mismatch of duration (timing of a liability) and is a classic way in which many banks in the past have failed.
- The real issue here is that in 2021 when SVB’s clients were raising money left, right and centre and depositing it in SVB, that its management did not see the writing on the wall for long-term treasuries.
- The sensible thing to have done would have been to invest in 90-day treasuries which pay less but would probably have allowed SVB to survive.
- SVB’s management decided to try and earn a higher coupon by locking up its clients’ money for 2 years or more and it completely failed to see the writing on the wall.
- At the time, the Fed was still pushing its highly spurious “transitory” narrative on inflation when it was patently clear to anyone with a calculator and a rudimentary understanding of economics, that inflation would be persistent meaning that interest rate rises were inevitable.
- This should have led SVB to keep its cash in short-dated treasuries or even cash thereby ensuring both the capital value of the assets on its balance sheet and its ability to meet demands from depositors.
- Consequently, I think that very poor management is mostly to blame for the collapse of SVB as in my opinion, this was a completely predictable and avoidable outcome.
- SVB now appears to be out of business permanently with its equity shareholders wiped out leaving its clients in real trouble.
- The first $250,000 will of deposits will be immediately accessible with another 40% or so being available within a month.
- The rest will take an unknown period of time which means that many start-ups now have 60% less cash than they did last week.
- This could easily create a liquidity crunch in the start-up ecosystem forcing emergency share issues at deeply discounted valuations as well as bankruptcies.
- I don’t think that this is the beginning of a 2008-style liquidity crisis, but it is always worth remembering that it is the small stones rolling down the mountainside that start an avalanche.
- In 2008 it was badly structured mortgage-backed securities and so perhaps this time it is the collapse of the start-up ecosystem that triggers the avalanche.
- This is good news for anyone who is holding cash as a panic rush to cash will trigger many valuable assets to crash in price as everyone rushes for the exit.
- One to keep an eye on is Coinbase which has a rock-solid balance sheet and is now pretty unpopular with the financial glitterati and meme traders.
- It still trades way above the other banks on a price-to-book value basis and so I would need to see it fall much further in order to get interested.
- In this environment, and with the collapse of SVB, widespread panic in smaller financial institutions may do trigger just that.
