What killed Silicon Valley Bank, and who will cover its losses?

The rapid shutdown last week of Silicon Valley Bank, with offices in West Conshohocken and dozens of other towns adjacent to tech centers, raised alarms at hundreds of software and biotech companies with uninsured deposits at the bank: Would they lose their money? Could they even stay in business, or pay their staff?

On Sunday, the federal government said it would order the bank insurance fund to cover deposits at Silicon Valley, the 16th largest U.S. bank, and those of Signature Bank, a New York lender to the troubled cryptocurrency business. That means healthy banks will pay the cost and pass it on, either as lower profits for their shareholders or by raising prices on their customers.

On Monday, most financial stocks tumbled, a sign investors worry there’s more crisis ahead. The Inquirer asked Richard Vague, a former top JPMorgan Chase executive, digital banking and energy company founder, and Pennsylvania’s past banking secretary, to explain what the government did. His comments are edited for clarity and brevity.

This was dramatic: The community of regulators came out with three rapid, powerful sets of policies.

People think of the Federal Reserve as managing interest rates and responding to unemployment. But the Fed was created [in 1913] to be the lender of last resort, so the government wouldn’t have to keep appealing to [rich Wall Street bankers] for money to stay afloat.

So I think the three things done [Sunday] were powerful and necessary. We can talk later about the moral hazard:

First, the Fed said it would offer lifeline funding to banks, at par [covering investment losses] up to $25 billion from its emergency fund. That’s a powerful statement — that ‘we are going to back up any bank that needs it.’

Second, what swept relief across Silicon Valley’s borrowers, they will cover all deposits, insured and uninsured, effective immediately. What better news could they ask for? On Friday they had been asking, ‘Can I pay my employees? Can my business survive?’

The third thing, an auction process [for selling what’s left of the bank].

An irony is that the Fed is solving a problem it created. The Fed increased interest rates — fast — in its purported battle against inflation. There’s a lot of disagreement whether they really needed to do this or to do it this much. But for entities like Silicon Valley [which invested in long-term fixed-rate bonds whose value falls as interest rates rise], higher rates have proved to be an enormous problem.

I attribute this inflation mostly to COVID supply-chain disruption and the Ukraine war. Higher interest rates don’t alleviate either of these. Together, Ukraine and Russia are the largest exporter of wheat, oil, natural gas, iron, and more. So this part of inflation will not be fully addressed until the war is fully addressed.

Even if you reject that view and say higher rates will stop inflation, shouldn’t we be giving it more time to work?

Yes. Asset-to-liability management and credit policy are the most important things you can do as the manager of a bank. In my career we spent time weekly and even daily testing long-term interest-rate scenarios, acquiring interest-rate swaps to eliminate worst-case scenarios, acquiring emergency lines of credit for emergency funding. [In short, sound banking means spreading the risk so you don’t get shocked by sudden, large moves in interest rates and other key payments.]

So yes, there are a lot of well-known things you can do to guard against these emergencies. But some bankers don’t prepare for those scenarios. They take things for granted.

Silicon Valley Bank focused on what they called the “innovation economy” sector. They dealt with companies that had a lot of cash from investors. And they had a lot of big corporate deposits. Bankers know large deposits are more likely to run off when there’s trouble [as Silicon Valley’s did last week]. And, it’s not surprising, Silicon Valley had only about half as much loaned out, as they took in as deposits. So they were extra vulnerable, if they didn’t manage their [bond investments] carefully.

I wouldn’t disagree. I’m sure there was an ongoing discussion in which they knew a year ago it was a problem, and a few months ago it was a big problem.

But the regulation apparatus is set up to intervene when the problem finally happens. Not so much preemptively. When regulators try to intervene creatively, they get howls of protest, not just from banks, but from senators and Congress members.

So they act when problems occur, not before. My view is that whenever you see lending in any sector is growing too fast, regulators can at least use their bully pulpit to warn. But a problem here is there are not a lot of practitioners among the national regulators. The folks in some of these jobs came from academia to a career in government. The knowledge that comes out of existential trauma as a banker would be useful.

Fairness is a huge question. Who missed the class about FDR starting the Federal Deposit Insurance Corp.? Don’t you realize it’s not good for anyone to have more than $250,000 [the insurance limit] in any given bank? You can put it in multiple banks, in money-market funds. You can manage it. [Silicon Valley Bank and its customers] clearly flunked.

We hear the bank was a central presence in the tech community. Bringing in all those customer deposits may have been a good customer-management strategy, but it [raised] their credit risk.

It’s not a sign of health for an industry to be that dependent on one institution. It’s a sign of weakness. You hope the resolution will be more bankers serving this market, not just the one specializing in it with extra risk.