[English translation of my interview published in the Italian magazine micromega.net]
By Rita Viola, 20 March 2023
When we heard the news of the bankruptcy of the Silicon Valley Bank in recent days, our memory immediately went back to 2008 and the bankruptcy of Lehman Brothers, an event that triggered the severe financial economic crisis of the following years. To better understand what is happening and what we should expect for the future, we spoke with Emilio Carnevali, an economist at Northumbria University in Newcastle Upon Tyne.
Let’s start with the facts: what happened to the Silicon Valley Bank?
The bank suffered what in the jargon is called a bank run. On Thursday, 8 March alone, its customers tried to take something like 42 billion dollars out of the bank, or about a quarter of the total deposits. The bank found itself unable to find the liquidity to meet these demands and was declared insolvent by the Federal Deposit Insurance Corporation, the US authority responsible for insuring bank deposits.
Why did this bank run occur?
SVB had problems both on its liabilities (in simple terms, the bank’s debts, which include customer deposits) and on its assets (the bank’s claims on third parties). On the liabilities side, its customers were mainly concentrated among start-ups and venture capital funds in the technology sector. Moreover, in the US the limit for federal deposit insurance is $250,000. According to some estimates, at SVB the share of uninsured deposits exceeded 90%. The large influx of investments and capitals into technology start-ups that has occurred in recent years has inflated deposits at the SVB and thus made enormous liquidity available to the bank. A large part of this liquidity – and here we come to the asset side – was invested in bonds and fixed-income government securities and recorded on the balance sheet as ‘held-to-maturity’. This means that even if their price fell due to the rate increases enacted by central banks over the past year, their value for balance sheet purposes remained unchanged. This can work perfectly well, unless one is forced to sell the securities before their maturity, or use them as collateral to receive loans from third parties, including the central bank.
Is this what triggered the chain reaction that led to the declaration of insolvency?
Yes. But there is another important element of context to take into account. Things have not gone well for the entire technology sector in recent times. Just to give a few examples among the best-known names (even if not involved in the SVB affair), since the beginning of the year Meta, the owner of Facebook, has laid off 10 thousand people, Alphabet, the owner of Google, 12 thousand, Amazon 18 thousand, Microsoft 10 thousand. The situation is no different for smaller companies and start-ups. When deposits at SVB started to decline, the bank had to start selling some of the assets of a portfolio that had depreciated by about 15 billion. After an initial loss of USD 1.8 billion, it tried – unsuccessfully – to raise liquidity in the market by issuing new shares. But by then panic had spread among the account holders. After all, as mentioned earlier, these were deposits largely not covered by federal insurance. Using a metaphor, we can say that word spread that the boat was about to sink: one part of the passengers, knowing that there were no lifeboats, tried to move first and jump onto another boat. When many other passengers tried to do the same, the boat became unbalanced and sank very quickly.
SVB was just a medium-sized bank. Why did its failure have such an echo?
Yes, SVB was considered a ‘regional’, medium-sized bank. However, there are other banks with similar characteristics that may present similar risk factors, both on the asset side, with assets that have been severely devalued due to the recent increase in rates, and on the liability side, with a poorly diversified clientele and a large proportion of deposits above the threshold covered by federal insurance. Also, when we talk about phenomena such as bank runs, we enter territory where not all elements can be weighed in the light of ‘rational’ considerations. Under certain conditions, even institutions with decent economic fundamentals can suffer bank runs: their state of crisis becomes a self-fulfilling prophecy. Today, with online current accounts and social media, bank runs are even easier. In any case, SVB and Signature Bank – the other bank that has failed in recent days – were considered by the Biden administration to be large enough to invoke the ‘systemic risk’ exception and to guarantee even deposits above $250,000 that theoretically should not have been guaranteed. This means that shareholders and bondholders of the two banks will lose their money, but not the depositors.
It would therefore seem to be a ‘local’ issue, yet its effects have also been seen in Europe, right up to the Credit Suisse affair.
As far as Europe is concerned, regulation of the banking system here is stricter than in the US. However, the news from the US added up to ‘endogenous’, or closer, factors of concern, such as the situation at Credit Suisse, Switzerland’s second largest bank. Credit Suisse’s last years have been characterised by scandals and heavy losses; thus, its problems go back well before the recent market turmoil. However, the latest events, and fears of contagion from the US, have accelerated its crisis. It is news these hours that the bank is to be bought by UBS, Switzerland’s leading bank and its historic rival.
Many evoke the spectre of the Lehman Brothers bankruptcy, from which the serious economic crisis of 2008-2009 started: is the comparison apt?
There are several important differences. The first is that today perhaps, and I stress perhaps, we understand a little better what is going on than we did in the midst of the 2007-2008 storm. The problematic balance sheets of the banks involved are not linked to particular financial innovations. The 2008 crisis started in the real estate sector. When many borrowers began to have difficulties with the repayment of their loans and house prices began to fall, it became very difficult to understand the value of the financial products that had been created by securitising these (often high-risk) mortgages. This is why the Bush administration’s rescue plan, which consisted of buying the ‘toxic’ securities directly from the banks, had to be abandoned. The Obama administration had to proceed by directly recapitalising the most exposed entities.
Another difference is that the Lehman Brothers collapse was a ‘disorderly’ failure, so to speak. It was intended to somehow ‘teach the market a lesson’. Today, in the case of the two US banks that were declared insolvent, not only were their deposits fully guaranteed by the federal government, but the Federal Reserve has opened an exceptional line of credit for all other banks that can be accessed with collateral that will be valued ‘at par’. This means that, for example, government bonds whose price has fallen over the past year due to rising rates will be valued at their face value. This, in theory, should allow credit institutions with similar problems as SVB on the asset side to better manage possible liquidity crises.
Finally, it should be noted that the banking system itself is trying to coordinate to stem the crisis. In recent days a consortium of private banks, including JPMorgan Chase, Bank of America and Goldman Sachs, has put together a 30 billion aid plan for another ailing regional bank, the Fist Republic Bank. Although for the time being the intervention has not been enough to stop the collapse of its stock on the stock exchange, which lost about a quarter of its value on Friday afternoon.
One difference, however, that does not make the current situation any better, is the high inflation that we are experiencing today, and the consequent increase in rates decided by the central banks to try to get closer to the 2% target. We will see how central bankers will revise their strategy in light of recent events. On Thursday, Christine Lagarde decided to shoot straight with the already announced 50 basis point increase. But she also dropped the reference to further hikes in the immediate future. The decisions of the Fed and the Bank of England are expected in the coming days.
After the Lehman Brothers bankruptcy, it was said that the financial market had to be regulated: what has been done and why do such situations continue to arise? Were the interventions insufficient?
After the 2007-2008 crisis, much was done to better regulate the banking sector. Unfortunately, in some cases, after it was done, it was also undone. In the US, a milestone in the post-financial crisis re-regulation was the passing of the Dodd-Frank Act in 2010. Those were the years of the Obama administration, but it is significant that the law passed with the casting vote of three Republican senators. After that, as the economy recovered, the pressure to loosen the rules began again. It is a cycle that was very effectively described many years ago by the Amharican economist Hyman Minsky: crises are often prepared by the euphoria, optimism and extreme risk appetite that characterised previous periods of expansion.
In 2018, the Trump administration passed a law that, among other things, raised the threshold above which financial institutions are classified as ‘systemically important’ from $50 billion to $250 billion. Falling out of that category, as happened to Silicon Valley Bank, means being subjected to much less stringent rules with respect to both capital requirements – which measure how much one is able to absorb operating losses – and liquidity ratios – which measure how much one is able to cope with any short-term investor outflows. Now in the US a lot of people are moving their money to the bigger banks because they are deemed safer. It is quite a paradox that these rules, passed with the declared intention of favouring smaller banks, will produce even more concentration in the banking sector.