Silicon Valley Bank’s Collapse Is a Direct Consequence of Loose Monetary Policy

Silicon Valley Bank’s Collapse Is a Direct Consequence of Loose Monetary Policy
Employees stand outside of the shuttered Silicon Valley Bank headquarters in Santa Clara, Calif., on Mar. 10, 2023. (Justin Sullivan/Getty Images)
Daniel Lacalle
3/13/2023
Updated:
3/28/2023
0:00
Commentary

The second-largest collapse of a bank in recent history after Lehman Brothers folded in 2008 could have been prevented. Now, the impact is too large, and the contagion risk is difficult to measure.

The demise of the Silicon Valley Bank (SVB) is a classic bank run driven by a liquidity event, but the important lesson for everyone is that the enormity of the unrealized losses and financial hole in the bank’s accounts wouldn’t have existed if it hadn’t been for ultra-loose monetary policy. Let us explain why.

As of Dec. 31, 2022, Silicon Valley Bank had about $209.0 billion in total assets and about $175.4 billion in total deposits, according to its public accounts. The bank’s top shareholders are Vanguard Group (11.3 percent), BlackRock (8.1 percent), State Street (5.2 percent), and the Swedish pension fund Alecta (4.5 percent).

The incredible growth and success of SVB couldn’t have happened without negative rates, ultra-loose monetary policy, and the tech bubble that burst in 2022. Furthermore, the bank’s liquidity event couldn’t have happened without the regulatory and monetary policy incentives to accumulate sovereign debt and mortgage-backed securities.

The asset base of SVB read like the clearest example of the old mantra: “Don’t fight the Fed.” SVB made one big mistake: It followed exactly the incentives created by loose monetary policy and regulation.

What happened in 2021? Massive success that, unfortunately, was also the first step to the demise. The bank’s deposits nearly doubled with the tech boom. Everyone wanted a piece of the unstoppable new tech paradigm. SVB’s assets also rose and almost doubled.

The bank’s assets rose in value. More than 40 percent were long-dated Treasurys and mortgage-backed securities (MBS). The rest were seemingly world-conquering new tech and venture capital investments.

Most of those “low-risk” bonds and securities were held to maturity. They were following the rulebook of mainstream: low-risk assets to balance the risk in venture capital investments. When the Federal Reserve raised interest rates, those running SVB must have been shocked.

The entire asset base of SVB was one single bet: low rates and quantitative easing for longer. Tech valuations soared in the period of loose monetary policy, and the best way to “hedge” that risk was with Treasurys and MBS. Why would they bet on anything else? This is what the Fed was buying in billions every month, these were the lowest-risk assets according to all regulations, and inflation, according to the Fed and all mainstream economists, was purely “transitory,” a base-effect anecdote. What could go wrong?

Inflation wasn’t transitory and easy money wasn’t forever.

Rate hikes happened. And they caught the bank, suffering massive losses everywhere. Goodbye, bonds and MBS price. Goodbye, tech “new paradigm” valuations, and hello, panic. There was a good old bank run, despite the strong recovery of the SVB shares in January. Mark-to-market unrealized losses of $15 billion were almost 100 percent of the market capitalization of the bank. The result was a wipe out.

And in the words of an episode of the cartoon “South Park”: “... Aaaaand it’s gone.” SVB showed how quickly the capital of a bank can dissolve in front of our eyes.

The Federal Deposit Insurance Corp. (FDIC) will step in, but it won’t be not enough, because only 3 percent of the deposits of SVB were less than $250,000. According to Time magazine, more than 85 percent of Silicon Valley’s Bank’s deposits weren’t insured.

Even worse, one-third of U.S. deposits are in small banks and around half are uninsured, according to Bloomberg. Depositors at SVB will likely lose most of their money, and this will also create significant uncertainty in other entities.

SVB was the poster child of banking management by the book. The bank followed a conservative policy of adding the safest assets—long-dated Treasury bills—as deposits soared.

SVB did exactly what was recommended by those who blamed the 2008–09 financial crisis on “de-regulation.” SVB was a boring and conservative bank that invested the rising deposits in sovereign bonds and mortgage-backed securities and believed that inflation was transitory as everyone, except us, the crazy minority, repeated.

SVB did nothing but follow regulation and monetary policy incentives and Keynesian economists’ recommendations point by point. SVB was the epitome of mainstream economic thinking. And mainstream killed the tech star.

Many will now blame greed, capitalism, and lack of regulation—but guess what? More regulation would have done nothing because regulation and policy incentivize adding these “low risk” assets. Furthermore, regulation and monetary policy are directly responsible for the tech bubble. The increasingly elevated valuations of nonprofitable tech and the allegedly unstoppable flow of capital to fund innovation and green investments would never have happened without negative real rates and massive liquidity injections.

In the case of SVB, its phenomenal growth in 2021 is a direct consequence of the imprudent monetary policy implemented in 2020, when the major central banks increased their balance sheets to $20 trillion as if nothing could happen.

SVB is a casualty of the narrative that money printing does not cause inflation and can continue forever. The bank embraced it wholeheartedly, and now it is gone.

SVB invested in the entire bubble of everything: sovereign bonds, MBS, and tech. Did they do it because they were stupid or reckless? No. They did it because they perceived that there was very low to no risk in those assets. No bank accumulates risk in an asset they believe is high risk. The only way in which a bank accumulates risk is if it perceives that there is none. Why do they perceive it? Because the government, regulators, central bank, and the experts tell them so. Who then will be next?

Many will blame everything except the perverse incentives and bubbles created by monetary policy and regulation and will demand rate cuts and quantitative easing to solve the problem. That will only make things worse. You do not solve the consequences of a bubble with more bubbles.

The demise of Silicon Valley Bank highlights the enormity of the problem of risk accumulation by political design. SVB didn’t collapse due to reckless management but because it did exactly what Keynesians and monetary interventionists wanted. Congratulations.

Daniel Lacalle, PhD, is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”