Peter Morgan/AP Photo
An FDIC sign is posted on a window at a Silicon Valley Bank branch in Wellesley, Massachusetts, March 11, 2023.
Over the weekend, the banking system faced its greatest shock since the 2008 financial crisis. The 16th-largest bank in the U.S., Silicon Valley Bank, failed to raise enough capital to ease investor concerns, and then faced a bank run by depositors, totaling $42 billion in a single day last week. The panic spread to other medium-sized banks, notably First Republic and then Signature Bank in New York, notorious for its crypto clientele.
Though SVB held hundreds of billions on its balance sheet, most of its depositors were tech startups in the Bay Area, each funded by an even smaller network of venture capital funds. After the initial wave of withdrawals, VCs then demanded that the government make them whole again. The principal issue is that over 90 percent of Silicon Valley Bank’s deposits were uninsured. By policy, the Federal Deposit Insurance Corporation protects any customer with up to $250,000 but not above that limit.
With threats by VCs that the panic would spread across the financial system, the FDIC, Federal Reserve, and Treasury Department ultimately decided to step in and bail out uninsured customers. The ramifications of the decision are still unfurling throughout the banking and tech sectors as well as our politics. In wake of the banking collapse, some progressive lawmakers are calling for new financial regulations eroded by the Trump administration in 2018, aided by key Democrats and banking lobbyists including SVB.
Daniel Davies is a managing director of Frontline Analysts and previously worked as a regulatory economist at the Bank of England. In this interview with the Prospect, he explains how Silicon Valley Bank failed to manage risks and what options were on the table for government officials had they decided to forgo a bailout of venture capitalists.
Luke Goldstein: How did Silicon Valley Bank become the go-to bank for venture capitalists in the Bay Area?
Daniel Davies: There are a lot of analysts who were caught off guard by this collapse and are calling it the best bank to ever go bust. Clearly that wasn’t entirely the case. What Silicon Valley Bank did well was essentially high-end customer service and hand-holding for inexperienced startup companies made up of maybe four computer programmers with four different passports who just came to the U.S. within the last six months—you get the picture. SVB would help get them set up with company credit cards and even manage business decisions for them, because most of these early-stage startups don’t have dedicated chief financial officers. That’s really why venture capital funds would encourage their founders to bank with SVB.
SVB went to all this trouble because the companies were funded with blue-chip venture capital money and you want to have good relationships with those big players in the Valley.
But their entire investment and lending strategy was based on a zero-interest-rate environment. A bulk of $50 million non-interest varied deposits and 30-year mortgages are trash when the interest rate is 5 percent. SVB avoided all the warning signs, they didn’t start charging fees for these services, raise the basis points for depositors, and even stop accepting new deposits. They thought they could just ride it out.
How unusual is this business model and what risks did it expose SVB to?
The central problem is that the big company deposits are hot money; I learned about this from Swiss bankers. With those kinds of accounts you can only make short-term investments because you never know when the money is going to leave or dry up.
You might have thought that it was a source of strength that all these companies were backed by VCs who have great contacts and deep pockets. It also meant that a bank that seemingly had a lot of depositors, two or three thousand accounts, in reality are not independent entities. They’re all funded from the same group of VCs. You actually have nine or ten clients who are making the real financial decisions.
So all this apparent independence in depositors disappears. The Bay Area is a small town in many ways and all these guys know each other. That’s how you get the run.
What mistakes did SVB make that led up to the run and were there ways to avoid the panic?
It looks like SVB management wasn’t taking it seriously, to be honest, they had a deficit and thought the deficit would cure itself as the securities portfolio rolled over and in six months they’d be fine. But when you’re a bank in trouble, you need to raise capital and raise more than you think you need, because you’ve got to restore confidence. And then SVB did the worst thing you can do in this situation, which is announce you’re raising capital and then fail to do so.
Then after that, the bank run began, but really your clients are just a dozen or so VC customers who all know each other. I’ve only seen something like this before with very small Swiss banks in the ’70s and ’80s who made huge mistakes about high-net-worth depositors with sketchy finances. What usually ended up happening was the biggest depositor or someone in their circle ended up taking over the bank to make it whole or recapitalizing it.
What about Signature Bank and the others?
I was looking at that a year ago and remember thinking this is the most run-prone deposit structure I’ve ever seen in my life because its deposit base was crypto exchanges and wealth management and the wealth management was all super-hot rich person money.
The demo of depositors were essentially dentists around the state who were brokered by aggressive wealth management types. Those deposits were all running in a second if they thought they were in trouble.
So it doesn’t surprise me that Signature had enough withdrawals that it would go out of business, and that in itself wouldn’t have perhaps raised alarms but you had that with SVB and First Republic and that’s when it got the FDIC and Fed’s attention to act over the weekend and step in.
Venture capitalists immediately called for a bailout of SVB and raised alarms about a wider bank run on the financial system if the government didn’t act. What other off-ramps do you think were available to government officials and could have been weighed?
First of all, on a very basic level, VC holds billions of dollars in capital. They could have just sat tight and then picked up some of SVB’s capital issues so that their bank didn’t fail. That’s not uncommon in other situations. Swiss banks get bought by their highest-net-worth clients and then sourced among their friends temporarily. From what I’ve gathered, the VCs didn’t want to do anything that would make them qualify as a bank holding company because once you do that you’re under a different set of regulations and it becomes very difficult to get out of them.
Some suggest that the cash wasn’t on hand and it would be a hassle to raise it. Here’s the thing though, those are exactly the problems equity capital people are paid billions of dollars each year to solve. If I had a career making $5 million a year organizing these funds, you should have a risk strategy or at least be able to figure it out over the course of a weekend.
If a bunch of hedge funds with $10 to $100 billion under management suddenly fell victim to a cyber attack, and it turned out that none of them had employed a CTO [chief technology officer] or used widely available firewall software, would everyone suddenly be given cybersecurity insurance provided by taxpayers? That’s hard to imagine.
Here’s another scenario we should consider: Let’s say I’m one of these venture capitalists and I’ve given all these startups millions and told them to go to SVB. If a company loses $10 million but I really believe in the company, you write another check. It’s not pleasant but that’s what it is and that’s how it could have played out when payroll came due on Monday.
The venture capitalists basically used the threat of thousands of startups shuttering as a political human shield to get a bailout.
Because let’s be clear, the vast majority of deposits came from venture capitalists and the majority of the losses were on venture capitalists. The FDIC bailout is for the venture capitalists even though that’s obfuscated because it’s split between all these many companies.
Why do you think these scenarios weren’t really part of the Federal Reserve and Treasury’s calculus, as far as we can tell, and do you think the VC bailout sets a bad precedent?
I think everyone was panicking and ultimately FDIC did this because it doesn’t cost that much to do so. In this case, SVB doesn’t have that many messy investments on its asset sheets. The problem is all on the liability side. They had a whole set of market-to-market unrealized losses of portfolio, but we know what those market-to-market losses are just by looking.
So the FDIC basically said over the weekend that it’s not a huge cost to take care of uninsured funds since there’s a decent risk that it’s spreading to Signature Bank and others.
