A run for their money

In April 1906, with San Francisco still burning after the earthquake, Amadeo Giannini set up his bank on a plank laid across two barrels.^{8Santa Clara University Digital HumanitiesAmadeo Peter Giannini} He paid out to depositors who wanted their money and lent on a handshake to those who wanted to rebuild. Bankers then understood their trade as a matter of trust: depositors stay only as long as they believe their money will be there tomorrow.

Silicon Valley Bank, the lender of choice for a generation of technology startups, found out how quickly that belief can go. On 8 March its parent company said it had sold about $21bn of securities at an after-tax loss of about $1.8bn, and that it would sell $1.25bn of common stock to plug the hole.^{5SEC EDGARSVB Financial Group free writing prospectus: strategic actions8 Mar 2023} Founders and their investors read the announcement, did the arithmetic and reached for their phones. On 9 March customers tried to withdraw $42bn, about a quarter of the bank’s deposits, in a single day.^{9California Department of Financial Protection and InnovationOrder Taking Possession of Property and Business: Silicon Valley Bank10 Mar 2023,10SECSVB Financial Group Form 10-K for fiscal year 2022} The next morning California’s banking regulator closed the bank, citing inadequate liquidity and insolvency, and handed it to the Federal Deposit Insurance Corporation (FDIC).^{1California Department of Financial Protection and InnovationCalifornia Financial Regulator Takes Possession of Silicon Valley Bank10 Mar 2023}

By the measure of size this was no small-town failure. At the end of 2022 SVB had about $209bn in assets and $175.4bn in deposits.^{2FDICFDIC Creates a Deposit Insurance National Bank of Santa Clara to Protect Insured Depositors of Silicon Valley Bank10 Mar 2023} It was the first FDIC-insured bank to fail since October 2020.^{2FDICFDIC Creates a Deposit Insurance National Bank of Santa Clara to Protect Insured Depositors of Silicon Valley Bank10 Mar 2023} Its mistake was an old one. During the boom of 2020 and 2021 startups were awash with venture money, and they parked it at SVB. The bank put much of that cash into long-dated government bonds, which were safe from default but not from changes in interest rates. When the Federal Reserve raised its benchmark rate from near zero to 4.5-4.75%,^{6Board of Governors of the Federal Reserve SystemFederal Reserve issues FOMC statement1 Feb 2023} the value of those bonds fell. Meanwhile the deposits themselves were going out the door, as startups that could no longer raise money easily spent what they had.

What made the run so quick was who the depositors were. Federal insurance covers $250,000 per depositor per bank. SVB’s customers were firms holding payroll for dozens or hundreds of staff, and according to the bank’s annual report an estimated $151.5bn of its $173.1bn in deposits, more than 87%, was uninsured.^{10SECSVB Financial Group Form 10-K for fiscal year 2022} They were also unusually alike. They read the same newsletters, sat in the same group chats and took advice from the same few hundred investors. A bank with a million retail customers loses deposits gradually. One with a few thousand closely connected startups can lose them before lunch.

Over the weekend the panic spread from Santa Clara to the rest of the startup world. Garry Tan, who runs Y Combinator, wrote that “the real victims of the SVB fallout are the depositors”,^{7AFP, via Gulf NewsWorry for tech startups after Silicon Valley Bank failure12 Mar 2023} many of whom could not be sure of making payroll on Monday. On the evening of 12 March the Treasury, the Fed and the FDIC acted. Invoking a “systemic risk exception”, they promised that depositors would have access to all of their money starting on 13 March, insured or not.^{3Board of Governors of the Federal Reserve SystemJoint Statement by Treasury, Federal Reserve, and FDIC12 Mar 2023} They did the same for Signature Bank, a New York lender closed the same day.^{3Board of Governors of the Federal Reserve SystemJoint Statement by Treasury, Federal Reserve, and FDIC12 Mar 2023} The Fed also opened a Bank Term Funding Program, which lends to banks for up to a year against government bonds valued “at par”, their face value, not their battered market price.^{4Board of Governors of the Federal Reserve SystemFederal Reserve Board announces it will make available additional funding to eligible depository institutions12 Mar 2023}

The strongest objection is moral hazard. If uninsured deposits are in practice guaranteed, the $250,000 limit means nothing. Large depositors then have no reason to check their bank’s balance sheet, and bankers lose a source of discipline. That worry is fair, and Washington has not answered it. But the alternative was worse. Letting thousands of firms miss payroll to teach a lesson about counterparty risk would have punished cleaning staff and engineers for decisions made by a bank’s treasury desk. And with every regional lender’s depositors watching, it might well have started runs elsewhere. The authorities protected depositors, not owners. SVB’s shareholders and some unsecured bondholders, the statement noted, “will not be protected”.^{3Board of Governors of the Federal Reserve SystemJoint Statement by Treasury, Federal Reserve, and FDIC12 Mar 2023} That keeps a good part of the discipline in place.

The lesson for founders cannot be left to the government, since next time it may choose differently. Keep enough money to meet payroll spread across more than one bank. Ask where the rest is held. Treat a bank’s balance sheet with the same suspicion a venture capitalist brings to a pitch deck. Giannini kept his customers because they trusted his judgment, not because Washington stood behind him.

The guarantee arrived in time, but only just.