After two historic US bank failures, here’s what’s next
Two large banks serving the technology industry, collapsed after a bank robberygovernment agencies are taking emergency action to support the financial system, and President Joe Biden is reassuring Americans that the money they keep in banks is safe.
All of this is eerily reminiscent of the financial crash that began 15 years ago when the housing bubble burst. However, the initial pace seems to be even faster this time around.
The US has seized two financial institutions over the past three days after a Santa Clara, California-based Silicon Valley bank was raided. It was the biggest bankruptcy since Washington Mutual’s bankruptcy in 2008.
How did we get here? And will the steps the government unveiled over the weekend be enough?
Here are some questions and answers about what happened and why it matters:
WHY DID THE SILICON VALLEY BANK CRUSH UP?
The Silicon Valley Bank has already been hit hard by hard patch for tech companies in recent months, and the Federal Reserve’s aggressive plan to raise interest rates to fight inflation has exacerbated its problems.
The bank holds billions of dollars worth of treasury bonds and other bonds, which is typical of most banks as they are considered safe investments. However, the value of previously issued bonds has begun to decline as they pay lower interest rates than comparable bonds issued in today’s higher interest rate environment.
This is usually not a problem either, because bonds are considered long-term investments, and banks are not required to take into account the declining value until they are sold. Such bonds do not sell at a loss unless there is an emergency and the bank needs cash.
There is an emergency in Silicon Valley, the bank that collapsed on Friday. His clients were mostly startups and other tech-focused companies that needed more money last year, so they started withdrawing their deposits. This forced the bank to sell some of its bonds at a heavy loss, and the rate of withdrawal accelerated as rumors spread, in fact makes the Silicon Valley bank insolvent.
WHAT DID THE GOVERNMENT DO ON SUNDAY?
The Federal Reserve, the US Department of the Treasury and the Federal Deposit Insurance Corporation have decided guarantee all deposits at Silicon Valley Bank, as well as at Signature Bank in New York, which was confiscated on Sunday. Importantly, they have agreed to guarantee all deposits above the $250,000 insured deposit limit.
Many Silicon Valley startups and venture capitalists had well over $250,000 in the bank. As a result, up to 90% of Silicon Valley deposits were not insured. Without the government’s decision to support them all, many companies would have lost the funds needed to pay salaries, pay bills and keep their jobs running.
The aim of the extended guarantees is to prevent bank runs as clients rush to withdraw their money, establishing the Fed’s commitment to protecting businesses and individuals’ deposits and calming nerves after a agonizing few days.
Also late on Sunday, the Federal Reserve initiated a massive emergency lending program designed to bolster confidence in the nation’s financial system.
Banks will be allowed to borrow money directly from the Fed to cover any potential withdrawal rush by customers without forcing them into unprofitable bond sales that would threaten their financial stability. Such sales caused the collapse of Silicon Valley Bank.
If all goes according to plan, the emergency loan program may not have to lend a lot of money. Rather, it will reassure the public that the Fed will cover their deposits and that it is willing to lend heavily to do so. There is no limit to the amount banks can borrow other than their ability to provide collateral.
HOW IS THE PROGRAM INTENDED?
Unlike the more elaborate efforts by the Fed to bail out the banking system during the financial crisis of 2007-2008, this time the Fed’s approach is relatively simple. He established a new lending facility under the bureaucratic name of the Bank Term Financing Program.
The program will provide loans to banks, credit unions and other financial institutions for up to a year. Banks are asked to place Treasuries and other government-backed bonds as collateral.
The Fed is being generous in its terms: it will charge a relatively low interest rate—only 0.1 percentage point above market rates—and will lend at the face value of the bonds, not the market value. Bond face-value lending is key to allowing banks to borrow more money as the value of these bonds, at least on paper, has fallen as interest rates have risen.
At the end of last year, US banks held about $620 billion in unrealized losses, according to the FDIC. This means that they will suffer huge losses if they are forced to sell these securities to cover the rapid withdrawals.
HOW DID BANKS HAVE SUCH BIG LOSSES?
Ironically, much of that $620 billion in unrealized losses could be due to the Federal Reserve’s own losses. interest rate policy for the last year.
In the fight to cool the economy and reduce inflation, the Fed quickly raised its benchmark interest rate from almost zero to around 4.6%. This indirectly boosted yields or interest on a number of government bonds, especially two-year Treasury bonds, which were above 5% through the end of last week.
When new bonds with higher interest rates come in, existing bonds with lower yields become much less valuable if they have to be sold. Banks are not required to recognize such losses on their books until they sell the assets that Silicon Valley was forced to do.
HOW IMPORTANT IS STATE GUARANTEES?
They are very important. The FDIC is required by law to take the cheapest route when liquidating a bank. In the case of Silicon Valley or Signature, this would mean following the rules, meaning that only the first $250,000 in depositors’ accounts would be covered.
Getting beyond the $250,000 limit required a decision that the collapse of two banks constituted a “systemic risk”. The Fed’s six-member board unanimously reached this conclusion. The FDIC and the Treasury Secretary also supported this decision.
WILL THEY SPEND TAX DOLLARS ON THESE PROGRAMS?
The US says it will not require taxpayer funds to guarantee deposits. Instead, any losses from the FDIC’s insurance fund will be made up by charging banks additional fees.
However, Krishna Guha, an analyst at investment bank Evercore ISI, said political opponents would argue that higher FDIC fees “end up falling on small banks and businesses on Main Street.” In theory, this could cost consumers and businesses in the long run.
EVERYTHING IS WORKING?
Guha and other analysts say the government’s response is expansive and should stabilize the banking system, even though mid-sized banks like Silicon Valley and Signature tumbled on Monday.
“We think a double-barreled bazooka should be enough to quell potential runs on other regional banks and restore relative stability in the coming days,” Guha wrote in a note to clients.
Paul Ashworth, an economist at Capital Economics, said the Fed’s loan program means banks need to be able to “ride out the storm.”
“Those are strong moves,” he said.
However, Ashworth also added a caveat: “Rationally, this should be enough to prevent any infection from spreading and more banks being destroyed … but infection has always been more about irrational fear, so we would like to emphasize that there are no guarantees that it will work.”
Image credits: AP/Andrew Harnick