The Silicon Valley Bank Failure: a Fragile Market that Has Not Understood the Lehman’s Lesson

Mario Calvo-Platero
 Columnist for la Repubblica, Guarantor for the Italian edition of the New York Times, President Gruppo Esponenti Italiani New York, Chairman Palazzo Strozzi Foundation USA

Silicon Valley Bank (SVB) failure gains historical significance not so much with regard to a possible systemic reaction – which is of concern today – that could ensue, but because it is the first financial failure of a digital nature. The striking aspects of this financial failure are not only the speed with which deposits evaporated and the size of the fluctuations in value, typical of a digital economy; but also the bank’s client portfolio: mostly companies and venture capital funds, which are financially sophisticated and very reactive.

It is also striking how the age-old, often irrational emotional response that leads to bank runs persists even in this age dominated by unfailing algorithms and risk-taking entrepreneurs with nerves of steel. In this affair – which could easily have been avoided – there are three basic elements to worry about. The first concerns the possible systemic impact of SVB's failure. The second is regulation, especially in a post-2008 context from which the banks wanted to exit. The third is on the macroeconomic and political outlook: are we facing the first recessionary tailspin? And how will Joe Biden react if the country descends into recession between October 2023 and November 2024? At the system level, the risk is always present. For small regional banks, which are more vulnerable in a psychological bank run environment; for bank customers – such as USD Coin, which had USD 3.3 billion in uncollected cash with SVB and went below watch values; for First Republic, a major bank, identified as vulnerable by investors, whose stock lost 34% in a few days. That said, given the particularity of SVB's model, the risk of a broader systemic failure seems far for now.

The bank’s business model seemed prudent: most deposits were invested in US Treasury bonds. But with an average yield of 1.7% on Treasury bonds purchased in the magical era of zero interest rates, the bank began to suffer when yields on treasuries rose in reaction to restrictive monetary policy. And here three vulnerabilities that could have been avoided jump to the eye: the bank never engaged in hedging transactions to protect itself against a possible rise in rates; since it had long-term maturities, it did not have to do the normal mark-to-market reporting. This did not allow the Security and Exchange Commission (SEC) to have a complete picture of the situation, although its oversight has been questioned.

And finally, although the crisis was foreseen, timing was poor: it was already known that the sale of some $20 billion of bonds, half of the total assets, would generate a loss of $1.8 billion. A capital increase by Atlantic Investors, mediated by Goldman Sachs, was ready to be put in place. The bank however added the sale of convertible shares, which required an extra day, blocking the overnight capital increase. So, in the real-time era, the Tsunami effect started: in the morning companies withdrew funds instantly (another vulnerability, thousands of retail customers would have taken longer) and in a couple of days the bank failed with digital-age speed.

Due to these structural peculiarities of SVB, hopefully its failure will not have a systemic impact. With regard to laws, it is unlikely that the banks' pressure to remove post-2008-crisis rigidities will be heeded; indeed, in light of the fragilities that have emerged with SVB, new rules could be introduced. Finally, the macroeconomic side: could this failure be a recessionary wake-up call in the more general context of the impact of rising rates on the US economy? Possibly. History tells us that under conditions of obstinate inflation, central banks' restrictive reactions lead to a recessionary transition.

In this case, however, there is a counterweight to consider: the long wave of extraordinary post-Covid expansionary fiscal policy, unprecedented in history. The Fed is tightening now, and perhaps will accelerate the tightening (in Jay Powell’s word), aiming for a coincidence of timing between the exhaustion of the fiscal stimulus, the containment of inflation, and the end of monetary tightening by 2023. A perfect coincidence could thus avert recession. But we know that perfect timing – and the SVB case teaches – does not exist.