Silicon Valley Bank

Starting last Friday and extending over the weekend, we saw two very large bank failures: Silicon Valley Bank (SVB) and Signature Bank. Those followed the collapse last week of Silvergate, the “crypto bank.” These are some of the largest bank failures in U.S. history, and they all happened in the past several days. What is going on here—and could we be headed for the next Great Financial Crisis?

The Bottom Line
This situation is something to keep an eye on, but it is not the start of the next financial crisis. Unlike in 2008, the government has stepped in early and stepped in hard. While we can certainly expect market turbulence—and we are seeing it this morning—the systemic effects will be limited. We are not set for a rerun of the Great Financial Crisis. This is not the end of the world.
Instead, the takeaway so far is that regulators and the Feds are on the case and are willing and able to support the financial system. Sunday night, the U.S. Treasury announced that depositors would be fully protected, in the interest of maintaining systemic confidence, and that funds were being made available to support banks under stress. Unlike in 2008, the government is getting ahead of the problem rather than trying to clean up afterward. That is a very positive sign. So, given all that, what is going on? And what does it mean for our investments?

What to Expect Next
Many people have written good descriptions of how and why these banks collapsed, and I won’t try to replicate that. As investors, the why is interesting, but we need to know what it all means for the future. And this is what we know now.
Recession more likely. First, the rise in interest rates engineered by the Fed is indeed affecting the financial system. While the effects on the assets of SVB were more intense, other banks are wrestling with the same problem. Expect to see banks and the financial sector as a whole pull back on lending and risk until they get their houses in order, and this will slow economic growth and likely pull markets down. In some respects, this is good (it is what the Fed has been aiming for), but it makes a recession much more likely, quite possibly in the short term.
Slowdown in tech. Second, the fact that the collapses have principally been in the tech and crypto spaces suggests that these sectors are even more at risk than the economy as a whole. While other banks will likely move to replace SVB, they will not be as focused or as dedicated to the sector, which will slow things down going forward. One of the primary enablers of the tech boom is now gone. Both of these are reasonable outcomes. They are also ones we have not only seen before but were expecting. The real question, though, is whether these bank failures signal a wider systemic problem. And here the news is good.

Some Good News
First, three things caused the financial system to lock up in 2008:
1. A lack of transparency around asset values, causing a lack of liquidity for those
2. A lack of sufficient capital by the banks to weather a crisis
3. A lack of available credit in the early stages of the crisis to support them until
liquidity came back
We are in a very different place now on all three. For the assets, U.S. banks now largely hold very liquid assets, dominated by U.S. Treasury notes. Those values are clear, and there is a large market for them. Banks can raise cash if they need to, simply by selling or borrowing against those assets. Second, U.S. banks are by and large very well-capitalized. They have the money to weather storms and, as noted in point 1, can access it, which are both very different than in 2008. But the third part is where we have to be careful. Banks have seen those Treasury notes decline in value significantly as rates rose, and there are questions in some cases whether the value of the bank capital still covers the liabilities. This is what drove the collapse of SVB. What the Treasury did Sunday, however, was to solve this problem by providing a way for banks to borrow against long-term assets like Treasuries based on the par value, and not the current market value. That largely eliminates the insolvency problem and will provide the credit that was missing in 2008. It will not eliminate the problem—banks still may need to rebuild their capital bases—but it will allow the banks the time to recover, which will be a key piece of the rebalancing of the system.

Not Another Crisis, But More Turbulence Ahead
In other words, compared to 2008, the system is more transparent, with a more solid foundation, and the government has identified the remaining problems and put programs in place to deal with them. From a depositor’s standpoint, the decision by the government to stand behind all of the deposits also reduces the risks of further bank runs. With a more solid system and the government being aggressively proactive, as of right now, there looks to be little systemic risk in place. We won’t see another Great Financial Crisis. We will, however, see continued turbulence. Even though the system will hold, investors still need to figure out the effects of all of this. Expect a bumpy ride, but it’s a ride we will eventually be able to get off of. This story is not over yet, and we don’t fully know how it will end. We do know, however, that we will make it through.