This past quarter provided a shock to our system with the first run on a major bank since the Great Recession in 2008-09. It reminded us of how tenuous (and yet, at the same time surprisingly robust) our banking system often is as well as how shocks to the financial markets can come, seemingly, out of nowhere.
On March 10th Silicon Valley Bank (SVB) – a mid-sized bank located in the heart of Silicon Valley in California – collapsed into FDIC receivership due to “inadequate liquidity and insolvency”. The news came as a shock to investors; SVB was a well-capitalized bank and had no problems with asset quality. Over the subsequent weekend, Signature Bank – a New York bank with strong links to the crypto industry – was also taken into receivership. Authorities moved quickly to guarantee all deposits from both banks, including uninsured deposits. But markets opened that Monday still anxious about the potential for problems to emerge at other regional banks.
What Went Wrong
As of this writing, although there has been a shift in deposits away from small and mid-sized banks to larger banks (First Republic Bank here in the Bay Area has required support), no other bank has failed. It is also important to remember that SVB was an unusual bank with a concentrated customer and deposit base of venture capitalists and their portfolio companies. Most of the bank’s deposits were large and therefore uninsured. Additionally, since SVB’s customers did not need loans, the bank invested most of its deposits in longer-duration Treasury bonds.
The rise in interest rates over the last year hit SVB much harder than other banks. When the venture capitalists realized that the bank needed to raise capital, they got spooked and demanded their deposits – all at once. SVB’s management also made mistakes: their risk management was sub-par, they did not move quickly enough to fix issues that regulators flagged back in 2021, and they did not realize they needed help from the Federal Reserve until the window for getting emergency funding had closed.
SVB was a special case but even so, further banking industry issues cannot be ruled out. Higher rates could trigger asset quality issues in other areas and tightened standards throughout the banking system could lead to a slowdown in overall lending growth. Having said all that, the banking crisis also highlighted that the banking system, especially with the larger and more institutionally important banks, is in fact in good shape. They have broad depositor bases, diverse loan books, and very healthy and liquid reserves.
There Is No Crystal Ball
In the end, the story of SVB’s demise serves as a reminder of how unpredictable life as an investor can be. Unexpected developments that can have significant positive or negative effects on asset prices are continually occurring. Just over the last three years, investors have seen a pandemic, war in Europe, the resurgence of inflation, record low interest rates, sharply rising interest rates, the worst yearly performance from fixed income securities on record, and now a bank run straight out of It’s A Wonderful Life.
These events cannot be predicted with any accuracy. As we sit here today, we might still have a recession this year – or we might not. Inflationary forces could continue to dissipate, encouraging equity and bond prices higher – or they could stay stubbornly strong. As investors, however, we are not helpless against this uncertainty. We can protect ourselves from the things over which we have no control by acting on the things we can control.
Control What You Can
We can start with a well-diversified portfolio of stocks and bonds, something that SVB could have certainly benefited from. Staying away from speculative investments is also helpful. Investments with little or no intrinsic value are often highly volatile and can fall sharply in adverse market environments. And, as always, it is important to maintain a long-term time horizon and resist the temptation to try and time the market.
Spending and savings are other pieces of our financial planning puzzle that we have a great deal of power over. Keeping to a sensible spending and savings plan can ensure that we don’t take on too much debt and that we can maintain a “cash cushion” to draw upon in emergencies. Finally, it behooves us all to pay attention to FDIC insurance limits. Rules were stretched this time, and almost certainly will be stretched again next time, but it is best to err on the side of caution.
The financial landscape is full of ups and downs. The prudent, sensible way of navigating as investors is to think carefully over the things we can control, stay focused on the long term, and try hard to keep emotion out of the decision-making process.