The collapse of Silicon Valley Bank (SVB), the largest bank failure since 2008, posed a systemic risk to America’s innovation system and economy. Government intervention can create a moral hazard within the financial system, but when weighed against the costs of inaction and possible contagion, the federal government did the right thing.
The Financial Times provides a good overview of what led to the collapse, as does Noah Smith. In short, low-interest rates led to an investment boom which fueled a surge of deposits in SVB from $49 billion in 2018 to $189 billion in 2021. SVB invested heavily in long-term US Treasury bonds and mortgage-backed securities, which were considered safe in a low-interest rate climate. But when the Federal Reserve increased interest rates to fight inflation, the bonds’ value dropped sharply, resulting in $15 billion in unrealized losses.
Moody’s Investors Service then threatened to downgrade SVB’s credit. SVB scrambled and announced that it would sell much of its bond portfolio at a $1.8 billion loss and raise $2.25 billion to cover the losses. Instead of reassuring investors, it triggered a panic. Lulu Cheng Meservey detailed the communications failures, but the end result was a run on the bank. Unfortunately, as Stratechery’s Ben Thompson points out, a bank run can become a self-fulfilling prophecy.
That’s precisely what happened as venture capital funds urged their portfolio companies to switch banks, setting off a wave of similar actions across the industry. By Thursday, SVB was facing a massive $42 billion in withdrawal requests, equivalent to almost a quarter of its total deposits, leading the Federal Deposit Insurance Corporation (FDIC) to take over SVB by Friday. The best chance for preventing runs on other regional banks was to find a buyer for SVB, but an auction launched on Saturday produced only one bidder that the FDIC reportedly rejected.
Federal policymakers had to anticipate the potential impacts of their actions or inaction as well as what authorities and tools they had available to intervene in this crisis. By late Sunday, the Treasury Department, Federal Reserve, and FDIC announced they would invoke a “systemic risk exception” which enables the use of the FDIC’s Deposit Insurance Fund to safeguard the funds of SVB account holders with more than $250,000. The Federal Reserve also announced it will support bank liquidity by lending against eligible collateral.
The two programs were intended to prevent widespread bank runs, particularly regional and mid-sized banks similar to SVB. It also solved the immediate needs of SVB clients who needed cash to make payroll this week.
The events leading up to this collapse should be vigorously investigated, but the actions taken by the federal government seem entirely appropriate. Without a clear purchaser of SVB, it was entirely plausible that there could be additional runs on regional banks on Monday. The costs for stabilizing these banks is likely much less than the cost of cleaning up a broader financial collapse.
Several factors suggest that SVB’s collapse met the criteria for a systemic risk exemption. While not necessarily “too big to fail”, SVB had grown ”too big to ignore” given its critical role in America’s innovation economy. It banked 44 percent of 2022’s venture-backed tech and healthcare IPOs. More than 55 percent of its loans were to venture capital and private equity firms, who in turn supported thousands of start-ups. The bank played a similar role supporting life sciences, healthcare companies, and frontier innovations in AI and climate technology.
In addition, the bank’s collapse has ripple effects beyond technology. SVB’s clients also included nonprofits and charter schools, and the inability to access funds could have impacted more than 15 percent of Massachusetts’s public charter schools, disrupting the education for more than 9,247 public school students. Similar disruptions would likely have occurred in educational technology and telehealth companies if they were unable to make payroll.
While needed, this emergency action is far from ideal. The events over the last week do not demonstrate a system working as it should, from the regulatory oversight to the lack of flexible policy tools that can quickly be deployed to head off a crisis. And there are real tradeoffs for this action. This intervention may signal that the federal government is more willing to intervene in the financial market than previously believed, which could lead to unintended outcomes like uninsured banks relying on federal intervention for protection.
Maintaining the US’s position as the global leader in innovation is critical to its continued economic success and national security. The events leading up to this collapse should be vigorously investigated to ensure proper oversight and prevent future crises, but federal intervention here seems entirely appropriate since the cost for stabilizing these banks is likely much less than the cost of cleaning up a nationwide meltdown.
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