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Silicon Valley Bank Followed Exactly What Regulation Recommended

Daniel Lacalle

The second largest collapse of a bank in recent history could have
been prevented. Now, the impact is too large, and the contagion risk
is difficult to measure.

The demise of the Silicon Valley Bank (SVB) is a classic bank run
driven by a liquidity event, but the important lesson for everyone is
that the enormity of the unrealized losses and financial hole in the
bank’s accounts would have not existed if it were not for ultra-loose
monetary policy.

Let us explain why.

As of December 31, 2022, Silicon Valley Bank had approximately $209.0
billion in total assets and about $175.4 billion in total deposits,
according to their public accounts. Their top shareholders are
Vanguard Group (11.3%), BlackRock (8.1%), StateStreet (5.2%) and the
Swedish pension fund Alecta (4.5%).

The incredible growth and success of SVB could not have happened
without negative rates, ultra-loose monetary policy, and the tech
bubble that burst in 2022. Furthermore, the bank’s liquidity event
could not have happened without the regulatory and monetary policy
incentives to accumulate sovereign debt and mortgage-backed
securities.

The asset base of Silicon SVB read like the clearest example of the
old mantra: “Don’t fight the Fed”.

SVB made one big mistake: Follow exactly the incentives created by
loose monetary policy and regulation.

What happened in 2021? Massive success that, unfortunately, was also
the first step to its demise. The bank’s deposits nearly doubled with
the tech boom. Everyone wanted a piece of the unstoppable new tech
paradigm. SVB’s assets also rose and almost doubled.

The bank’s assets rose in value. More than 40% were long-dated
Treasuries and mortgage-backed securities (MBS). The rest were
seemingly world-conquering new tech and venture capital investments.

Most of those “low risk” bonds and securities were held to maturity.
They were following the mainstream rulebook: Low-risk assets to
balance the risk in venture capital investments.

When the Federal Reserve raised interest rates, they must have been shocked.

The entire asset base of SVB was one single bet: Low rates and
quantitative easing for longer.

Tech valuations soared in the period of loose monetary policy and the
best way to hedge that risk was with Treasuries and MBS. Why would
they bet on anything else? This is what the Fed was buying in billions
every month, these were the lowest risk assets according to all
regulations and, according to the Fed and all mainstream economists,
inflation was purely “transitory”, a base-effect anecdote. What could
go wrong?

Inflation was not transitory and easy money was not endless.

Rate hikes happened. And they caught the bank suffering massive losses
everywhere. Goodbye bonds and MBS price. Goodbye tech “new paradigm”
valuations. And hello panic. A good old bank run, despite the strong
recovery of the SVB shares in January. Mark-to-market unrealized
losses of $15 billion were almost 100% of the market capitalization of
the bank. Wipe out.

As the famous episode of South Park said: “…Aaaaand it’s gone”. SVB
showed how quickly the capital of a bank can dissolve in front of our
eyes.

The Federal Deposit Insurance Corporation (FDIC) will step in, but it
is not enough because only 3% of the deposits of SVB were less than
$250,000. According to Time Magazine, more than 85% of Silicon
Valley’s Bank’s deposits were not insured.

It is worse. One third of U.S. deposits are in small banks and around
half are uninsured, according to Bloomberg.

Depositors at SVB will likely lose most of their money and this will
also create significant uncertainty in other entities.

SVB was the poster boy of banking management by the book.

They followed a conservative policy of adding the safest assets
-long-dated Treasury bills- as deposits soared.

SVB did exactly what those that blamed the 2008 crisis on
“de-regulation” recommended.

SVB was a boring and conservative bank that invested the rising
deposits in sovereign bonds and mortgage-backed securities and
believed that inflation was transitory as everyone except us, the
crazy minority, repeated.

SVB did nothing but follow regulation and monetary policy incentives
and Keynesian economists’ recommendations point by point.

SVB was the epitome of mainstream economic thinking. And mainstream
killed the tech star.

Many will now blame greed, capitalism and lack of regulation but guess what?

More regulation would have done nothing because regulation and policy
incentivize adding these “low risk” assets. Furthermore, regulation
and monetary policy are directly responsible for the tech bubble. The
increasingly elevated valuations of non-profitable tech and the
allegedly unstoppable flow of capital to fund innovation and green
investments would never have happened without negative real rates, and
massive liquidity injections. In the case of SVB, its phenomenal
growth in 2021 is a direct consequence of the insane monetary policy
implemented in 2020, when the major central banks increased their
balance sheet to $20 trillion as if nothing would happen.

SVB is a casualty of the narrative that money printing does not cause
inflation and can continue forever.

They embraced it wholeheartedly, and now they are gone.

SVB invested in the entire bubble of everything: Sovereign bonds, MBS
and tech. Did they do it because they were stupid or reckless? No.
They did it because they perceived that there was exceptionally low to
no risk in those assets. No bank accumulates risk in an asset they
believe has considerable risk. The only way in which a bank
accumulates risk is if they perceive that there is none. Why do they
perceive it? Because the government, regulators, central bank, and the
experts tell them so. Who will be next?

Many will blame everything except the perverse incentives and bubbles
created by monetary policy and regulation and will demand rate cuts
and quantitative easing to solve the problem.

It will only worsen. You do not solve the consequences of a bubble
with more bubbles.

The demise of Silicon Valley Bank highlights the enormity of the
problem of risk accumulation by political design. SVB did not collapse
due to reckless management, but because they did exactly what
Keynesians and monetary interventionists wanted them to do.