Timeline of Silicon Valley Bank Collapse:
- 2020: The COVID-19 pandemic hits the United States, resulting in widespread economic shutdowns and job losses.
- March 2020: The US government passes the CARES Act, which includes $2.2 trillion in economic relief to individuals and businesses affected by the pandemic.
- Mid-2020: The Federal Reserve implements Quantitative Easing (QE) measures, including purchasing $4.5 trillion in bonds to increase liquidity in the market.
- December 2020: The US government passes a $900 billion stimulus package, bringing total COVID-related relief spending to $2.2 trillion.
- March 2021: The US government passes a $1.9 trillion stimulus package, bringing total COVID-related relief spending to $5.2 trillion.
- March 2023: Silicon Valley Bank collapses due to a combination of a bank run and a capital crisis, becoming the second-largest failure of a financial institution in US history.
Analysis:
The collapse of Silicon Valley Bank in March 2023 can be traced back to the COVID-19 pandemic and the US government’s response to it. The pandemic led to widespread economic shutdowns and job losses, prompting the government to pass massive economic relief packages totaling $5.2 trillion.
While the relief was necessary to support individuals and businesses during the pandemic, the sheer amount of money being injected into the economy had consequences. The Federal Reserve’s QE measures, including purchasing $4.5 trillion in bonds, increased liquidity in the market but also led to concerns about inflation.
Inflation occurs when too many dollars are chasing too few goods, which became a real possibility as a result of the massive influx of money. The money supply normally grows about 7% per year, but QE of more than $4 trillion increased the money supply by 14% per year over the past decade. The $5 trillion in COVID relief increases the money supply by 27% and does so very quickly – the floodgates are open.
As a result, there were concerns about rising interest rates and bond prices. Banks typically buy bonds as a safe haven against inflation, but if interest rates increase, the value of those bonds can decrease, resulting in losses for the banks.
The collapse of Silicon Valley Bank can be attributed to a combination of factors. The Federal Reserve’s QE measures, combined with the massive COVID-related relief spending, led to concerns about inflation and rising interest rates. This caused many tech firms to draw down their deposits at Silicon Valley Bank to fund their operations, which led to a bank run and a capital crisis.
While analysts believe that the collapse of Silicon Valley Bank is unlikely to set off a domino effect in the banking industry, smaller banks that are disproportionately tied to cash-strapped industries like tech and crypto may be in for a rough ride. The collapse highlights the challenges that the classical banking system faces in an era of massive government spending and increased liquidity.
In conclusion, the collapse of Silicon Valley Bank can be seen as a warning sign for the banking industry and the broader economy. The correlation between the COVID-19 pandemic, printed money, inflation, bonds, and interest rates highlights the need for a more nuanced and comprehensive approach to economic policy. The classical banking system is not yet ready to handle the challenges of the modern world, and policymakers must work to find solutions that balance economic growth with stability and sustainability.
Banks often hold bonds in their portfolio as a way to manage their risk exposure and protect against inflation. When banks make loans to businesses or individuals, they are exposed to the risk of default, which can lead to losses for the bank. To mitigate this risk, banks may invest in bonds, which offer a fixed income stream and lower credit risk compared to many types of loans.
Bonds can also serve as a hedge against inflation. As we mentioned earlier, inflation can erode the value of money over time, and the fixed income from bonds may lose value as prices rise. However, some types of bonds, such as Treasury Inflation-Protected Securities (TIPS), are designed to protect against inflation by adjusting their principal and interest payments based on changes in the Consumer Price Index.
When interest rates rise, the value of existing bonds may decline. Banks that hold a large amount of bonds may be exposed to interest rate risk if they are unable to sell their bonds without taking significant losses. In this scenario, banks may experience a liquidity crunch if they are unable to convert their bonds to cash quickly enough to meet their financial obligations.
This is why banks need to carefully manage their bond portfolios and monitor interest rate changes. If interest rates rise too quickly, banks may be caught off guard and suffer losses. However, if they are too conservative and do not hold enough bonds, they may miss out on potential returns and leave themselves exposed to other types of risk.
Banks with large reserves in bonds are not necessarily guaranteed to have serious problems, but they are exposed to interest rate risk. If interest rates rise quickly, banks may be unable to sell their bonds without taking significant losses, which can lead to liquidity issues and potentially even bankruptcy if the losses are large enough. However, banks typically manage their bond portfolios to mitigate interest rate risk and may also have other assets to fall back on in case of such an event. Therefore, it is important to note that holding a large number of bonds is not necessarily a guarantee of financial trouble for a bank, but it does expose the bank to potential risks.
In summary, banks may hold bonds in their portfolio to manage risk and protect against inflation. However, they also need to be mindful of interest rate risk and carefully monitor their bond holdings to ensure that they can meet their financial obligations in a changing interest rate environment.
The Federal Reserve is about to increase rates even more, if interest rates rise too quickly, banks may struggle to adjust their operations and portfolios, which can lead to liquidity issues and potential financial trouble. It is important for banks to manage their risk exposure and be prepared for potential changes in the interest rate environment to mitigate the impact of rate hikes on their financial stability.
