SVB casts a long shadow

#Web3Weekly: March 5–11, 2023

This post is adapted from the latest edition of my newsletter #Web3Weekly. If you would like to receive it in your inbox every Sunday, subscribe here.

It was a profoundly scary week for decentralized and traditional finance alike.

Silicon Valley Bank shut down on Friday, the largest failure of a U.S. bank since the financial crisis of 2008. A classic bank run ultimately did in SVB, but that was really just the last straw in a longer series of misfortunes.

Some useful context from the Wall Street Journal:

SVB’s deposits boomed alongside the tech industry, rising 86% in 2021 to $189 billion and peaking at $198 billion a quarter later. The bank poured large amounts of the deposits into U.S. Treasurys and other government-sponsored debt securities. Soon after, the Fed began increasing rates.

Rising rates and the tech downturn caused deposits to decline, spurring the bank to sell substantially all of its available-for-sale securities.

SVB announced further plans to restructure its balance sheet. But that ultimately backfired, according to Fast Company:

Late Wednesday, SVB said it was hoping to raise $2.25 billion via a stock sale and investments in order to strengthen its balance sheet, as deposits from startups struggling for funding have dropped in recent months. That spooked both customers and, more importantly, venture capitalists, many of whom advised their clients to pull their money from the bank.

As word of that advice leaked out, other customers began to pull money out at a phenomenal rate. SVB had reportedly hired an adviser to explore a possible sale, but with the run on the bank happening, it found itself at risk of collapse. That’s when California and the [Federal Deposit Insurance Corp.] stepped in, closing SVB and creating the new Deposit Insurance National Bank of Santa Clara, which took over all insured deposits at SVB.

SVB thus became the biggest bank to be rescued by FDIC since Washington Mutual in the early days of the 2008 financial crisis.

It’s of course never good when comparisons to that sad chapter come into play. It also doesn’t help that SVB’s meltdown happened on the heels of recent struggles at firms like investment bank Credit Suisse and crypto bank Silvergate as well.

People naturally wonder whether a similar global contagion to 2008 could take hold now, spilling into the “real economy” of factories and shopping malls and corner stores and other tangible stuff in everyday life.

For now, the consensus in the market seems to be “probably not.” But that doesn’t necessarily mean all is well either. There is, after all, a wide range of plausible near-term scenarios between the extremes of “2008-style armageddon” and “booming bull market.”

Some insightful stories about the risks ahead:

• MSNBC’s Ali Velshi caught up with Sheila Bair, who served as FDIC chair during the 2008 crisis. She provided a nice layman-friendly explanation of what protections SVB depositors enjoy and what the next steps for FDIC might be to help them move on. FDIC ensures all accounts up to $250,000. It will also attempt to sell SVB’s business to a larger bank, which would hopefully carry on operations as normal for account holders for years to come. But if such a sale stalls or falls through, larger depositors above the $250,000 limit could experience real headaches in recovering their money, according to Bair.
• Unfortunately, the latter profile covers a lot of SVB account holders, since the bank’s clientele focused on startups, founders, and the venture capitalists who back them. Aaron Klein, a former senior official at the U.S. Treasury, noted in an interview with CNN’s Michael Smerconish that SVB had only 16 branches even though it was among America’s top 20 banks by total deposits — a reflection of how focused its business was on relatively large customers.
• In the wake of the FDIC takeover, several tech companies filed disclosures to the Securities and Exchange Comission about their exposure to SVB. Roku, Etsy, Rocket Lab, Roblox, Lending Club, and Bill.com were among those reporting multi-million dollar accounts with SVB whose status is now uncertain, according to Barron’s. In each case, the cash was a portion of the company’s reserves, and none reported that their regular operations will be affected by SVB’s failure.
• USDC issuer Circle had a $3.3 billion account with SVB, according to an update the company published for users. Worries about the stablecoin caused it to lose its peg to the dollar on Friday, hitting a low of 88 cents. It has since recovered, recently trading at 96.03 cents, according to CoinMarketCap. Circle vowed that the coin will remain redeemable for full value against the dollar soon.
• The Federal Reserve faces a tough choice as well. The U.S. central bank’s policy committee, which has been aggressively fighting inflation by raising official interest rates, is due to meet again March 21–22. Data released Friday showed strong U.S. job growth, which could be interpreted by the Fed as a sign favoring further rate increases to keep the economy from overheating. But now Fed governors will also have to weigh whether further hikes could destabilize the financial system by undermining banks’ bond portfolios.
• The debt ceiling debate also looms large in Washington. If Congress doesn’t raise the legal limit on the federal government’s borrowing by the summer, the U.S. could default on its payments against outstanding Treasury bonds, currently valued over $24 trillion. Any U.S. default could thus destabilize the entire global debt market and set off a 2008-style crisis.

Frankly, as someone who covered the 2008 fiasco for the Wall Street Journal, the debt ceiling strikes me as a particularly dangerous piece of the puzzle right now. Perhaps even underappreciated in the mainstream press as a potential trigger event. I’m worried much more about this than insitutions like SVB.

Conventional wisdom among U.S. political pundits right now is that the two parties in Congress will go through tough negotiations but ultimately reach some compromise to raise the debt ceiling in time. This is essentially what’s happened in the past.

But betting on normalcy or compromise hasn’t exactly been a high percentage the last few years in Washington. Regardless of one’s personal leanings, I think it’s safe to say these aren’t normal times in U.S. politics. At all.

To put it a different way, we’ve recently seen a non-trivial portion of Congress members posture their way through two presidential impeachments, an insurrection at the capitol that threatened their own lives, and a pandemic that’s killed more than a million Americans and counting. At every turn, these people have worried more about attention seeking and personal brand building than shaping substantive policy to fix problems.

Why shouldn’t we think they would do the same through a U.S. Treasury default?

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Note: #Web3Weekly content is intended for journalistic purposes only, not as investment advice. Always DYOR and consult appropriate financial professionals before making investment decisions.

Best wishes for a healthy and productive week ahead.