“We hold these truths to be self-evident, that all men are created equal….” Banks? Not so much. Last Friday Silicon Valley Bank failed, and as is the nature of the financial media, they have stoked fear at every turn. There are laws against yelling fire in a crowded theater, and there should be laws about trying to frighten people in the financial markets for ratings.
One of the lessons we obviously did not learn from the 2008 financial crisis is that the term bank can apply to all different kinds of financial firms. The retail bank is where most of us have exposure: They hold personal checking and savings accounts and provide loans for things like cars and home purchases.
The next bank is a commercial bank. Often part of the same bank, the commercial bank provides loans and banking services to businesses. They tend to be very conservative, and most small businesses must find financing elsewhere until they have been able to establish good credit. Both retail and commercial banks are frankly boring, and when it comes to something that should be stable and reliable, boring is a good thing.
The next bank type is the investment bank; this is where the action is. These bankers are deal makers, helping startups get funding, bringing private businesses to the public market and funding mergers and acquisitions between companies. This is the heart and soul of Wall Street (assuming Wall Street has a soul).
There are also mortgage banks that do nothing but home loans, and there are trust companies that custody assets held in trust for various types of beneficiaries. We often do not get into this detail because it is needlessly complicated, but most 401(k) plans are actually trusts, held by a corporate trustee.
What is my point? Silicon Valley Bank is not a typical bank. They were a commercial bank that specialized in providing banking services to technology startups. This is not your grandparents’ savings and loan; this is just about as risky as a commercial bank can get. In addition, they seem to have been incompetent. I know Californians march to a different drumbeat, but were they unaware that the Fed had been raising interest rates for a year now?
They went under because of losses in their bond portfolio. Were they unaware of hedging strategies? Did they not realize the yield curve has been inverted, meaning shorter term bonds actually pay more? Well, they did have an unfilled opening for a risk manager…won’t need that anymore.
The other failures over the last week are all crypto-related. One of them had Barney Frank, former congressman of Dodd-Frank financial reform fame, as a board member…this is why I don’t see the need to read fiction – no author would have dreamed of that.
These failures are all very risky endeavors and not indicative of any problem in the normal banking system. However, all banks are always vulnerable to a run. As Jimmy Stuart taught us, the banking business model is to take deposits and loan that money out. Your money isn’t here, it is in Martini’s house – are you going to foreclose on your friend Martini? If every customer comes to the bank at once and asks for all of their money, the bank will fail. This is why we have FDIC insurance.
This is also why it is even more irresponsible than usual for the financial media to be stoking fear. We are not in a financial crisis, but we can be by the end of this week if everyone sells everything and hides the cash under their mattress. The banking system is built on trust, and while trust takes years to build, it can be destroyed by a simple rumor – which may be good for ratings, but is dangerous for society.
The Fed made it too easy to borrow money and they did it for too long. The crypto meltdown and SVB are symptoms of a lack of actual business maturity. It is a combination of apparent ignorance and astonishing arrogance. There will be more to report on this scenario, but meanwhile we should be thankful for prudent investing. Markets react negatively to shocks, but quality companies bounce back quickly. As I said often during the 2008 financial crisis, panic is never a good strategy, and this too shall pass.
Chuck Osborne, CFA