Making money from a bank mistake

Making money from a bank mistake
Making money from a bank mistake

March 14, 2023

ASU economist Dennis Hoffman explains the fall of Silicon Valley Bank

Within a few days, Silicon Valley Bank (SVB) in California went from the belly to bail out.

The institution, which took care of technology startups around the world and was backed by billionaire entrepreneurs, is now considered the most significant bank failure since the Great Recession.

And there’s a tie to the Valley of the Sun: More than a decade ago, the bank put down roots in an upscale office on Tempe’s Hayden Ferry Lakeside.

The Biden administration recently announced that it would bail out the bank’s depositors, but not its executives or shareholders. This fiasco, which will now involve taxpayers’ money, is unfolding in real time and presents more questions than answers.

What went wrong will undoubtedly resolve itself through more federal investigations, congressional hearings and the legal system. But what is the immediate way forward?

Dennis Hoffman, director of the L. William Seidman Research Institute at the WP Carey School of Business and director of ASU’s Office of the University Economist, provided some answers to ASU News as this story unfolded.

Man in blue suit and tie smiles

Dennis Hoffman

Q: This is a complex story. In a nutshell, can you explain what happened?

Answer: SVB failed to plan adequately for the possibility that they would experience a significant loss of depositors. Its assets were neither sufficiently liquid nor large enough to compensate for the loss of deposits, and it could not tap into other resources in time to stem the tide.

Question: SVB was a unique bank with a unique purpose, and the investors were not mum and dad. Can you explain the importance of this bank and the significance of its failure?

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ONE: SVB addressed entrepreneurs and innovators in its loan portfolio, and the deposits consisted mainly of large technology firms and venture capitalists. When these depositors became restless and withdrew, contagion took hold and the bank could not recover.

Question: This happened in a time of light regulation. It seems that when an error like this happens, it is during this period.

ONE: We will learn much more in the coming months. But many community banks lobbied Congress for regulatory relief in 2018. Some of the tightest provisions of the Financial Choice Act (formerly Frank-Dodd) were removed for smaller banks; the reform proposal was adopted with a broad bipartisan majority. From history, it remains unclear whether the more burdensome regulatory constraints would have prevented this standard. In fact, the asset portfolio of SVB was in pretty good shape. Its reliance on large depositors with the ability to quickly move large deposit sums proved to be the bank’s downfall. It’s unclear whether the full Financial Choice Act would have accounted for that in a way that would have saved the bank.

Question: What should we do in the future to limit this atmosphere?

ONE: Bank owners will police to some extent. The owners and employees of SVB are out of business and have incurred significant losses. In the same way, localized banks will try to avoid ending up in a similar situation. More consolidation will help prevent this, but it is not clear that less competition in banking is good for the consumer. When the final report on SVB is finished, we will probably have a new round of regulations to prevent this from happening again.

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Question: The government has stated that they want to save the bank. How does this benefit the country and our citizens?

ONE: This is not true. Depositors were protected to prevent national depositors from withdrawing money from the banks. The owners of SVB lost their business. Equity shareholders in SVB lost everything. They are not rescued.

Question: Is it fair or accurate to say that we, the taxpayers, will bail out this bank, and if so, how will this affect us in the short and long term?

ONE: Depositor money will be collected by FDIC (Federal Deposit Insurance Corp.) funds, which come from fees paid by all banks. So the fees will increase. When banks pass these costs on to customers, the burden will be spread. It seems like a small price to pay to maintain the stability of the financial system. You can read about “Wildcat Banking” in the 19th century before we had regulations. Things were far worse than the events of the last week with SVB.

Q: What is the big lesson to be learned here?

ONE: The lesson will mainly fall on bank risk evaluators. If your bank has a fragile deposit base that can disappear within days, you need access to ready liquidity (cash). And in the face of a possible run on your bank, you must be prepared to calm the waters. If you fail to do this, you will not last long as a bank owner or investor.

Top photo illustration courtesy of iStock/Getty Images

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