A Tale of 2 Banks: Why Silvergate and Silicon Valley Bank Collapsed

It was the best of times … well, okay, my highfalutin analogy is already falling apart.

It’s just the worst of times.

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This week has seen major trouble for financial institutions tied to innovative and forward-looking sectors of the economy. Silvergate Capital, a holding company for a bank that since 2016 had bet big on servicing the emerging crypto economy, announced Thursday that it will wind down bank operations. Silicon Valley Bank (SVB), which has long played a similar role managing money for venture capital-funded startups, was shut down by state regulators Friday.

In broad strokes, both banks were undone by the same challenge: classic bank runs. Their erstwhile customers, whether crypto exchanges or tech startups, are facing broad business challenges thanks, in part, to economic and financial conditions. That has led to declining deposits and rising cash withdrawals at a time when a lot of the banks’ long-dated non-cash holdings were also being battered by the markets.

That meant when cash demands got high enough, Silvergate and Silicon Valley Bank had to sell those backing assets at substantial losses. Silvergate announced a $1 billion loss on the sale of assets in the fourth quarter of last year, while Silicon Valley Bank (with a larger overall balance sheet) also lost $1.8 billion while liquidating assets. In both cases, importantly, U.S. Treasury bonds made up large portions of the money-losing liquidations.

(This is a useful contrast with the inexcusably sloppy mischaracterizations of FTX’s collapse as a “bank run” by many major media organizations back in November. What happened at FTX has very little in common with the liquidity crises that have hit Silvergate and SVB.)

There are two upstream sources for these problems: Real business cycle issues, and Federal Reserve interest rate tightening. Those factors are also interrelated, and essentially go back to COVID-driven disruptions.

Fed rate hikes are the most immediate pressure that crushed Silvergate and SVB. I’ve been making a conventional warning in this space for going on a year: Rising yields on U.S. Treasurys would crowd out new investments in high-risk sectors including tech and crypto.

See also: Is Bitcoin an Inflation Hedge? Investors Are Still Unsure

But rising interest rates present another, seemingly widely overlooked threat to banks’ stability. As the Wall Street Journal explains in bracingly simple terms, the issuance of new Treasury bonds with higher yields has lowered the market value of pre-hike bonds with lower yields. Most banks hold large amounts of Treasurys as legally required collateral, meaning the same risk that hit Silvergate and Silicon Valley Bank applies to some degree to a whole lot of banks. That’s one reason bank stocks, particularly regional or mid-sized banks, are tanking across the board this morning.

But Silvergate and Silicon Valley Bank also faced specific business cycle issues that may not apply more broadly. Both catered to sectors – crypto and venture-funded tech firms, respectively – that saw huge runups in the early stages of the COVID-19 pandemic. Both sectors benefited from COVID lockdowns, and crypto in particular benefited from the pandemic relief checks sent to Americans.

That means both banks saw massive inflows through 2020 and early 2021. Silicon Valley Bank’s balance sheet tripled between the end of 2019 and March 2021. Silvergate’s assets also grew massively in 2021.

Both banks would have bought more bonds as collateral to backstop that deposit growth – at a time when rates on those bonds were still around 1%. Rates on new bonds are now closer to 4% thanks to Fed rate hikes, driving down demand for the older bonds. That’s why, at the exact moment customers in bubbly or reversing sectors started drawing down their deposits, Silvergate and SVB had to cash in liquid assets at a loss.

If you look at just one part of the picture you can probably cherry-pick reasons to blame this mess on whoever is most flattering to your personal biases. But it’s probably closer to the truth that everyone is simply escaping the same COVID-wrought shipwreck in the same leaky lifeboat, while fighting over who gets eaten first.

For example, some (particularly bitcoiners) will be tempted to blame the Fed for hiking rates, but that’s a genuinely necessary measure to rein in inflation. That inflation, in turn, was the result of both real cost rises linked to COVID-19, and a money supply significantly expanded by COVID relief and bailout policies. The net cost and benefit of those policies will take years to fully reckon with, but an anti-Fed critique at this moment is at best reductive.

On the other hand, it will be tempting for many in the mainstream to blame the cryptocurrency sector itself for the incipient banking crisis. The most obvious evidence for this claim is that Silvergate, “the crypto bank,” fell first. In the coming weeks you may hear it referred to as “the first domino to fall” or some such pablum, but that’s simply not the reality on the ground.

See also: 4 Potential Winners of the Silvergate Unwind | Opinion

Silvergate was indeed more fragile because it participated in a sector-wide degenerate long bet on crypto, one that was far ahead of the curve of actual adoption and sustainable revenue. But that’s not what caused its liquidity crisis, and its fall isn’t going to materially feed into any future bank failures.

Rather, every bank in America, whether they’re funding server farms or the literal corn and peas variety, is facing many of the same structural pressures. Their root cause is a massive real disruption in the economy – a virus that has killed more than six million people. If there’s one lesson to absorb right now, it’s that fiddling with financial levers can’t entirely smooth over that kind of real-world chaos.