After Silicon Valley Bank’s failure, should you pull all your cash from the bank? Many of you have asked about what happened and if it’s safe to keep your money in the bank, especially a small one.
The TL;DR Answer:
As long as your accounts are at an FDIC-insured bank, and the total of each account is less than $250,000 per depositor, you’re fine. Please note that some accounts may have limits higher than $250,000 — for details click here to review the FDIC’s deposit insurance limits.
If you’re over the limit on any accounts, you may want to open new accounts to ensure that all your cash is covered (or move excess cash to a short-term Treasury ETF in a brokerage account).
As far as your investment accounts go, the cash in these accounts is protected by a different entity — the Securities Investor Protection Corporation (SIPC). So, there’s nothing you need to do there.
Markets will likely experience some gyrations over the coming weeks, as you would expect. There’s no need to deviate from your current investment strategy.
So, What Happened Here?
In the case of Silicon Valley Bank, only 7% of its accounts were FDIC insured. Think about this for a second. Most of the bank’s accounts were business accounts well over the $250,000 FDIC deposit insurance limit. We’ll come back to this in a second.
So, banks make money by having an interest rate spread between what they pay for deposits and what they charge for loans. It’s boring. And, of course, the bank just can’t lend out 100% of their deposits in case one of their depositors needs to make a withdrawal. So they have to carry a certain fraction of their deposits on their balance sheets for such events. This is what is known as “fractional banking”.
The reason why Silicon Valley Bank got over its skis was because of its balance sheet. They bought $80 Billion worth of Treasury bonds back when they were yielding 1.6% and proceeded to lend that money out.
The reason this became problematic was because of the interest rate hikes we saw last year. And it’s the reason that almost everybody’s investments were down last year – as interest rates rise, bond values drop.
So think of it this way. Let’s say you paid $1,000 for a CD from the bank that was paying 2%. A week later, the bank announces that their CDs are now paying 3%. Okay, that’s a bummer – while you could have gotten an extra 1% by waiting a week, you know that you’ll still get your $1,000 back, plus 2%, in 12 months.
You could always turn around and buy a higher-yielding CD at that time if you wanted.
But what if you needed to sell the CD before it matured? Nobody would pay you $1,000 for it because they could get an extra 1% over your CD from the bank. You’d have to sell it for less than $1,000 to get someone to accept a yield that’s 2% versus what’s available in the market.
That’s why bond prices drop when interest rates rise.
So when the Federal Reserve started jacking up interest rates last year, Silicon Valley Bank’s reserves started plummeting. Treasury rates are somewhere between 3.5% to 4% now, so these $80 Billion in Treasurys – even though they’ll be worth that much at maturity – aren’t listed for nearly that much on the bank’s balance sheet. This is because of “mark-to-market accounting”, something else that came out of the 2008 Great Financial Crisis.
Add to this that a bunch of these tech companies who banked with Silicon Valley Bank wasn’t doing too well – and were making withdrawals from their cash reserves. It put pressure on Silicon Valley Bank to shore up its balance sheet to look healthy.
Well, once the word got out that the bank was looking to borrow money to fix its balance sheet, some investors started to withdraw their money. And upon seeing this, other customers started to withdraw their money. Pretty soon, it turned into a classic bank run.
Remember those fractional reserves? Well, if too many customers want their money at once, there aren’t enough reserves to handle the withdrawals and the bank goes out of business.
And that’s what happened.
So the question became, does the government let Silicon Valley Bank go out of business and risk panicking the public? Do they broker a purchase deal with another bank that would want to buy Silicon Valley Bank’s customers? Or do they bail out the bank and risk the ire of the public?
It was a tough call.
Silicon Valley Bank’s failure was the second-largest bank failure in U.S. history. The largest was Washington Mutual in 2008. But it’s important to note that every customer of Washington Mutual got their deposits back, thanks to the FDIC.
For Silicon Valley Bank, the Fed and the FDIC took a hybrid approach. They would guarantee all of the customers’ deposits at the bank but allow the bank’s shareholders and lenders to get taken out.
They tried to walk the fine line between quelling the public’s fear of reliving the Great Financial Crisis and bailing out the bank – and creating more adverse incentives for financial firms.
But the interest rate risk that caught Silicon Valley Bank with its pants down is still out there. By insuring the bank’s depositors, the Federal Reserve has essentially provided an insurance policy for banks against interest-rate risk. And will the premiums on that insurance be passed along to smaller banks in the form of “special assessment fees” to cover losses from the FDIC’s insurance fund? It may be more of a bailout than we think.
Eventually, someone will purchase what’s left of Silicon Valley Bank. It wasn’t a bad bank, they just made a pretty bad balance sheet mistake by going all-in on those Treasury bonds in a rising interest rate environment. Someone’s going to get a deal on the good parts of the bank that are left when this thing is all said and done.
The question becomes, are there other banks out there with this kind of interest rate risk on their balance sheets? The Fed has already made a precedent by stepping in to insure the depositors of Silicon Valley Bank.
But what if another bank comes along and they don’t?
You know, kind of like Bear Stearns. Remember them?
However, I don’t foresee this as a risk right now. If there was one lesson for the Federal Reserve to learn from 2008, that was it. Right now, it’s best to turn off the news and stick to your long-term investment strategy.
We’ll be watching this carefully, and if anything changes, we’ll let you know.
If you need help with your investments and retirement savings, then click here to set up a quick, complimentary introduction call to see if Prana Wealth is a good fit. We do still have the capacity to take on new clients.
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