From: allin
The recent banking crisis, highlighted by the bank run on Silicon Valley Bank (SVB) and subsequent shutdowns, has brought significant attention to the underlying macroeconomic factors impacting the financial system [00:02:00]. This period has been described as “terrifying” by some insiders, observing people pulling money out of banks and struggling to meet payroll [00:02:17].
The Banking Crisis: An Overview
Multiple Bank Failures
In roughly a week, five banks either failed or narrowly avoided outright failure:
- Silvergate [00:06:41]
- Silicon Valley Bank (SVB) [00:06:44]
- Signature Bank [00:06:54]
- First Republic Bank – Backstopped by the Feds to prevent collapse [00:07:03]
- Credit Suisse – Avoided failure due to backstopping by the Swiss government [00:07:10]
These were not small institutions; Credit Suisse is a globally systemically important bank, and the others are top 20-30 banks, involving hundreds of billions of dollars in deposits [00:07:21]. SVB, Signature, and Silvergate experienced traditional liquidity crises due to duration mismatching, where short-term deposits were invested in long-term assets, leading to huge unrealized losses when depositors wanted their money back [00:10:06].
Misinformation and Scapegoating
There have been accusations of venture capitalists (VCs) spreading panic and causing bank runs [00:05:46]. However, the timeline shows that VCs tweeted about SVB only after it was in receivership and other bank runs had already begun [00:08:42]. The notion that VCs, as one class of depositors, are to blame is dismissed, as the problem is systemic [00:06:48]. A particular critique against VCs in the SVB case is the “complicated, intertwined relationship” where VCs received cheap loans and lines of credit, then directed their portfolio companies to hold deposits at SVB. This created incentives that might have led to a lack of “functional responsibility around how to be a true fiduciary” [00:22:10]. Some VCs also had SVB as a limited partner (LP) in their funds, creating a conflict of interest that should have been disclosed [00:24:15].
Key Macroeconomic Factors at Play
The crisis stems from a larger phenomenon not caused by depositors [00:07:31].
Interest Rate Hikes and Bank Balance Sheets
Banks hold huge unrealized losses on their balance sheets due to the sudden spike in interest rates [00:07:47]. The Federal Reserve’s (FED) rapid tightening cycle, raising the FED funds rate from near zero to almost five percent in the last year, broke many things in the financial system [00:07:56]. Poorly run banks with pre-existing problems were the first to show cracks under this stress [00:08:08]. This is a core part of the market volatility.
Government Spending and Inflation
The FED raised rates due to inflation, which itself was caused by “out of control spending due to Covid” by both Republican and Democratic administrations [00:09:30]. The initial response to COVID-19 involved shutting down the global economy and government intervention with giant checks, which created a massive cost to be borne later [00:15:02]. The FED’s initial claim that inflation was transitory exacerbated the problem, leading to continued spending and quantitative easing (QE) for six more months, which created an economic “bubble of 2021” [00:19:30]. This delayed rate hikes, making the eventual tightening cycle more vicious [00:19:48]. These points are central to the macroeconomic discussion on inflation and Federal Reserve policy.
Regulatory Environment (Dodd-Frank)
The loosening of Dodd-Frank rules in 2018, pushed partly by Silicon Valley Bank, contributed to the crisis [00:14:13]. This created a two-tier banking system: systemically important banks (SIBs) were fully guaranteed and backstopped, while regional banks were more lightly regulated [00:20:11]. This structure led to a “poison chalice” for regional banks, as confidence shifted, causing money to flow from regional banks to SIBs [00:20:24].
The root problem also involves supervisory failure, as regulators should have real-time visibility into bank balance sheets for duration mismatching and escalated reports when banks like SVB overextended in Q4 2022 [00:12:18]. An article from Seeking Alpha published on December 19th, 2022, titled “SVB Financial: Blow Up Risk,” precisely identified the potential losses, unrealized losses equal to book equity, and pressure on deposit base from startup funding environment, indicating the problem was “hiding in plain sight” [00:13:33].
The Federal Reserve’s Response
The FED essentially created a “buyer of last resort” facility [00:27:42]. They allowed banks to give them assets (e.g., bonds bought for 0.95) and receive a loan at face value ($1) with interest [00:28:08]. This covers about two trillion dollars in underwater assets for banks outside the top four [00:28:47]. The incentive for banks is to immediately offload these assets to the FED, get a loan, and buy new, higher-yielding assets [00:29:05]. This is seen as kicking the can down the road for a year, as the problem will resurface unless interest rates are significantly cut to re-inflate asset values [00:30:06].
Long-Term Macroeconomic Challenges
The current banking crisis is a ripple effect of shutting down the global economy during COVID-19, which created a “giant gaping hole” that still needs to be addressed [00:15:02].
Global Debt and Unfunded Liabilities
The global economy is burdened with debt, with a 360% global debt-to-GDP ratio [00:18:00]. Additionally, there’s a “massive underfunding” of promissory obligations, such as pensions and Social Security, to the global workforce [00:33:58]. This represents a “critical macro tension” that will come to a head, as people expect their retirement benefits to keep up with inflation or be paid out as promised [00:34:48].
Potential Solutions: Taxation and Productivity
To fill this hole and avoid massive inflation, potential solutions include:
- Significantly higher tax rates on corporations and high-net-worth individuals [00:35:51].
- Extraordinary productivity gains driven by technology, such as AI, automation, and cheap energy [00:36:37]. If productivity grows fast enough, it could help the economy escape the debt bubble and meet liability obligations [00:37:00].
- Austerity measures or cutting spending [00:37:38].
The next U.S. election is predicted to focus on the need for fiscally responsible administration that controls the balance sheet [01:27:03].
Impact on the Investment Landscape (Venture Capital)
The current state of the market indicates a “hard reset” in venture capital and startup funding [00:58:08].
The “Hard Reset”
- Fund Size Reductions: Founders Fund, for example, is reportedly cutting its new fund in half (e.g., from 900 million funds) [00:54:46]. This suggests that “valuations and the marks that we think we have for existing companies and the future value that smart investors like this see all roads lead to it says we’re in for a slog” [00:55:02]. Peter Thiel is noted for leading this charge [00:55:24].
- Valuation Haircuts: Stripe, considered one of the best-run and highly valued private companies, took a 50% valuation haircut [00:55:49], which will “eviscerate… a lot of people’s portfolios” [00:56:02].
- Fund Performance: Sequoia Capital, a top investor, reportedly had poor returns for UC Berkeley’s investments made since 2018 [00:56:11]. Tiger Global also wrote down the value of their private book by 33% for 2022, with their overall value dropping from 50 billion in a year [00:56:43].
- Downsizing: Y Combinator (YC) let go of its growth team, signaling a focus back on earliest-stage companies [00:56:57].
While this period is challenging, the correction in valuations and the emergence of an “interesting AI wave” suggest that new vintages of VC funds will likely perform better than those from 2021 [00:58:51].
Shift in Investment Philosophy
The “hard reset” means that the era of “theatrics and white papers and ICOs and just nonsense and absurd valuations and people wanting credit for work not done” is over [01:07:15]. The focus is shifting back to “dogged, pragmatic, absolutely customer-centric, product-centric Founders” [01:07:11]. The “milestone-based funding” system is returning, where founders receive rewards based on actual work and product delivery [01:08:20]. This return to fundamentals makes it a “great time to buy… stock” for investors, as underlying business value is still being created in Silicon Valley, but asset prices are significantly discounted [01:05:03]. This ties into macro investing and financial market strategy.
Proposals for Banking System Reform
Real-time Disclosure and Supervision
One suggestion is to implement a real-time dashboard at every FED branch for every bank they supervise, providing immediate data on assets, liabilities, and duration mismatching [01:22:20]. This would allow for “real-time Mark to Market” of bank holdings [00:32:00]. The idea is to write banking rules not just on paper, but in software, ensuring greater transparency for regulators [00:46:02].
Rethinking Banking Models (“Bank Vaults”)
A proposal for consumers and businesses is to bifurcate banking into “bank vaults” and “banks” [00:38:41]. In this model, a “bank vault” service would act as a custodian of money, charging fees for services (e.g., payroll, wires) but not using deposits for loans or investments [00:38:52]. This would protect deposits from bank failures, as consumers are not equipped to assess a bank’s solvency [00:40:01]. The current model, where a checking account is an “unsecured loan” to the bank, is seen as obsolete [00:40:04].
Individual and Business Strategies for Deposit Safety
To mitigate risks, individuals and businesses can:
- Use ICS (insured cash sweeps) accounts that automatically distribute money across multiple FDIC-insured institutions (up to $250,000 per institution) [00:51:29].
- Advocate for a doubling or tripling of the FDIC 250K limit, especially for businesses [00:51:51].
- Consider investing in short-term government debt directly through TreasuryDirect.gov [00:52:02]. However, this carries risks of duration mismatch, as businesses may need cash sooner than anticipated [00:52:27].
- A better alternative for startups is a 100% UST Bill backed money market fund run by large financial institutions, offering liquidity and no fees [00:52:48].
- Founders and VCs should prioritize having multiple banking relationships to split deposits and ensure redundancy [00:54:16]. This also highlights contagion risk in regional banking.
The overall goal is to build a robust and transparent financial system that minimizes the impact of macroeconomic trends and prevents future crises, while still allowing banks to fulfill their critical role as lenders that fuel economic growth [01:17:16]. This requires balancing regulatory oversight with the need for capital flow to businesses and individuals [01:17:16].