Silicon Valley Bank run and banking crisis

From: allin

The recent banking crisis, highlighted by the Silicon Valley Bank (SVB) run and subsequent shutdown, has drawn significant attention. This event, alongside other banking issues witnessed in the past week, has been described as “absolutely terrifying” by observers watching people pull money out of banks and struggling to meet payroll [02:17:19]. The podcast hosts, serving as insiders, aim to be candid and transparent about the unfolding situation [02:43:05].

The Initial Alarm and SVB’s Collapse

The “alarm bell” was sounded after Silicon Valley Bank was placed into receivership, followed by additional bank runs [03:28:11]. The initial assessment by some was that SVB’s failure was based on “panicky VCs rather than a systemic problem in the banking system” [06:48:49]. However, this perspective was quickly challenged as the crisis spread [06:51:30].

Expanding Banking Crisis

The banking crisis quickly expanded, sweeping in five banks in roughly a week:

• Silvergate [06:41:59]
• Silicon Valley Bank (SVB) [06:46:12]
• Signature Bank, which was seized on Sunday, refuting the idea that this was solely a Silicon Valley problem [06:54:10].
• First Republic, which would have fallen without federal backstopping [07:03:00].
• Credit Suisse, which avoided outright failure due to a backstop by the Swiss government [07:10:07].

These are not small institutions, with Credit Suisse being a globally systemically important bank and the others being top 20-30 banks, involving hundreds of billions of dollars in deposits [07:20:41].

Underlying Causes

The primary cause of this larger phenomenon is not venture capitalists (VCs) as depositors, but rather banks having “huge unrealized losses on their balance sheet” [07:31:34]. These losses stemmed from the “sudden spike in interest rates,” a result of the “most rapid Fed tightening cycle in our lifetimes in the last year” [07:50:07]. The Federal Reserve funds rate went from roughly zero to almost five percent, breaking many financial systems [08:01:43]. Banks with pre-existing problems and “horrible risk management” were the first to break under this stress [08:10:07].

This issue was “hiding in plain sight” [14:31:36]. An article from Seeking Alpha on December 19th warned about SVB Financial, citing potential losses in loan portfolios, unrealized losses in held-to-maturity portfolios, and pressure on deposits from startup funding environments [13:35:10].

One of the foundational reasons for the current economic instability traces back to the COVID-19 pandemic response. The decision to “shut down the global economy” [15:06:00] and have governments “step in to write a giant check” [15:12:00] created a “giant gaping hole blown into the global economy” [15:43:08]. The subsequent strategy involved dropping rates to zero and massive government spending, which ultimately overshot, leading to too much stimulus and low rates for too long [15:22:04]. This resulted in an acute whiplash when rates were rapidly increased [15:38:00]. The economic loss from this period is still being processed and is manifested in the wipeout of equity and bank assets [16:35:00].

Specific Issues at Play

While traditional liquidity crises (duration mismatching) affected Signature, Silicon Valley Bank, and Silvergate, the issues at First Republic and Credit Suisse were different [09:59:09]. First Republic’s situation concerned ensuring its loan book and depositors could be handled by a combination of banks to prevent further liquidity issues [10:37:46]. Credit Suisse, conversely, had ample liquidity, with its panic being attributed to “speculation around whether they would default on their bonds or whether they would theoretically need more liquidity,” [10:53:30] exacerbated by cherry-picked comments from a 9.9% shareholder [11:11:42].

Blame and Scapegoating

There are “serious accusations” and “scapegoating” regarding the cause of the crisis, particularly targeting venture capitalists [04:42:09]. The Wall Street Journal editorial board was criticized for mischaracterizing efforts to highlight a regional banking crisis as “spreading panic” [06:03:00].

Six parties have been blamed for the crisis:

1. Bank Management: Clearly demonstrated “poor risk management” [18:52:00].
2. The Fed’s Rapid Rate Tightening Cycle: The combination of poor risk management and the spike in interest rates clearly precipitated the problem [19:08:49]. The Fed’s claim that inflation was “transitory” in summer 2021 prolonged spending and quantitative easing, creating a “bubble of 2021” and making the subsequent rate cycle more vicious [19:32:00].
3. Biden Administration’s Spending: While beginning with COVID-19 under the previous administration, the Biden administration “really intensified it” [19:21:44].
4. 2018 Deregulation: Elizabeth Warren and Ro Khanna have argued that the 2018 deregulation contributed to the problem [19:58:00]. Creating a two-tier banking system, with “systemically important banks” fully guaranteed and a “second tier of regional banks,” might have been a “poison chalice” [20:09:00]. While regional banks were more lightly regulated, it has created a situation where people are less confident, leading to money flows from regional banks to systemically important banks [20:37:38].
5. “Wokeness” / ESG: Some blame “wokeness” or ESG initiatives, seeing them as a distraction [21:04:00]. While these programs exist, their role as the “key factor” is dismissed, as it would imply the entire Fortune 500 would be out of business [21:12:00].
6. Venture Capitalists (VCs): This is a complex area. While some argue against blaming depositors, it’s suggested that the “complicated intertwined relationship between VCs and Silicon Valley Bank” warrants scrutiny [22:12:43]. VCs allegedly received cheap loans and credit lines from SVB, then directed their portfolio companies to deposit funds there, potentially leading to a “lack of functional responsibility around how to be a true fiduciary” [22:20:00]. Some VCs also had SVB as a limited partner in their funds, creating a conflict of interest [24:16:00]. This intricate relationship, and the lack of disclosure compared to public markets, is a reason some “point the finger at VCs” [25:18:00]. However, not all VCs engaged in these practices, and founders often have multiple VCs on their board [26:21:00].

Proposed Solutions and Future Outlook

Fed’s “Buyer of Last Resort” Facility

The Federal Reserve has effectively become a “buyer of last resort” [27:48:49]. They accept bank assets (like bonds bought at $1nowworth$0.95 or less) at face value, providing a dollar as a one-year loan at an interest rate of about 4.9% [28:08:00]. The total “underwater” assets from regional banks amount to about two trillion dollars, with potentially another one to two trillion for the top four banks [28:49:00]. This move essentially “kicked the can down the road for a year,” until March 15, 2024, at which point interest rates would likely need to be cut massively for banks to repay these loans [30:06:00].

Regulatory Changes and Accountability

Several tangible suggestions for systemic change include:

• Real-time Disclosure and Mark-to-Market: Banks should have real-time dashboards for regulators, possibly with daily, weekly, or monthly mark-to-market disclosures of their assets and liabilities [31:55:00]. Regulators should have “100 percent transparency” into how banks operate [46:48:49].
• Reversing Dodd-Frank Loosening: The loosening of Dodd-Frank rules under the previous administration, partly driven by Silicon Valley Bank, is seen by some as a significant mistake that needs reversal [14:13:00].

Broader Economic Challenges and Solutions

The core problem is the “massive cost” of shutting down the global economy during COVID-19, which is still being borne out [15:55:00]. Compounding this is the “global ship” being loaded with debt, reaching a 360% global debt-to-GDP ratio [18:00:00].

Beyond banking-specific regulations, broader economic solutions are needed:

• Higher Tax Rates: Significantly higher tax rates, particularly on corporations and high-net-worth individuals, might be the only “stop gap” in the next decade to address the tension between rising demands on the system (e.g., unfunded pension liabilities) and current productivity/capital markets [35:46:00].
• Extraordinary Productivity Gain: This includes breakthroughs in technology, AI, automation, energy (e.g., getting energy costs down to three cents a kilowatt-hour), which could cause the economy to grow fast enough to get out of the debt bubble and meet liability obligations [36:37:00].
• Austerity: Cutting spending is another potential way to address the issue [37:38:00].

Rethinking Banking Models

A fundamental question arises: do consumers want a “bank” or a “bank vault”? [38:23:00] Many consumers and small businesses do not want their deposits used for “shenanigans” [38:30:00]. The current model where opening a checking account is an “unsecured loan” to the bank is seen as “completely obsolete and outdated” [40:04:00]. Depositors are not in a position to evaluate bank balance sheets; this is the job of regulators [40:57:00].

The idea of a “bank vault” service suggests consumers would pay for banking services (e.g., 10-25 basis points or a monthly fee) without allowing banks to use their money for investments [38:48:00]. While this would mean banks charge for services rather than profiting from lending deposits, it offers absolute protection from bank failure [42:51:00]. The current system, where depositors are effectively “making a risky investment decision” by opening a checking account, is deemed ridiculous [43:30:00].

However, traditional banks play a critical role as lenders, channeling capital to small businesses and individuals for mortgages [47:12:00]. If the lending aspect is too stifled, it could adversely affect economic growth and prosperity [48:12:00]. Shifting all deposits to money market funds would remove trillions from the system that are currently used to fuel purchasing in the form of loans [49:33:00].

Practical Advice for Founders and Individuals

In the absence of regulatory changes, individuals and founders can take tangible steps:

• ICS Insured Cash Sweeps: These accounts automatically distribute money across multiple FDIC-insured institutions, up to the $250,000 limit per institution [51:29:00].
• Increased FDIC Limit: The current $250,000 FDIC limit is considered outdated for businesses and should potentially be doubled or tripled [51:51:00].
• Treasury Direct.gov: Businesses can directly buy short-term government debt (T-bills) to hold themselves [52:02:00]. However, caution is advised as startups often underestimate when they will need their cash, leading to duration mismatch problems [52:26:00]. A better approach is to invest in a “100 percent UST Bill backed money market fund run by the absolute biggest of the big financial institutions,” offering liquidity and no fees [52:48:00].

The current situation requires a “financially sophisticated actor on the board” of startups, ideally a venture capitalist, who should not have conflicts of interest with the banks they direct companies to [53:51:00]. Founders should also have multiple banking relationships for redundancy [54:16:00].

Impact on Venture Capital and Startup Ecosystem: The Venture Reset

The crisis also highlights a “hard reset” [58:29:00] in the venture capital and startup landscape:

• Founders Fund Splitting Funds: Founders Fund split their latest fund (originally $1.8billion)intotwo$900 million funds [54:39:00]. This suggests that “smart investors” believe “all roads lead to it says we’re in for a slog” [55:10:00], making it economically unwise to deploy a large fund in the current environment [55:16:00]. Peter Thiel reportedly led this charge [55:24:00].
• Stripe’s Valuation Haircut: Stripe, considered one of the “best run, most highly valued company in Silicon Valley,” took a 50% valuation haircut [55:49:00]. This will “eviscerate” theoretical money in many portfolios [56:02:00].
• Sequoia’s Returns: A FOIA request for UC Berkeley’s investments revealed that Sequoia, despite its reputation, has not “done that well” since 2018, returning only about $40milliononover$800 million invested [56:11:00]. This implies UC Berkeley is effectively “out of business” as a limited partner for the foreseeable future [01:00:53]. While funds go through a “J curve” where initial value drops due to fees before investments mature and are marked up [01:02:40], these funds are beyond the typical 5-7 year period to return 1x DPI [01:01:59].
• Tiger Global’s Write-downs: Tiger Global wrote down the value of their private book by 33% for 2022, effectively going from $100billionto$50 billion in a year [56:41:00].
• YC Disbands Growth Team: Y Combinator (YC) let go of their growth-stage investing team (Continuity Fund) and 17 employees [56:57:00]. This signifies a refocus on their core strength: early-stage companies [57:13:00]. Even for a growth fund attached to a successful funnel like YC (6% unicorn hit rate), being successful was challenging [57:41:00].

This combination of factors indicates a “complicated place in venture capital and startup land” – a “reset” where it’s tough to make money, valuations are “totally wrong,” and significant cleanup work will take years [58:08:00].

Despite the challenges, some believe it’s a “better time” to be an investor now than two years ago because valuations have corrected [01:04:09] and an “interesting AI wave” presents new opportunities [00:59:00]. The market overbid asset prices, but fundamental business value is still being created [01:04:16]. This period marks a shift where “theatrics and white papers and ICOs and just nonsense and absurd valuations” are over [01:15:00]. The focus is now on “dogged, pragmatic, absolutely customer-centric, product-centric Founders” who are actually building minimum viable products (MVPs) [01:07:05]. The “milestone-based funding was so broken and now it’s back and it’s so functional” [01:20:00], reflecting a return to a “reward-based system” in Silicon Valley [01:08:00].