That's how capitalism works

‘That’s how capitalism works.’

With that quote, President Biden, Monday morning, addressed heightened stress in the banking sector. Over the last ten days, events immediately recalled the ghosts of 2008. Three banks failed within a week. Silvergate Capital was the first as they chose independently to wind down operations on March 8^th. Silicon Valley Bank failed by March 10^th, and on March 12^th, it was announced that Signature Bank had also failed. For those who lived through the great financial crisis, all this can be a little triggering.

However, as long-term investors, it’s prudent to take a breath, look at things objectively, and wonder, “What is actually going on right now?”

What happens in a bank failure?

When a bank fails, it no longer has enough liquid capital (cash in “the bank,” pun absolutely intended) to satisfy the obligations of its depositors and creditors. Usually, when a bank reaches this point, it tries to raise capital from investors. If it can't do that, the Federal Deposit Insurance Corporation (FDIC) will come in, shut down the bank, and take over while guaranteeing a certain amount of liquidity for deposits. The FDIC will then sell the bank's assets to other institutions. [1] For those of us in Washington state, we all know what happens at that point since many of us are now customers of JPMorgan Chase instead of Washington Mutual.

What does FDIC Insurance even mean?

In normal times, the FDIC insures deposits up to a limit of $250,000. However, there is some additional flexibility beyond that point [2]. That limit becomes problematic when depositors, especially small businesses, require accounts far more than that amount. This was the case at Silicon Valley Bank and Signature Bank, where it was reported that 97% of deposits exceeded the FDIC limit [3]. What happens then?

In abnormal times, the perpetual state of affairs since 2020, the FDIC can take emergency measures. In fact, it was announced in a joint press conference with Jerome Powell and Janet Yellen on Sunday, March 12^th, that, in this case, all deposits would be insured 100%, and as of Monday, March 13^th, depositors were able to withdraw their money in full. Especially important for businesses that need to meet payroll and pay bills.

This is also a dramatic shift from how the government and the Fed handled the GFC. They’re bailing out the depositors, not the bankers and the investors. When asked if there would be a bailout for these banks, Secretary Yellen replied, “We’re not doing that again.” [4]

What exactly happened to these banks?

All of these banks share two things in common. First, they concentrated heavily on start-up financing for technology and life sciences companies, inherently high-risk, high-reward endeavors. When these companies struggled as interest rates rose, those investments were stressed. These banks failed to diversify. Second, these companies all share some exotic risk-management techniques. Both these things compounded when Peter Thiel called for VCs to follow his Founder’s Fund in withdrawing money, and about $42 billion of deposits were withdrawn within a day [6]

And that’s really the meat of the issue, isn’t it? Risk is an inherent part of life, and one of the oft-cited quotes, as applicable to personal finance as it is to banks of all sizes, is that “Risk cannot be destroyed, only transformed.” It’s why we have emergency funds, it’s why we save and invest for the future, and it’s why we purchase things like health insurance. These banks got over their skis. They didn’t understand the risk. That’s where we can come back to the quote from President Biden early Monday morning, “That’s how capitalism works.” These banks forgot the cardinal rule of investing and did not fully respect their risk.

As with anything in finance, there’s a simple answer and an exponentially more complex one. If you’d like to dive in more, there’s an excellent piece written by Marc Rubenstein at Net Interest [5] that talks about some of the intricacies.

What does this mean for me?

First and foremost, if you know people who work at small to midsize tech companies who might need some support, as many of us do in “interesting times.” Reach out to them and check-in. See how they’re doing. It’s stressful right now, and they might appreciate it.

Second, we pride ourselves on making sure our clients are in a secure position. Whether it’s analyzing our clients’ cash position to make sure they have adequate emergency funds or taking a diversified risk-sensitive approach to your portfolio and structured financial plan that can help weather tough times and see the benefits of the upside when it comes. Despite the unsettling banking situation, investors can feel comfortable knowing their money in bank checking, and savings accounts (and CDs) is safe, backed up by the example of swift government action in these extreme cases. We also offer a range of FDIC-insured products to diversify our client exposure. The value of these broad options is that we will continue to ensure your financial safety is our priority.

Lastly, if you are nervous, call your advisor. We’re here to help, now more than ever, even if you just need someone to discuss these complex issues. Feel free to reach out to your advisor at any time. We will closely monitor the situation in the days ahead and evaluate any possible impact on your portfolio and financial plans.

It’s a weird world out there, and our promise to you is that you don’t need to feel like you’re alone in it; we’re all in this together.

References:

1. CBS News. (2023, March 12). Silicon Valley Bank fails, stock trading halted amid broader industry fallout. https://www.cbsnews.com/sanfrancisco/news/silicon-valley-bank-stock-trading-halted-financial-tech-industry/
2. (n.d.). What We Do. https://www.fdic.gov/about/what-we-do/
3. (n.d.). Deposit Insurance. https://www.fdic.gov/resources/deposit-insurance/brochures/insured-deposits/
4. (2023, March 12). Treasury Secretary Janet Yellen says US government won't bail out Silicon Valley Bank. https://www.cnbc.com/2023/03/12/treasury-secretary-janet-yellen-says-us-government-wont-bail-out-silicon-valley-bank.html
5. Rubenstein, M. (2023, March 10). The demise of Silicon Valley Bank. Net Interest. https://www.netinterest.co/p/the-demise-of-silicon-valley-bank?utm_source=Reading+List&utm_campaign=5c885d6cf6-EMAIL_CAMPAIGN_9_13_2020_12_27_COPY_01&utm_medium=email&utm_term=0_325454c9ab-5c885d6cf6-513930667
6. Baker, L., & Basak, S. (2023, March 11). SVB Depositors, Investors Tried to Pull $4.2 Billion on Thursday. Bloomberg. https://www.bloomberg.com/news/articles/2023-03-11/svb-depositors-investors-tried-to-pull-42-billion-on-thursday?leadSource=uverify%20wall