“I’ve never really seen one, but that’s got all the earmarks of a run.”
The events of this last week reminded me of that famous scene from It’s a Wonderful Life. When my wife asked what was happening in layman’s terms, I said, “It’s like the It’s a Wonderful Life bank run scene, but with venture-backed startups instead of Bedford Falls’ residents and houses.”
“You’re thinking of this place all wrong. As if I had the money back in a safe. The money’s not here.”
Depositors hold money in a bank for perceived security and to earn interest on their money. Banks then lend out the deposited money, or in some cases, purchase high-quality securities when they are unable to originate enough loans. Loans are often held at book value, or the price it was issued at, and thus are considered held-to-maturity (HTM) assets. While held-to-maturity securities may have unrealized losses, banks typically have other sources of liquidity and likely won’t need to sell them prior to maturity (as the name implies).
“Your money’s in Joe’s house, right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others. Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can.”
During the COVID crisis, bank deposits shot up to historic levels, due in-part to both the massive government stimulus as well as cutbacks on expenditures for both households and organizations.[1] It takes time for banks to originate loans, and banks were often unable to put these deposits to work for them in such a short period. As a result, banks broadly increased their securities portfolios, buying Treasury securities, mortgage-backed securities, and other assets that were sensitive to interest rates, hoping to earn a yield.[2] Pair that with the sharp rise in interest rates throughout the past 18 months (generally, as interest rates rise, existing bond prices fall), and many banks marked large unrealized losses on their securities holdings, particularly on bonds with longer maturities / durations.[3] The unrealized losses were not only unprecedented from a historical context, but also happened concurrently with negative deposit growth as depositors left banks to seek higher yields elsewhere.[1][4]
Source: “Deposits, All Commercial Banks“. Federal Reserve Bank of St. Louis, 15-Mar-2023, fred.stlouisfed.org.
“I got two hundred and forty-two dollars in here, and two hundred and forty-two dollars isn’t going to break anybody.”
The psychology of a bank run has similarities to the Prisoner’s Dilemma, where cooperation leads to a mutually beneficial albeit slightly suboptimal outcome, but self-interested action from all parties leads to mutual destruction.[5] As depositors take their funds from a bank, part of that bank’s funding goes away, forcing them to sell assets. The Bailey Building and Loan (from It’s a Wonderful Life) nearly went under, had it not been for the honeymoon savings and the kindness of the depositors to take only what they needed.
Contrarily, the depositors at Silicon Valley Bank (SVB) weren’t quite as patient, and nearly caused a collapse of the entire bank.[6] In It’s a Wonderful Life, the Baileys were able to survive the day and close up shop, but in the era of digital banking and instant money movement (not necessarily bad things), SVB depositors could withdraw all their money with a click of a button instead of waiting in line. Fortunately for SVB depositors, they were backstopped by the Federal Deposit Insurance Corporation (FDIC) beyond just the $250,000 insurance, and the FDIC took over leadership of SVB as an FDIC-operated ‘bridge bank’.[7]
“We made it! Look, (as George holds up two bills) look, we’re still in business!”
While a massive crisis seems to be averted, at least for now, the overall dilemma has not been solved by the Federal Reserve’s intervention in recent weeks. While SVB had a concentration of depositors in the venture and technology space, and likely had mismanaged risk by buying too many long-dated securities, the asset-liability balancing act is the core tenant for how a bank works. Trust in the system and rational behavior is ultimately what keeps the banks solvent.
That does not mean that you should rush to the bank, pull out all your money, and stuff it under the mattress. The FDIC for bank accounts and Securities Investor Protection Corporation (SIPC) for brokerage accounts provide moderate levels of insurance.[8][9] Nevertheless, sound financial management from both the banks and depositors as well as regulatory protections are vital.
For example, Charles Schwab - one of our preferred custodians for client assets - has both banking and brokerage businesses, which are required to be held separately.[10] Their brokerage assets are segregated from Schwab assets, and are not comingled with assets at Schwab’s bank.[11] Customer securities - such as mutual funds and ETFs - are segregated in compliance with the SEC's Customer Protection Rule and protected against creditors’ claims.[11] There are also reporting and auditing requirements in place by government regulators. As a result, we believe that there are prudent risk management policies and practices in place at Schwab that help to limit the risk of what happened at Silicon Valley Bank.
We understand the events of the last week may have led to questions, and we are always willing lend an ear and discuss any concerns.
Important Disclosure Information & Sources:
[1] “Deposits, All Commercial Banks“. Federal Reserve Bank of St. Louis, 15-Mar-2023, fred.stlouisfed.org.
[2] “Treasury and Agency Securities, All Commercial Banks“. Federal Reserve Bank of St. Louis, 15-Mar-2023, fred.stlouisfed.org.
[3] “Federal Funds Effective Rate“. Federal Reserve Bank of St. Louis, 15-Mar-2023, fred.stlouisfed.org.
[4] “Historical Returns on Stocks, Bonds and Bills: 1928-2022“. New York University - Stern School of Business, 15-Mar-2023, stern.nyu.edu.
[5] “Prisoner’s Dilemma“. Stanford Encyclopedia of Philosophy, 02-Apr-2019, plato.stanford.edu.
[6] “What Happened With Silicon Valley Bank?“ Telis Demos, 14-Mar-2023, wsj.com.
[7] “FDIC Acts to Protect All Depositors of the former Silicon Valley Bank, Santa Clara, California“. The Federal Deposit Insurance Corporation, 13-Mar-2023, fdic.gov.
[8] “Deposit Insurance“. The Federal Deposit Insurance Corporation, 15-Mar-2023, fdic.gov.
[9] “What SIPC Protects“. Securities Investor Protection Corporation, sipc.org.
[10] “About Schwab - What We Do”. Charles Schwab Corporation, aboutschwab.com.
[11] “Your assets are protected at Schwab“. Charles Schwab Corporation, schwab.com.
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