If you haven’t been paying attention to the news for the past week or so, I’ll give you a quick run down. On March 10, Silicon Valley Bank (SVB), the largest commercial bank of Silicon Valley, home to tech giants like Meta, Alphabet, Apple and cutting-edge start-ups, collapsed as a result of one of the largest bank-runs since the Great Depression in the 1930s, where customers ran to the banks to withdraw over $42 billion in cash.
Over the past two years, the Federal Reserve (the Fed), the US’s central banking system, has been raising interest rates in order to balance inflation. With high interest rates making borrowing expensive, tech and business investors began pulling their money out of banks, instigating a panic.
But America uses a fractional reserve system, in which our banks hold only a fraction of our deposits in their reserves and loans out the other portions to buy government bonds or property to make profits. Since a large portion of SVB’s financial holdings were long term government bonds, whose value decreases as interest rates increase, their assets fell. Therefore, when everyone rushed online to withdraw their money, SVB became insolvent, meaning the bank was unable to pay their debts, and did not have sufficient enough funds on-hand to give to the public.
In response to their lack of cash, SVB attempted to remedy their issue by selling their $21 billion bond portfolio and increasing the number of their stock market shares (IPOs). However, their endeavor to recover money failed as they incurred a $1.8 billion loss and their stocks dropped by more than 60% by the end of the day. At this point, the SVB shut down and the Federal Deposit Insurance Company (FDIC) stepped in and assumed receivership of the company’s assets.
So what is the issue with the bank shutting down? The initial issue was that when the FDIC assumed receivership of a bank, it was appointed custody of the bank’s property, finance and business operations and the FDIC would pay depositors up to their $250,000 limit. Fortunately for SVB’s clients, who are much more likely than the average consumer to store over $250,000 in their bank accounts, the Biden administration has stepped in and ensured that all deposits will be insured.
For the richest people in America, there is no issue. But for the rest of America, the situation has pushed the federal government and the Fed’s actions into the spotlight, and not a very good one either.
Not without good reason, the government took upon itself the burden and responsibility of paying back SVB’s depositors in full as the FDIC’s main goal is to ensure that financial crises are avoided, of which an incident like SVB’s implosion could certainly evolve into. However, when we think about the financial issues that ordinary Americans face, like student debt, minimum wage laws or a lack of funds for welfare programs such as Social Security or Medicaid which hit home for many people, the government does not bail the victims of these incidents out.
When these types of topics appear in the news, the government’s first response is to think about the budget rather than the impact that solving the issue would have. Meanwhile, the government was so quick to react and pour tens of billions of dollars into resolving SVB’s debts. Where is this money coming from? Straight from the government’s pockets and likely from our own pockets as well.
Knowing that the government will act as a backstop, bankers and investors will become more reckless, rather than more cautious, and end up putting more burden onto the American economy and citizens.
A special thanks to Professor Abeberese.