What are Bank Runs? The SVB example.

Are you confident that your money is safe at the bank right now? The correct answer to that question is always and will always be no because there is no such thing as a safe bank. Regulators and bankers, politicians and governments have spent decades, if not centuries, attempting to persuade the public that banks are safe. Nonetheless, the second largest bank failure in US history occurred on Friday, March 10, despite all of the regulations, precedents for bailouts, and the advancements and safety nets in our banking system today.

Understandably, the nation's faith in monetary system has been shaken yet again. So, how did we end up here? What caused this to happen? And, more importantly, who will be next? We must first examine how banks operate to answer all these questions. According to Murray Rothbard's article "What has government done to our money?" the bank creates new money out of thin air. It is not required to obtain it by producing or selling services. In a nutshell, the bank is already and will always be bankrupt. Its insolvency is only revealed when customers become suspicious and conduct bank runs.

A deposit is a liability for a bank. This is how it works: you have borrowed money from the credit card company when you swipe your credit card, meaning you owe them money. A deposit to a bank is the same thing, that bank is now owing you money. To offset that liability, they must create an asset that equals the liability so that it is offset and balanced on their balance sheet. They accomplish this by purchasing or producing an asset, which is usually a loan for banks. They take the money that you deposit and lend it to someone else. And this is the first indication of the true problem. This entire industry is based on a concept known as maturity transformation. Your deposit to the bank is known as an on-demand deposit. You can come to get those dollars from the bank at any time, but they have loaned those dollars out in an on-demand loan, which means they will receive those dollars back at a specific time and on a specific schedule. These loans have a longer maturity than the deposit you originally gave them, whether an auto loan, a mortgage, or even a credit card loan.

In normal circumstances, this isn't a problem because as long as they can wait the entire time until that loan is repaid, whether it's the six years from your auto loan or a different time for a different loan, they'll get all the money back plus the interest and then, if you try to get your money back, they'll be able to give it to you. However, if too many people request to withdraw their deposits all at once, and the bank had made loans that are worth less than they were when they were made, they will have to sell those loans, take the hit, and may not have enough money left over to meet all of the withdrawals.

This brings us to the next topic, which is how bank runs occur. Bank runs occur when a specific set of circumstances happen in any bank.
The first condition is when you have an asset maturity mismatch when deposits are converted into loans or assets with a longer maturity date.
The second condition is that, for one reason or another, the asset value of the asset purchased declines.
The third condition is early or excessive withdrawals.
You have a bank run when all three of these conditions are met.

So what is maturity transformation in the first condition? When an on-demand deposit arrives, the bank converts those dollars that you can get at any time into a loan that they can't get back at any time.
The second condition was a decrease in asset values. In this case, it happened because interest rates rose. Bond prices and interest rates are inversely related.

This is how it works: Let's say you borrowed $100 from a friend at 1% interest, meaning you owe them $101 in total. Now imagine your friend needs to get out of debt urgently. They turn to another friend and explain, "Hey, I owe $101 to someone, but I'd like to settle the debt for less than that. Can you help me out?" The second friend agrees to pay $99 to take over the debt, essentially buying the right to receive the $101 payment from you later on.
As the borrower, you still owe $101 to your original friend, but they only received $99 from their other friend. This means that the second friend's effective interest rate is about 2% because they paid $99 to receive $101 later on. This may seem like a small difference, but it's important to understand its impact on bond prices and interest rates. When bond prices fall, yields (i.e., effective interest rates) increase. And as interest rates and bond prices are inversely related, a change in one can affect the other. So interest rates and bond prices are inversely correlated.

The third condition was early withdrawals, which can be prompted or triggered by anything. This occurs when too many people try to withdraw their money from the bank at once. The bank can be forced to sell off assets such as loans to try and meet the demand. The problem with this is that the value of those loans may have already decreased for various reasons, such as rising interest rates. So when the bank sells them off, they may have to take a financial hit.

Let's say you deposit $100 into a bank, and the bank lends out that money, then sells those loans for $99. Now imagine that too many people want to withdraw their money at once. The bank may not have enough cash to meet all requests because they only have $99 left after selling the loans. As the withdrawal requests continue, the situation can escalate quickly. What starts as whispers can turn into shouts; before you know it, a bank run can occur. This is when panicked customers try to withdraw all their money simultaneously, putting even more pressure on the bank. Unfortunately, if the bank cannot meet all of the withdrawal requests, it can result in a bank failure.

If this were to happen to you in this situation, the first thing you'd do if you suspected that they didn't have enough money is to go get your money out as quietly as possible. But once you get your money out, you'll call everyone you know you care about the most and tell them to get their money out and keep quiet about it. But they'll all do the same thing you did. They're going to get their money out and then call everyone they know and tell them to go get their money out. So it begins with rumours, then whispers, and finally shouts. Everyone goes to get their money, and then the bank fails.

So, let us now get into the specifics of what happened with Silicon Valley Bank. As you'll see, understanding exactly what happened with Silicon Valley Bank is critical because it gives you information about the other banks' state. It all begins with deposits, just like any other bank. SVB, in particular, was heavily focused on technology. Silicon Valley Bank receives deposits from many startups and technology companies. It ranks among the top twenty banks in the United States.
SVB had thousands of corporate deposits and over $200 billion in total assets at the end of last year. Silicon Valley Bank accepts deposits and then makes loans like any other bank, and they do so by either creating a new loan or purchasing an existing loan. Most of what Silicon Valley Bank did was buy previously existing loans to the United States Government. Over half of Silicon Valley Bank's assets were in Treasuries and agencies. This is not an extremely risky portfolio, by all accounts, this is a very conservative portfolio.

The next thing that happened was that interest rates began to rise last year. These bonds were purchased when interest rates were essentially zero, the lowest point in history. As a result, when interest rates begin to rise from there, the value of all those bonds begins to fall. However, the rate increase for Silicon Valley Bank is double whammy because tech companies have been hit recently by rate increases. Venture capital has been scarce. According to the report, many startups have been forced to withdraw funds from banks specifically held by Silicon Valley Bank.

In this case, Silicon Valley Bank had to make a difficult announcement: they did not have enough cash to meet the withdrawal deadline and would have to sell assets to meet the demand. However, the bank had purchased these assets when they were worth more than they are now, so selling them would result in a financial loss. Customers began to panic as the bank began to sell off assets to meet the demand for withdrawals. When one customer learned about the situation, they withdrew all of their funds and advised their friends to do the same. This triggered a chain reaction of panic and withdrawals, forcing the bank to sell more and more of its assets to meet demand. The bank eventually ran out of assets to sell and could not meet all redemption requests. This is a difficult situation for any bank, and it can have serious ramifications for the bank and its customers.

In a shocking turn of events, several prominent venture capitalists, including Peter Thiel, instructed their portfolio companies to withdraw cash from Silicon Valley Bank. Just 48 hours later, the bank collapsed - the second-largest bank failure in US history. Fortunately, the FDIC (Federal Deposit Insurance Corporation) stepped in to guarantee any account with Silicon Valley Bank up to $250,000 in value. To do this, the FDIC established a new bank - the Deposit Insurance National Bank of Santa Clara - and also provided access to up to $250,000 in funds by Monday, March 13. For those with accounts at Silicon Valley Bank exceeding $250,000, the bank will still meet redemption requests and deposits up to the extent they can as the bank's assets are sold off. This means that the bank is more likely to be bailed out, bought out, or absorbed by a larger player such as Goldman Sachs or Chase. But why did this happen in the first place?

It is due to who was exposed to Silicon Valley Bank. As I previously stated, a large number of tech companies had all of their money there. It worked with nearly half of all venture capital-backed startups in the United States. These businesses and investors have far more than $250,000 in their accounts. As a matter of fact, more than 85% of Silicon Valley Bank's deposits exceeded the $250,000 limit. As a result, the FDIC's intervention here means almost nothing for a bank like SVB. Nobody else intervened, and it was left alone. This could literally mean the demise of many brand-new tech companies and startups across the country. They could go bankrupt in a matter of days or weeks simply by not being able to meet their payroll because they had, let's say, ten million in the bank and now have zero.

The fall of SVB has left many questions unanswered. Two of the most pressing questions are: which companies kept the majority or all of their cash at Silicon Valley Bank, and who owns the majority of these companies? Answering these questions is important because if enough big banks have exposure to the equity ownership of these companies, they may be incentivised to absorb these assets and bail out the rest of the affected accounts themselves without needing the Federal Reserve to step in. In other words, if larger banks own a significant number of the affected companies, those banks may be able to take over the assets and deposits of those companies and avoid a larger-scale financial crisis.

The collapse of Silicon Valley Bank has left many wondering which bank will be next to fail. The problem is that all banks in the United States operate in a similar way: they accept deposits and use those deposits to make loans. Lending to the US government by purchasing treasuries is considered a safe investment for banks. However, as interest rates have risen from record lows to multi-decade highs in the last year, banks face significant unrealised losses. Even the top four banks in the US are dealing with major losses. This means that any bank run could have the same result as what happened with Silicon Valley Bank. If too many people try to withdraw their money at once, the bank may be forced to sell assets at a lower price than they paid to meet the demand for withdrawals. This can cause panic and further withdrawals, potentially leading to the bank's collapse. The lesson here is that the financial system's stability is fragile, and any bank can be at risk of collapse in the right circumstances. In an ominous echo of history, there have been no bank failures in the last two years, 2021 and 2022. The last time this happened was in 2005 and 2006, the years preceding one of the most severe bank failure periods in recent US history, suggesting that this is just another calm before the storm and that Silicon Valley bank may be the first domino to fall.

So there is some good news as well as some bad news. First, some good news. The good news is that we are unlikely to see a massive banking crisis in the United States in which all banks, including the big banks, fail. Three trillion dollars in bank reserves plus two trillion dollars in reverse repo facility means American banks have adequate capitalisation system-wide. It is concentrated in the largest banks, but it is sufficient enough to keep people from getting too spooked up to make enough withdrawal requests at the big banks to spark a bank run. However, this is not the case with small banks. Customers of small banks have been alarmed, and many started to pull their funds out quietly. This is a bad sign for small banks across the country because recent economic conditions have been extremely difficult for tech companies, requiring them to begin drawing down on a large portion of their cash, which sparked the bank run at Silicon Valley Bank. However, it has not been entirely limited to technology, and many people across the country have recently experienced difficult economic times. As a result, withdrawals have already begun and now that people are more concerned, even if there is nothing wrong on the surface with the small bank, simply moving it out to bigger banks like Bank of America, Chase, or Wells Fargo just in case.

This brings us to the real issue at hand, which is consolidation. Ten tyrants competing for power are better than one who has it all. A thousand small banks spread across the country means a far more robust and secure banking system than concentrating everything in the hands of the five largest banks. And you can bet that if we have a series of bank runs, and the next two are with small banks, everyone will take all their money out of the small banks and move it to the big ones, causing the collapse and consolidation of banking across the country into the hands of the big four or five banks.

Consider the following scenario: first is an epidemic of small bank runs; second, all of these small banks fail; third, the taxpayer must step in because the FDIC does not have enough money to cover larger than 250K deposits of those banks. So the taxpayer bails out the FDIC to meet all of these bank runs and collapses, and then all of the remaining assets are consolidated at the top to the big five. The nation is outraged now, furious at all of the banks taking excessive risks, making excessive profits in easy money times, failing to practise proper risk management, big bonuses for fat cats and bank executives, and now the big banks, who are the worst perpetrators of all, are reaping the benefits of the rest of the nation's banks collapsing.

In the aftermath of the collapse of Silicon Valley Bank, the government could potentially quickly pass legislation to nationalise the entire banking system under the FED. The idea is that this could help to prevent excessive profit-taking and ensure that nothing like this ever happens again. However, the implications of nationalising the banking system are significant. With full governmental control over the entire banking system, banks would become plumbing for the financial system under the FED rather than private businesses. This is also known as a central bank digital currency (CBDC), which some argue could lead to financial tyranny. The concern with a CBDC is that it would give the government complete control over the financial system, with the ability to monitor and control all financial transactions. This could lead to potential abuses of power and privacy concerns for individuals. While nationalising the banking system may seem like a solution to prevent future collapses and protect the financial system's stability, it's important to carefully consider the potential implications and consequences of such a move.

So the real issue here is banking consolidation and nationalisation in the United States. And I believe they are already on that path, regardless of whether we see another bank run, two bank runs, or even an epidemic of bank runs. And if it does escalate, we know that the banks deemed "too big to fail" will be the ones rescued. However, even Silicon Valley Bank, a top 20 American commercial bank, was allowed to fail. And once that power is concentrated in the hands of a few, it's only keystrokes away from being consolidated into one.