If you’re wondering why Silicon Valley Bank, one of the biggest lenders to tech start-ups, had to be taken over Friday by the Federal Deposit Insurance Corporation, one good place to look is the Federal Reserve.
The Fed has raised interest rates extremely rapidly over the past year to squelch inflation. So thanks to the Fed, banks are having to pay much higher rates on their deposits and other liabilities. But they’re not earning much more on their assets, which include the loans they make and the Treasury bonds they purchase.
The real problem, though, for banks — not just Silicon Valley Bank — is not so much the higher rates as the rapidity of their increase.
Here’s a professor from Silicon Valley — Darrell Duffie, a professor at Stanford’s Graduate School of Business — to explain the crunch: “Normally interest rates go up really slowly and depositors hardly notice that they’re not getting a very good rate relative to market rates.”
Slowly moving, inattentive depositors leave their money in low- or zero-yielding deposits, making the banks very happy, Duffie explained. And when interest rates rise slowly, banks have plenty of time to replace low-yielding assets with higher-yielding ones.
Not now though, Duffie told me. “This time has been quite different because the Fed has raised rates very sharply,” he said. “And it’s still raising.”
He’s right: The top end of the target range for the federal funds rate has zoomed from 0.25 percent a year ago to 4.75 percent now, and most forecasters expect the Fed to increase it an additional half a percentage point or three-quarters of a percentage point in coming months. For speed, that rivals the bursts of rate increases by the Fed from 1979 to 1981 under Paul Volcker.
So banks are paying much more to borrow but haven’t been able to increase the yields on their assets. For example, they can charge more for new loans, but they’re stuck earning low rates on the vastly larger number of loans they issued in the past.
It’s actually worse than that. To raise cash for withdrawals, banks are having to sell Treasury bonds whose market value has plummeted because of the Fed’s rate-raising campaign. (Bonds, which have fixed interest rates, become less valuable when new bonds come out that pay higher rates.)
Why Silicon Valley Bank, though? What made it especially vulnerable? One reason is that many of its loans are in the tech sector, which as you may have heard is hurting. Another, perhaps more important reason is that it relies heavily on deposits from institutions rather than individuals.
The people who run companies, investment funds and other institutions are always looking for the highest yield they can earn, so they’re quick to yank money from a bank and put it in, say, a money-market fund. Also, institutions will rush to pull their money out of a bank if they think it might go bust. Even if they’re convinced that the bank is solvent, they might take their money out because they fear others will pull their money out.
That’s a classic bank run. True, institutions’ deposits are protected by the F.D.I.C., but only up to $250,000, which is meaninglessly small for them. Before the F.D.I.C. takeover, Sunny Juneja, founder of Canopy Analytics, a Bay Area start-up focused on real estate technology, told The Times that he was “doing everything I can” to yank his money out of Silicon Valley Bank: Although the bank had been a good partner, he saw no upside to staying and no downside to leaving.
Silicon Valley Bank is “the slowest antelope in the pack,” Anil Kashyap, a professor at the University of Chicago’s Booth School of Business, told me.
Stock prices of some other regional banks have fallen as well. In contrast, the nation’s biggest banks — Bank of America, Citibank, JPMorgan Chase and Wells Fargo — have held up better because they rely more heavily on small individual depositors who pay less attention and move their money more slowly.
Anat Admati, a colleague of Duffie at Stanford, told me that banks would be less vulnerable to runs if they had thicker safety cushions of equity. That would mean less borrowing for any given level of assets, so that even if those assets lost a lot of value, they’d still be worth more than the liabilities.
The big question now, for markets and regulators, is whether many other banks are about to falter. To prevent a cascading financial crisis, the F.D.I.C. could insure all of banks’ liabilities, including all deposits without limit, as it did during the global financial crisis. But taxpayers wouldn’t like bailing out banks and their big depositors from their bad decisions. “Being so heavily indebted, banks always want to benefit from magnified upside (juiced by leverage) and leave downside to others,” Admati wrote in an email.
Besides, Kashyap said, “I don’t think that the banks that are essential to the health of the economy are anywhere close to insolvent. The regulators care about the system, not any particular bank. Maybe this wakes everybody up.”
Or maybe if more banks get in trouble, the Fed might slow down its pace of rate increases. Until now it’s been watching for signs that higher rates were affecting the nonfinancial parts of the economy. Somewhat surprisingly, the job market has held up well: On Friday, the Bureau of Labor Statistics reported that payrolls grew by 311,000 jobs in February. The unemployment rate edged up, but only to 3.6 percent, still very low by historical standards.
The Fed chair, Jerome Powell, and his fellow rate setters will surely be asked about how their policies are affecting banks in the weeks to come.
The Readers Write
Interesting newsletter on student loan forgiveness, but I believe the real problem is the obscene interest rates, particularly for loans taken out when interest rates were at historic lows. Why should someone have been able to take out a personal line of credit for $100,000 (which can be discharged in bankruptcy, while student loans cannot) for under 3 percent with the freedom to do whatever they want with the money, while someone who takes out student loans to attend, say, a state law school is stuck paying 7 percent or higher on federal loans? These are personal examples (I went to U.C.L.A. School of Law and it was worth it). If student loan interest rates were lower I bet more people would be motivated to pay them off! And we would show that we actually value education in this country.
Palo Alto, Calif.
You quoted Chief Justice John Roberts asking why the government should forgive a student loan but not the loan of an 18-year-old who borrowed to start a lawn service. A partial answer to Justice Roberts’s questions is that the lawn service person can get a discharge in bankruptcy. Making it easier to discharge a student loan in bankruptcy would be fairer than the Biden plan, but, of course, that would require legislation and the legislation is impossible.
The colleges and universities are the primary beneficiaries here. Just make them co-sign the loans!
Quote of the Day
“Alice laughed. ‘There’s no use trying,’ she said: ‘One can’t believe impossible things.’
‘I daresay you haven’t had much practice,’ said the Queen. ‘When I was your age, I always did it for half an hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast. There goes the shawl again!’”
— Lewis Carroll, “Through the Looking-Glass: And What Alice Found There” (1871); Project Gutenberg edition (2021)