Silicon Valley Bank and Easy Money Policy
The 2008 banking crisis was a story of a rogue system. During the 2008 crisis, the entire system seemed to have been driven by greed. Bankers were taking risks that they obviously should not have taken. In short, the 2008 crisis was caused by the flamboyance and recklessness of the bankers at the time.
However, the Silicon Valley Bank is nothing of the sort. Silicon Valley Bank can be described as reckless. Instead, it was a boring bank that followed the rulebook and did exactly what it was supposed to do. Instead of investing money in high-risk high-yield instruments, the Silicon Valley Bank invested most of its money in boring government debt! Hence, recklessness is definitely not the cause of this crisis.
The fall of the Silicon Valley Bank points to deeper issues in the banking industry. Anyone who believes that the Silicon Valley Bank was caused by raising the interest rates should also acknowledge that the growth of Silicon Valley Bank was also the by-product of artificially low-interest rates and an easy money monetary policy.
In this article, we will have a closer look at the relationship between easy money and the Silicon Valley Bank fiasco.
- Rising Deposits: The Silicon Valley Bank crisis could become a huge event only because the bank had $220 billion in deposits. It needs to be understood that Silicon Valley Bank did not always have these deposits. In fact, the deposits of Silicon Valley Bank had almost doubled during the preceding two years.
The crisis would not have happened without this doubling of deposits or at least, its magnitude would be quite small. It is important to note that most of these deposits came into the Silicon Valley Bank because of the loose monetary policy of low-interest rates as well as quantitative easing followed by the central bank.
- Unsecured Deposits: Not only did the Silicon Valley Bank have a large number of deposits but it also had a large number of uninsured deposits. Almost 85% of the deposits present in the Silicon Valley bank were uninsured. Also, only about 3% of the banks deposits were below $250,000. This was also because of the easy money policy.
Since businesses across the United States were simply being handed out money, a lot of this money reached the banking system. Also, since the companies which the Silicon Valley Bank was dealing with, belonged to the tech sector, their deposits were increasing organically as well. The fact that most of these deposits were uninsured is essential since that is what ultimately triggered the bank run.
- Liquidity Trigger: From the above points, we can see that the monetary policy followed by the Fed was one of the key reasons behind the accumulation of these deposits. However, it needs to be understood that the liquidity event that ultimately caused the demise did not happen out of the blue.
Startups and tech companies which deposited money in Silicon Valley Bank started withdrawing money since they needed the money. This need for the withdrawal of money was caused by increasing interest rates which were nothing but a reversal of the earlier easy money policy.
Also, the value of the assets purchased by Silicon Valley Bank dropped. Once again, this was the result of the reversal of the earlier easy money policy. Hence, the sudden and steep rise in the interest rates caused the rapid pull-out of deposits just like the easy money policy earlier had led to a rapid increase in deposits.
- Belief That the Interest Rates Will Not Rise: The easy money policy i.e. the policy of sustained low-interest rates as well as quantitative easing had been followed by the Fed for a very long time. Hence, there was a sense of complacency and complete belief that these interest rates will not rise. This belief and complacency can be seen from the fact that the Silicon Valley Bank continued to purchase a large amount of government debt.
It is a known fact that government debt is very sensitive to interest rate announcements. However, the Silicon Valley Bank decided to not hedge its very large exposure. The analysts at Silicon Valley Bank do not seem to have believed that the Fed will raise rates so quickly and when it did, they were caught off guard and this led to the crisis.
- Bad Investments: After the fall of the Silicon Valley Bank, many are blaming the bank stating that it made bad investments in the technology sector. However, it needs to be understood that the investments seem bad now i.e. when the interest rates and the opportunity cost has risen very high.
At that time, when there was an atmosphere of low or even negative interest rates in the market, these investments seemed very profitable. Hence, the artificially lowered interest rates caused the malinvestment which is contributing to the downfall of the Silicon Valley Bank today.
The fact of the matter is that the Fed and its easy monetary policy have had a huge impact on the Silicon Valley Bank crisis. It is also important to realize that there might be many other banks akin to the Silicon Valley Bank which might go kaput because of similar reasons.
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