SVB and Stopping the Contagion

Week #19

Hello! I’m Aaron Kardell. In this Sunday newsletter, I pick one random topic weekly to go deep on and have some disparate quick hits at the end.

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Imagine you’re running a business. You learn on Friday that your company’s funds are frozen, and you don’t have access to your primary bank accounts. Worse yet, this is due to no fault of your own but instead due to some poor management decisions at – your bank! Now your employees likely aren’t going to get paid next week.

Many suggest that 30-50% of venture-backed companies bank at Silicon Valley Bank. If you’re a tech CEO or CFO, the last 72 hours may have been the most stressful of your career. You spent much time wondering and planning what you’ll do if you don’t have access to a bank account on Monday.

Since late Thursday night, I’ve received 15 emails preparing for the potential fallout from the demise of Silicon Valley Bank. Some venture capitalists were planning for the ramifications to their own funds’ bank accounts, if they banked at SVB. All venture capitalists were concerned about what to do in advising their portfolio companies and how to get through this.

Fortunately for all involved, moments ago, a joint statement was issued by the Treasury, Federal Reserve, and FDIC. All the depositors of Silicon Valley Bank will have full access to their funds. However, the equity holders (owners) of Silicon Valley Bank will likely be wiped out in the process.

There seemed to be some confusion for a while, which often took the form of: “Why would the government bail out venture capitalists or silicon valley?” This talking point missed the more significant issue.

It’s one thing to say the investors IN Silicon Valley Bank shouldn’t be bailed out. That I agree with. The management and investors in Silicon Valley Bank should stand to lose their entire investment due to poor management. They don’t need to be bailed out.

It’s an entirely different thing to say companies and individuals who deposited their money there should lose access to it. As Mitt Romney said, “depositors should recover and have access to their deposits in order to meet their payrolls, pay their suppliers, and prevent contagion.”

If the government hadn’t stepped in here, hundreds of thousands would not get their payroll checks in the next week or two, and untold other second-order consequences would hit.

Moreover, everyone would be moving their funds from all regional banks and funneling them into a small number of “too big to fail” banks.

So what sparked this whole mess in the first place? It essentially comes down to two things.

First, SVB’s management team made some abysmal investment decisions. This wasn’t similar to 2008 – for the most part, they didn’t invest in “risky assets.” It was just poor management, plain and simple. They bought a LOT of long-term bonds. When interest rates started to go up, they didn’t move quick enough to counteract the moves.

So how can a “non-risky” asset blow up so quickly?

Let’s say I buy a 10-year bond for $100,000 that pays 1.5% annually. If I hold to maturity, I get a quarterly interest payment while I hold the bond and my $100,000 back at the end of the 10-year term. But what if, for reasons I didn’t foresee, I need to sell that bond to someone else in a year instead of holding it to maturity? If interest rates remain around where they were when I bought, I can probably sell the bond for close to the same $100,000 I invested to buy it. However, interest rates have increased to 5% since I bought them. Suddenly, no one wants to buy my bond at face value because the bond only pays 1.5%. I now have to sell the bond for a significant discount to make up for it. Maybe I only get $80,000 for it.

In the case of SVB, they had over $80 billion in these long-term bonds, only paying 1.5%. All would’ve been okay if they could have held them to maturity. But…

The second thing that caused SVB to blow up was poor communication by SVB about their situation on Wednesday, which led to fear and panic and many depositors wanting to pull their funds out on Thursday and Friday. Over 25% of deposits were withdrawn on Thursday alone. And if you hear everyone else is pulling out their money, you have no incentive to keep yours in and wait it out. This forced SVB to start selling many of their positions and taking on losses they may not have otherwise had to.

It was all very avoidable.

I could write many more paragraphs about this, but I’ll keep it simple. I’m glad the government stepped in. The trickle-down ramifications to the rest of the economy could have been bleak if they didn’t. Hopefully, this prevented the contagion from spreading.

To all of my founder friends – especially those of you banking with SVB – I hope you sleep easier tonight!

If you want to read more on this topic, check out the following two long reads, in order:

Why was there a run on Silicon Valley Bank?

Preventing panic in the banking sector

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This Week’s Quick Hits

• ChatGPT continues to blow my mind. I had a specific work task this week that either wouldn’t get done or would’ve taken me nearly an hour I didn’t have to complete. I chose a third path and asked ChatGPT to write some words for me instead. In less than five minutes, I made minor edits, finished the thing, saved an hour, and moved on to more productive activities. More to come on my ChatGPT findings in a future post.

Photo by Mariia Shalabaieva on Unsplash