By: Ethan Erickson June 19, 2023
On Friday, March 10, Silicon Valley Bank collapsed, setting off a minor chain reaction. The Federal Reserve was forced to step in an unprecedented manner.
Experts believe the bank, which was the 16th largest in the United States, failed from a combination of complex factors. The first factor was a lack of deposits from its clients, many of which were high-profile tech companies such as Roblox and Roku. These companies have been recently struggling to raise capital due to interest rate hikes. The second was an exaggerated bond position (essentially low-risk loans to the government) that was opened during the COVID-19 recession when interest rates were very low. As interest rates have increased precipitously since then, the bonds have lost a lot of value.
The result was disastrous. When money isn’t coming in and liquidity (free-flowing available money) is tied up in declining long-term government bonds, a run on the bank is inevitable. Companies and individuals alike got scared and decided to pull their money out.
Luckily for everyone involved, the federal government stepped in. The FDIC (Federal Deposit Insurance Corporation) insures all deposits up to $250,000, so most of the average individuals were safe regardless of the event. In fact, the federal government extended this insurance to cover all deposits — saving the various tech company clients and averting an economic crisis in the process.
The Federal Reserve, in an effort to combat a global financial crisis reminiscent of 2008, changed the requirements for the discount borrowing window. This system is meant to allow banks to borrow money from the Federal Reserve against assets used as collateral (like the aforementioned bonds of Silicon Valley Bank). The only catch, however, is that the assets must exceed the value of the cash borrowed, which is meant to discourage banks from borrowing freely.
After the collapse of Silicon Valley Bank, this requirement has changed. Now the collateral must only equal the amount borrowed, leading to a significant uptick in the usage of the borrowing window.
Ideally, for Federal Reserve Board Chairman Jerome Powell, this measure would ensure banks have enough liquidity to remain solvent. Although, that has not been the case. In succession, Signature Bank, First Republic Bank, and Credit Suisse have all faced issues.
Signature Bank received the same deposit guarantee from the federal government as Silicon Valley Bank did before shutting its doors, but the response to the collapse of First Republic was very different. First Republic was kept afloat by 11 competing larger banks that were able to come up with over $30 billion. Their move reflects their belief that banks of all sizes, including small regional banks like First Republic, are important to the health of the U.S. economy. It is important to note that some experts think that the near-failure of First Republic was something of a fluke. They believe that fear from investors who moved their money into “too big to fail” banks like J.P. Morgan Chase was unjustified and had an unfortunate outcome.
The failure of Credit Suisse, a Swiss investment bank, has particularly scared investors that believe this issue could spread globally. While the Swiss central bank provided Credit Suisse with $54 billion to ensure investors could get their money out, many still are not convinced the worldwide economy is safe. The interconnectedness of the global economy gives many investors reason to believe that bank failures could continue to spread.
The coming weeks will be the most critical - all eyes are on the Federal Reserve and how well they can put out the forthcoming banking fires. Balancing these issues, while simultaneously trying to defeat inflation will certainly prove to be a Herculean task for Chairman Jerome Powell.