OpinionTrending Commentary

Silicon Valley Bank, Another Victim of Expansive Monetary Policy

If you’ve checked the news recently, you’ve probably witnessed headlines and front pages dominated by the story of the United States’ second biggest bank failure in history: that of Silicon Valley Bank, or SVB. The failure began when the Santa Clara-based commercial bank, and the 16th largest in the United States, announced to investors last week that it needed to raise more than $2 billion in funds for its balance sheet, a small ask compared to its $212 billion in total assets.

Nonetheless, in just one day its holding company’s stock sunk by over 60 percent as its customers, mainly tech startups, withdrew $42 billion of deposits from the bank, leaving it with a negative cash balance of $958 million. Now, worries have grown that SVB is only the first in a line of many banking casualties, with New York’s Signature Bank suffering a similar fate as SVB on Friday.

As pandemonium continues to hit much of the financial world after its collapse, a question worth asking is how SVB arrived at such a dire situation in the first place, suddenly and surprisingly announcing its need for billions of dollars in funds. Although pundits and politicians have pointed blame in a number of directions, from venture capitalists to diversity, equity, and inclusion, an often-overlooked culprit in SVB’s spectacular rise and fall is another United States bank: the Federal Reserve.

While an undoubtedly complicated story with a number of perpetrators, the role of the Federal Reserve and its expansionary monetary policy over the pandemic cannot go unnoticed, with SVB’s (and other banks’) unhealthy reliance on the Fed’s unprecedented measures taking a turn for the worse once interest rates began to rise. By scrutinizing the Fed and SVB’s decisions over the last few years, we can learn how to avoid a banking failure of similar magnitude in the future.

Loose Monetary Policy & Balance Sheets

Over the course of the pandemic, banks in the United States found themselves with an influx of cash thanks to the Fed’s unparalleled monetary policy, which saw the money supply increase by over 40 percent in a little over two years through measures such as quantitative easing, the establishment of new lending facilities, and the reduction of interest rates to near-zero levels.

As a result of these actions, the total value of all assets owned by commercial banks (banks that accept deposits from the public, like SVB) grew by over 27 percent, as banks heavily invested their new cash into bonds such as Treasury securities and mortgage-backed securities. Of SVB’s $212 billion in total assets, for example, $117 billion of it was in securities like those mentioned above.

Why bonds? Because the value of bonds rises as interest rates fall. So as the Fed both slashed interest rates during the pandemic and bought trillions of dollars in bonds through quantitative easing (thus increasing their demand), the value of bonds sharply increased. Commercial banks picked up on this upward trend in the value of bonds, buying large amounts of them with hopes to sell them at a later date, profiting off their rising value.

While both Treasury securities and mortgage-backed securities did appreciate over the pandemic, rampant inflation that naturally followed the Fed’s massive monetary expansion forced the central bank to quickly raise interest rates to combat rising prices. What this obviously meant, in turn, was a sharp decline in the value of the bonds that commercial banks were holding in large sums, since interest rates and bond values are inversely correlated.

For SVB more than other banks, this spelled trouble. Almost 43 percent of its portfolio had been invested in bonds, a portfolio that had suffered from $15 billion in losses by the end of 2022. Despite SVB’s size, its lack of diversification in assets and its reliance on tech startups—which are especially sensitive to interest rate increases—rendered it vulnerable to the Fed’s sharp reversal in policy.

Tech companies’ withdrawals of deposits over the last year, and SVB’s increasing inability to finance them due to its declining balance sheet, reached a breaking point a week ago when the bank made its announcement, triggering a bank run. Nonetheless, SVB’s sudden and swift collapse could spell trouble for other commercial banks.

According to the Federal Deposit Insurance Corporation (FDIC), by the end of 2022 US banks held $620 billion in unrealized losses, or assets that have declined in value but haven’t been sold yet. FDIC Chairman Martin Gruenberg states,

“The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies… “Unrealized losses weaken a bank’s future ability to meet unexpected liquidity needs (unexpected withdrawals of deposits).”

Drawing Conclusions

An important reality of SVB’s demise, and its gloomy implications for other commercial banks, is that there isn’t just one culprit. Sure, SVB could have diversified its balance sheet more so that losses on its bonds wouldn’t have been as severe. It also could have purchased shorter-term bonds whose maturity dates came sooner. Indeed, writer Connie Loizos for TechCrunch may be right in her conclusion that “Silicon Valley Bank shoots (it)self in the foot.”

However, as alluded to by Gruenberg’s remarks, declining bond values have become a widespread threat to commercial banks’ balance sheets, with both Signature Bank and Silvergate being two other notable banks forced to shut their doors over the last week amidst declining balance sheets. In the midst of this troubling trend, the Fed may stand out as having provided the fuel for the subsequent fire. Bank analyst Christopher Walen contemplates in a tweet:

“Is it possible that nobody has asked Chair Powell about the deteriorating solvency of US banks due to QE (quantitative easing)? Where do you think that -$600 billion number will be at the end of Q1 23?”

The “-$600 billion number” is in reference to the FDIC’s estimate of US banks’ unrealized losses. Although any conversion from an expansionary to a tight monetary policy may warrant a decline in the value of bonds, the Fed’s unprecedented expansion of the money supply through the purchase of trillions of dollars in securities may have artificially pushed up their value, making bonds look like a much greater investment than they actually were and deceiving banks into widespread purchases that they’re currently experiencing losses in.

As the US battles with both a fragile banking sector and persistently high levels of inflation, it’s worth calling into question the Fed’s lack of restraint in opening the floodgates for money printing over the course of the pandemic. Whether or not the central bank can recognize and learn from its previous errors, however, remains to be seen.

Content syndicated from Fee.org (FEE) under Creative Commons license.

Agree/Disagree with the author(s)? Let them know in the comments below and be heard by 10’s of thousands of CDN readers each day!

Support Conservative Daily News with a small donation via Paypal or credit card that will go towards supporting the news and commentary you've come to appreciate.

Related Articles

Back to top button