What’s next after the failure of Silicon Valley and Signature banks

BY CARA EISENPRESS AND AARON ELSTEIN

Questions are swirling around the swift and surprising failure of two large regional banks and what it means for depositors, investors and the broader economy. Here's what we know about some key issues.

WHAT JUST HAPPENED AND WHY?

SILICON VALLEY BANK failed March 10, and Midtown-based Signature Bank followed suit March 12. Normally banks collapse when they’re overwhelmed by bad loans, but that’s not what happened here. Instead, Silicon Valley was brought down by too many depositors racing to withdraw money—$42 billion in deposits—at the same time. The panic spread to Signature, and regulators deemed that an unacceptable risk to the financial system, causing them to step in and shut down the bank.

COULD THIS HAPPEN AT MY BANK?

IS THIS A GOVERNMENT BAILOUT?

FOR ALL INTENTS AND PURPOSES, yes, although the government and banking industry officials were careful not to frame it that way.

Essentially, the federal government is now valuing the bonds on banks’ balance sheets at face value, not what they are worth today on the open market, in order to back-stop all deposits, even those above the normal limit of $250,000 per account. The transaction will make depositors whole, even those whose accounts were above the insurance limit, but will not protect shareholders. Regulators say taxpayers won’t be on the hook at all because any losses that cover uninsured deposits will be recovered by a special assessment on banks. Going forward, the government is guaranteeing that it will buy any safe assets—such as government-backed mortgage and Treasury bonds—on a bank’s balance sheet, even if they are technically illiquid, and no one but the government would buy them at face value.

DID THE CRYPTO CRISIS PLAY A ROLE?

BARNEY FRANK, a former director at Signature Bank, thinks so. But crypto’s collapse is a supporting player to the star of the show: rising interest rates. Higher rates forced Silicon Valley Bank to swallow a big loss when it sold Treasury bonds to meet depositors’ demand for cash. The bank’s depositors were especially anxious because the tech sector has had an awful year since the Federal Reserve started raising interest rates. It’s true that Signature Bank housed deposits for crypto exchanges and billions of deposits had left the door in the aftermath of FTX’s collapse. But before the run on Silicon Valley, Signature had reported deposit balances were steady.

WILL THE FED CONTINUE ITS PLANNED INTEREST RATE HIKES?

THE MARKET IS BETTING NO. Early last week futures traders bet the Fed would pause, at least for a while, now that the failures have revealed a downside of rate increases. The battle to bring down inflation continues, however, and the Fed may view bank failures as unfortunate but unavoidable casualties. February’s inflation reading ran slightly down from January, at 6% for the year, which could give the Fed cover to hold the line on rates. But 6% is still a lot higher than 2%, which makes the Fed’s deci sion more difficult. The other interest rate question, notes Nick Colas in his DataTrek newsletter, has to do with whether the Fed’s capital requirements are strict enough for the current moment. Banks have to hold a certain amount of funding in reserve to cover risky activities. But those levels “as sume very low Treasury rates in a crisis,” according to DataTrek. With rates high, they “are inadequate in the current environment.”

SVB AND SIGNATURE WERE unusual banks in that both specialized in serving businesses and had relatively few retail customers. Business clients (often with much bigger balances) are more prone to yank their deposits when they sense something is amiss, such as when Silicon Valley couldn’t raise cash to fill a $1.8 billion hole created by the bank’s selling Treasury bonds at a loss. When the government seized Silicon Valley, it said accounts whose deposits exceed the Federal Deposit Insurance Corp.’s $250,000 insurance cap would be given an IOU instead of a guarantee they could access their money. On March 12 the government reversed course and said all bank deposits would be guaranteed. Banks with large retail deposit bases such as JPMorgan Chase and Bank of America have been barely affected by the turmoil. Some regional banks, however, such as First Republic Bank, are seeing big share drops, suggesting wariness remains among depositors and investors.

HOW DO INTEREST RATES PLAY INTO SVB’S PROBLEMS?

SILICON VALLEY HELD OVER HALF of its deposits in longterm bonds purchased when interest rates were low, often less than 1.5%. Since then the Federal Reserve has been battling inflation, and interest rates have gone up to 4.5%. But when interest rates go up, old bonds are worth less. The shrunken assets were not a pressing problem until depositors asked for their money. That’s when the balance sheet problems became real. By the close of business March 9, customers’ requests had driven SVB’s cash balance to negative $958 million, according to paperwork filed with the state of California.