Joint statement by the Fed, Treasury, and the FDIC:
"Today we are taking decisive actions to protect the U.S. economy by strengthening public confidence in our banking system. This step will ensure that the U.S. banking system continues to perform its vital roles of protecting deposits and providing access to credit to households and businesses."
The government is bailing out corporate depositors of Silicon Valley Bank and Signature Bank. The announcement will stop a contagion of withdrawals from banks, i.e. a "run." Businesses with deposits greater than $250,000 will get FDIC protection. The banks' stockholders will be wiped out, but the depositors--even large ones--will be made whole.
Let me review how banking works. For some people this will be condescendingly obvious. For others, it will be a useful reminder. People know different things.
Banks take in deposits and then re-lend most of that money, making money on the spread between what they pay depositors and what they earn from loans they make. Banks serve depositors by storing their liquid money. Paychecks go in, mortgage payments go out. The bank keeps track of that money flow. For most individuals, that $250,000 insurance is ample. But many businesses keep a balance well above $250,000 to receive deposits and pay employees and vendors. Their intention is still to be depositors, not at-risk investors.
Normally the pool of parked money is predictable-enough that the bank can lend out most of it. A bank's loan portfolio is not liquid and stable in value the way checking account deposits are, which is a risk for banks. So they keep some cash in reserve to meet unexpected withdrawals.
The problem for Silicon Valley Bank is that they matched too many of their deposits from technology companies with two-year and three-year government bonds. This year's rapid rise in interest rates means that the current re-sale value of these bonds is less than face value.
U.S. government bonds change price on their journey toward maturity. SVB's portfolio of government bonds lost value because when they bought them a year ago interest rates on two and three year Treasuries were about 2%. Today they are about 4.6%. If SVB needs to sell their three-year bonds to meet redemptions, those bonds still have two years until maturity. Someone buying those bonds expects to earn the current return on two-year bonds. The buyer will pay a discounted price reflecting the difference between 2% and 4.6% for the remaining two years. That price is about 96 cents on the dollar.
In an orderly and slow withdrawal of deposits the bank would hold the bonds to maturity and enjoy the 2% they earned. But if too many depositors want their money now, they must sell at present value. That total value is less than SVB owed depositors. Businesses with more than $250,000 in deposits became at risk. Worse, in the chaos of a failing bank, the business' money would be tied up, the accounting uncertain, and employees and vendors would not get paid on time. It would be chaos for them.
There was "career risk" for the company comptrollers and treasurers if their company lost money and bills did not get paid on time. The prudent--necessary--thing to do was withdraw deposits now from a questionable bank. That created the contagion.
Contagion has systemic effects. Businesses who banked elsewhere were on notice that the only safe place for parked money was at JPMorgan, Citibank, Bank of America and other very large banks. We learned in 2008 that the government would not let those "too big to fail" banks disrupt the U.S. system of payments by letting them fail. The failure of SVB, the nation's 18th largest bank, would signal that the prudent thing for company treasurers to do is withdraw money from the banking system and park it in treasuries while they established new banking relationships with only those very largest banks. Withdrawal of money from the banking system would force previously healthy banks to stop loaning money and to try to call in loans made to healthy businesses. They would need to scramble. That would accelerate the contagion. After the dust settled, America would have lost a banking system of mid-size and regional banks. We would have in their place an oligopoly of giant banks operating with far less competition.
So the Federal Reserve, the FDIC, and the Treasury did what they had to do. They assured the large depositors they would get all their money back. They protected the banking system. It was the right thing to do because it was the necessary thing to do. Chaos in the banking system doesn't just affect the wealthy. It affects everyone who gets a paycheck, pays a mortgage, or operates a business.
Thank you Peter for the explanation. It was well written and understandable. We may see other banks close before the news runs its course.
Thank you for explaining. Understanding the minutiae of banking and finance are not strengths for many people. Don't hesitate to enlighten us on topics which you understand. Those who feel condescended to will be few I think.