When word got out that Silicon Valley Bank, the 16th largest bank in the US and the second largest to go under in history, had collapsed, it triggered flashbacks to the 2008 global financial crisis — and for good reason. SVB’s USD $209 billion implosion was second only to the collapse of Washington Mutual at the height of the GFC.
It’s fair to say that markets, and individuals, are spooked. In under a week, three major banks have collapsed in America, triggering fear throughout the global financial system, while dozens of others have seen billions wiped off their valuations.
In Europe, one of the region’s largest banks, Credit Suisse, has hit an all-time low in its share price after falling 24% overnight. The domestic ASX continues to trend downwards after all gains made since the start of the year were wiped out on Tuesday. While they bounced back, shares in the big banks were down by 2% on Thursday.
Are we about to see a repeat of 2008 with scenes of bankers trudging out of their offices carrying cardboard boxes of their stuff and protesters with placards reading ‘jump, you bastards’? Here’s what you need to know about the 2023 global financial crisis.
How Did Silicon Valley Bank Collapse?
SVB was largely the go-to bank for tech companies and health start-ups in the Californian capital of the big technology disruptors. As such, they weren’t working with a heavily diversified portfolio and were at risk if things went south.
Ostensibly, this was an old-fashioned bank run. As Jacob Goldstein, author of Money: The True Story Of A Made-Up Thing, has pointed out, banks are inherently unstable. All the money you think they have? They loan it to try to make a profit on their investments. This means if everyone who has money a the bank wants it all back at once, they can’t get it without scuppering the bank. This doesn’t normally happen, but if, say, everyone in an industry that’s struggling all banks at the same place and needs to make a withdrawal, that’s where problems start. As soon as one person indicates they’re having a problem withdrawing, everyone piles on to get their money out before the bank collapses, ironically causing the feared collapse.
“Silicon Valley Bank did not have brilliant risk management,” Associate Professor Mark Humphery-Jenner, School of Banking and Finance at UNSW Business School, told The Latch.
“They were reportedly without a permanent chief risk officer for several months. They also took a lot of that deposit money and put it into things that weren’t necessarily very sensible.”
For example, much of their investments were in government bonds with a 2% yield per year. When the Federal Reserve increased its funds’ rate to well over 4%, the bank was essentially underwater. They were forced to sell some of their bonds at a loss of USD$1.8 billion. When this was revealed during a capital raising round where they asked investors for $2.25 billion, people started pulling their money.
The US government, fearing ‘contagion’ in the system, took over SVB and guaranteed that “all insured depositors will have full access to their insured deposits.” The Federal Reserve then created a lending facility for the country’s banks to give them liquidity that would buffer against market concerns.
“The banking system is safe,” US President Joe Biden declared on Monday. “Your deposits will be there when you need them.”
However, this isn’t quite the full story as it’s likely that SVB was on the way out well before the bank run. SVB CEO Greg Becker sold USD $3.6 million of company stock less than two weeks before the bank collapsed. It was a plan he had begun to put in place in January. By the time of the capital raising, the bank had between USD$15 and $16 billion in unrealised losses. Right before the rubber hit the road, SVB paid out bonuses worth up to USD$140,000 to its 8,528 employees. Corruption is certainly a factor in this tale.
Could a Similar Financial Crisis Happen in Australia?
Following the collapse of SVB, Signature Bank, in New York, and Silvergate Bank, also went under. This was partly due to them both having similar investment portfolios in US Government bonds which were unhedged against rising interest rates and being mid-sized banks that people were suddenly frightened to have money in.
It was poor financial management and a lack of stress testing of these mid-sized banks that sent them south, forcing the US government to step in and bail out their creditors after deciding the banks were ‘too big to fail’, in that letting them collapse would have serious knock-on effects to the rest of the economy.
That ‘too big to fail’ metric is one that was put in place after the GFC by the US government which deemed that any bank with assets of more than USD$50 billion should be subject to tighter regulations to avoid a repeat of the mega bailouts of 2008.
Those laws were however watered down in 2018 with the passage of the Economic Growth Act. Essentially, Republicans caved to lobbying from Wall Street that allowed the financial sector to shake off regulation and take more risks.
Banks with assets of up to $250 billion would be subject to much less stringent stress tests, something that Democratic Senators at the time warned would cause mid-sized banks to collapse in the near future. This is exactly what we saw this week. And the banks involved in that lobbying? Silicon Valley Bank and Signature.
“Hopefully the regulators do look at some of what went wrong. I’m not necessarily saying we need more regulation for the sake of regulation, rather, we need the correct type of regulation,” Humphery-Jenner said.
This could involve, for instance, ensuring banks spread their risk and engage in proper hedging practices, or penalise banks that don’t by requiring them to hold more capital to protect against a run.
The financial regulatory system is quite different over here as it is in the US, so experts do not think that Australia is particularly vulnerable to a similar run.
Professor Eliza Wu, Head of Finance and Banking at the University of Sydney Business School, told The Latch that Australian banks have a much larger spread of assets and are primarily invested in mortgages which aren’t going anywhere at present.
“Capital requirements here have firmed up with the financial inquiry that we had, plus the Royal Commission,” she said. “I think banks here are in a relatively good place. The capital buffers that they have are over and above the regulatory minimums which are really quite healthy.”
Is This the Beginning of the End?
Where problems could arise is if a larger bank, more interconnected than SVB, were to go. That could have serious knock-on effects for us.
The collapse of Lehmann Brothers in 2008 was the trigger for the GFC. 2023 is a vastly different place, with banks well-capitalised to protect against such disasters. But it doesn’t help that Joseph Gentile, the CAO at SVB, was also the CFO at Lehman Brothers. Comparisons are rife, but experts say they’re not warranted.
Like I said, Lehman 2.0 – when you’re levered over 10x++ and you sell assets for a loss, it’s a catastrophe.
Prior to joining in 2007, he served as the CFO for Lehman Brothers’ Global Investment Bank. pic.twitter.com/QtRCeP4EtU
— Straton Oak (@straitonOak) March 12, 2023
Systemically, there aren’t the same structural issues of banks over-leveraged in assets that aren’t worth what they’re valued at — ie, housing — but the perception that banks could fail is driving the market to scepticism.
If more mid-sized banks continue to collapse, and investors start pulling their money from the financial sector, it could trigger a recession in the US, which would flow through to Australia.
The Reserve Bank would then likely respond by cutting interest rates to give mortgage holders extra cash to weather the storm and that’s how you get spiralling inflation. This is what some financial markets are currently betting on, but it’s likely too early to tell. This would likely be a worst-case scenario if it were to happen.
With the financial panic however spreading to Europe in the form of Credit Suisse, Australian regulators are getting nervous. This is no longer a foreign banking crisis but an international one. The Reserve Bank, APRA, ASIC, and the Treasury have been meeting, with Treasurer Jim Chalmers speaking to assure Australians that “We are closely monitoring the situation and potential impacts for Australia caused by the collapse of the Silicon Valley Bank in the US.”
“Our institutions are solid, our banking sector is well-capitalised, and we’re in a better position than most other nations to deal with the challenges we face in the global economy,” he added.
With financial stability at front of mind for the financial industry, the job of keeping the ship steady has just been dealt another round of swell to grapple with. It’s simply a matter of hoping that those in charge can act quickly and decisively enough to calm things down before they get out of hand.