When the trouble started, Silicon Valley Bank was forced to sell US government bonds at a loss. : NPR

The banking sector has been hit by the failure of a Silicon Valley bank. But the bank had money, which was supposed to be the safest asset. What happened?

TIMOTHY A. CLARY/AFP via Getty Images

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TIMOTHY A. CLARY/AFP via Getty Images

The banking sector has been hit by the failure of a Silicon Valley bank. But the bank had money, which was supposed to be the safest asset. What happened?

TIMOTHY A. CLARY/AFP via Getty Images

Risk. It’s complicated. Try to avoid one set of risks, you just might end up in front of another. So it was with Silicon Valley Bank.

“Silicon Valley Bank was a very good bank … until it wasn’t,” said Mark Williams, a Boston University finance professor and former Federal Reserve bank examiner.

A victim of his own success

Williams says that the problem at the Silicon Valley bank really began with its tremendous success. Many of his tech company clients were raising money early in the pandemic.

“Silicon Valley Bank was just overwhelmed,” he says. “Its deposit base tripled between 2020 and 2022, with billions and billions of dollars flowing in.”

Most of those billions came from all the risk the bank took on lending to startups and companies that couldn’t get loans from other banks. Those risks paid off.

And the Silicon Valley bank took all the billions it made from taking those risks and put them into the least risky investment of all, US government bonds.

Bonds. The risk-free asset

Bonds are like a small loan that you give to the government for 3 months, 1 year, 10 years, etc. depending on which bond you buy.

At the end of that time, the government will pay you back that loan, plus a small percentage. US bonds are considered the safest investment on the planet. The US always repays its debts. They are often called risky assets.

The negative side. Government bonds do not pay much. Super safe, not super profitable. But some of these bonds are a little more profitable than others.

Longer-term bonds (like 10-year bonds) usually end up paying more than 3-month or 1-year bonds, which makes sense; You get more return—more pay—for that wait.

“Basically what happened was Silicon Valley Bank wanted a bigger payout,” said Alexis Leondis, who writes on bonds for Bloomberg. “So they basically wanted to get to longer-dated bonds because I think they thought what they were going to get from shorter-dated bonds was kind of a joke.”

Risky business

A Silicon Valley bank has locked up billions of dollars in 10-year bonds. But there were risks he didn’t see.

Risk #1: Access. Those billions were now locked up for years. Getting that money in an emergency won’t be easy.

Risk #2: Interest rates. As interest rates began to rise, the market value of Silicon Valley Bank’s bonds fell.

This is because the bank bought its government bonds before interest rates rose. The price you get for bonds is directly related to interest rates. When interest rates rise, the market price of old bonds falls because newer bonds pay higher interest rates.

As exchange rates began to rise rapidly, the price of Silicon Valley Bank’s bonds fell.

Risk #3: Really, really rich customers. When news of the bank spread, customers panicked and started withdrawing their money. Because they were wealthy individuals and companies, this meant that multi-million, even billion-dollar accounts were being cashed all at once.

A Silicon Valley bank needed a lot of cash fast. But, of course, most of his cash was locked up in 10-year bonds. Now it had to try and sell them to get cash.

Fire sale of government bonds

Here’s where the interest rate risk hit Silicon Valley Bank. trying to sell those second-hand, low-interest bonds at a time when all the new bonds being issued were paying far more was not easy.

“Now the same bond and the yield would be about 20 times higher,” says Mark Williams. “So to encourage investors to even consider your old bond, you had to discount it.”

Discount as well as fire sale.

Silicon Valley Bank took huge losses selling its bonds, and more investors panicked and pulled their money out. Williams says it was a bank on a scale the US hadn’t seen since the Great Depression.

“In one day last week, depositors knocked on the door and pulled out 41 billion depositor dollars,” Williams said. “That’s about a quarter of their total deposits. No bank, no matter how strong, could ever survive such a withdrawal…

The rest of the Silicon Valley bank’s depositors were bailed out.

Guilt by association

Mark Williams says that even though the Silicon Valley bank made very specific mistakes, people across the country got scared and started pulling money out of smaller banks.

“That means these small, regional banks are potentially destabilized,” Williams says.

Where are these nervous investors putting their money? Williams says most of it is deposited in big banks, which customers see as safer. In addition, many people put their money in US government bonds.

Demand for the safe-haven asset increased throughout the week.

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