There is a high-octane drama unfolding in global financial markets as Silicon Valley Bank, the 16th largest bank in the US catering to the start-up ecosystem, had to down its shutters towards the end of last week. As the spectre of 2008, Bear Stearns, Lehman et al reared its head, the word ‘contagion’ is once again doing the rounds.
It’s a little early to say if this is the tip of a giant iceberg or whether the crisis has been contained by the concerted action of the US government, Federal Reserve and the FDIC. Another Bank, Signature Bank, has followed in SVB’s footsteps and has been closed down. Other regional US banks such as First Republic and Charles Schwab are also on the brink. The Federal Reserve has supplied a lifeline through short-term financing against government bonds as collateral.
With the deposits of SVB being shifted to a new bridge bank and given the limited exposure of Indian companies and banks to SVB, the systemic risk from this episode seems to have been staved off, at least for now. But a large elephant in the room is not being talked about – the gargantuan pile of easy money that caused this crisis.
Most of the commentary on the events which led to the collapse of Silicon Valley Bank has focused on the events since the last quarter of 2022, how troubles faced by start-ups resulted in deposits being pulled out, leading to the bank selling government securities at a loss, its inability to raise capital due to the collapse of Silvergate, a crypto-focused lender, and the bank run.
But we need to go back a few years, to the beginning of the pandemic, to get to the genesis of this crisis, in which global central banks, led by the Federal Reserve, played a large part.
Cheap money chases risky assets
SVB had been around since 1983, but its troubles began when its deposits surged over two-fold to nearly $200 billion between 2020 and 2022. This inflow was fuelled by the ultra-cheap funds supplied by global central banks to fight the recession caused by the Covid 19 pandemic. Global central banks, including the Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan, not only moved interest rates close to zero, but also went on a note-printing spree.
Sample this, the Federal Reserve’s balance sheet grew from $4.1 trillion in February 2020 to $8.96 trillion by April 2022. In other words, almost $4.8 trillion of liquidity was infused into the economy when borrowing cost was close to zero. Similarly, the ECB, which never stopped its note printing since the global financial crisis in 2008, added another 1.5 trillion euros after 2020. Central banks of other advanced nations also used their preserve as the owners of the world’s reserve currencies to print copious notes to flood the global economy.
The trouble is that this money came when businesses were hit by movement restrictions and struggling to stay afloat. With traditional venues for investing this low-cost money no longer attractive, investors began chasing highly risky assets with little or no fundamental worth, such as cryptocurrencies, SPACs, and non-fungible tokens. Start-up companies, that could spin a good yarn and sell their dreams effectively to private equity and venture capital investors also attracted funds.
This money also made the stock market soar, lifting all stocks, good or bad, from the Covid-induced depths.
The bubbles pop
The bubbles created by the central bank money was highlighted in the piece ‘Bubbles everywhere, where will all this end?’ published in May 2021.
These bubbles have been popping since the last quarter of 2021 when the Fed and other Central Bankers stopped infusing money into the economy and began hiking interest rates. Bitcoin has lost 66 per cent of its value since the 2021-peak. The SPACs and NFTs, which went at a sky-high valuation in 2020 and 2021, are unlikely to find any takers now.
Assets with fundamental worth, such as equity, have fared better. The MSCI world index is down 18 per cent since December 2021, but the cut in NASDAQ, which witnessed higher speculative fervour, is down 30 per cent. Start-ups which went for subsequent funding rounds in 2022 have seen their valuations correct steeply.
How much pain is left?
The first round of pain has been felt by investors who chased these risky assets. The crash in prices of risky assets such as cryptos, tech stocks, frothy startups etc has already made investor wealth erode. That is the reason why many private equity, venture capital and hedge funds are reporting large losses and have become very selective with fresh investments.
The second round impact is being felt by those who financed these risky operations. Companies such as Silvergate, which primarily funded cryptos have had to shut down as their clients struggled to manage their businesses and began withdrawing their deposits.
Smaller US banks with greater exposure to start-ups and other new-age companies with dodgy or suspect business models are in similar straits as SVB. Not only will the deposits evaporate, but fresh funds will also now come at a much higher price, thanks to rising rates.
Investment books of banks are showing large losses due to two reasons. One, due to rising bond yields, their treasury holdings are now sporting unrealised losses. According to FDIC, the total unrealised losses of US banks from their holding in treasury securities towards the end of 2022 was $620 billion. Two, their investments in tech and new-age companies are also at a loss due to falling valuations and declining stock prices.
If these losses had to be recognised in a crunch situation, it could lead to the requirement for additional capital, leading to further problems.
Coming to tech and other new-age digital companies that benefited from the era of easy money, they are already in dire straits, going by the large-scale layoffs and other structural adjustments to their business models. The smaller companies will have to shut shop as funding dries up and vendors get wary.
The cracks have, therefore, just begun to show with SVB. We need to brace ourselves for more pain ahead.