What was Silicon Valley Bank (SVB) debacle all about? The bank lent money to the tech industries, and start-ups primarily in the tech domain. On March 10, news broke that the bank did not have enough funds to pay back its depositors. SVB was the biggest US lender to fail since the 2008 global financial crisis. To know the origins of the debacle, we will have to step back three years. In March 2020, the world saw an outbreak of Covid-19. Economies were not prepared to face this ‘exogenous’ shock, and GDP growth collapsed. Both demand and supply-side shocks broke out. Demand fell because of lack of jobs and loss of livelihoods.
Supply-side disruption occurred as people stopped going out for work. International trade got disrupted because of supply chain disruption, in particular from China. This meant cheaper imports also stopped coming.
The US economy suffered one of the sharpest contractions in its history during 2020. To fight the fall in growth rate, the US government followed a massive expansionary fiscal policy. It pumped $1.5 trillion to save the economy during Covid times. The generous social security meant that the US workers did not have to work and money kept coming to their bank accounts. The US citizens were receiving anything between $600 and $900 per month.
Demand remained intact with the help of social security, whereas there was a gradual fall in real economic output. However, as the economy gradually started opening up starting early 2021, mismatch between supply and demand emerged owing to social security dole and later the inability of supply to match the spurt in demand. This drove up prices higher and higher.
Simultaneously between 2020 and 2022, commercial banks faced a problem of plenty, thanks to quantitative easing. Banks were flush with funds and SVB was no different. The deposits of SVB doubled. The bank’s management thought of playing safe and parked almost three-quarters of the incremental in demand deposit that occurred between 2020 and 2022, in US Treasury bills — perceived to be the safest asset during that period. Yield to the US bonds during 2021 was quite low meaning that the bond prices (value of the assets) were high. So if they wished to liquidate bonds they would have realised good money. However, the SVB management could have never foreseen that the Covid dole of $1.5 trillion would within a matter of two years drive US inflation to a 40-year high.
The US Fed started fighting this inflation, though a bit late. It increased the rates too fast and too high. The one year US Treasury rate increased almost 500 per cent from 1 per cent during Covid times to almost 5 per cent level in early March 2023. This meant the value of the bonds that SVB was holding in its portfolio fell, and the SVB stock crashed almost 60 per cent in a single day. The bank lost $1.75 billion in a single day.
Broadly, once the economy came out of Covid-19, profitability of the tech firms started falling. This led to big tech companies laying off thousands of workers. Therefore, SVB also started losing money from its clients, which were primarily tech firms. Before the world could fathom the SVB crisis, soon there was news that Credit Suisse (CS), one of the largest investment banks in Europe, was also taking a hit. CS lost money because of lending out to a series of businesses that went bad because of accounting fraud and investing in high risk assets. Losing money because of bad investment had nothing to do with the central banks following a quantitative tightening policy.
The writer is Professor, Mahindra University