Tales from the Silicon Valley Bank Collapse
Plus, ETH is a commodity. No, wait, it's a security!
Number of the Week: $9 billion (explanation below)
Tales From the Silicon Valley Bank Meltdown
It’s bad enough that the failure of Silicon Valley Bank (SVB) has left tens of thousands of customers unsure whether they will get some or all of their deposits back, and has tied up that money for an undetermined period when companies need it to make payroll and pay bills.
But the bank’s failure has also picked the pockets (if, probably, temporarily) of people who didn’t even know that they were connected to SVB. Nima Olumi is an economist who runs a Boston-based marketing firm called Lightyear Strategies. He uses the HR and payroll service Rippling. On Friday morning he received a disturbing text message labeled URGENT. “You need to inform your bank immediately about an important change to the way Rippling debits your account,” the message began. “If you do not make this update, your payments, including payroll, will fail.”
The message went on to note that Rippling “has historically relied upon Silicon Valley Bank (SVB) as our banking partner for processing payments,” and that “out of an abundance of caution,” Rippling was moving parts of its payment infrastructure to JPMorgan Chase.
“I didn’t even know I was banking with SVB,” Olumi said in a FIN interview. “TD is my bank.” He said that his firm has about $18,000 in limbo, which probably will be recovered, given that SVB is covered by the Federal Deposit Insurance Corporation (FDIC), which guarantees deposits up to $250,000. Even so, he says, “What do I tell my team?”
Olumi’s company may be a minor victim in the SVB meltdown, but its experience indicates just how far-reaching the meltdown’s effects might be. As of this writing (Sunday, March 12) consensus among the smarter economists FIN knows seems to be that SVB, ranked as the 16th largest US bank, does not pose systemic risk to the broader economy.
We’ll embrace that optimism for the moment, while still noting that SVB’s collapse continues to have troubling ripple effects that are not obvious, and perhaps don’t enter into the reassuring calculations of experts accustomed to measuring only traditional finance. For starters, markets around the globe were clearly spooked by SVB’s collapse. In another example, the value of USDC, one of the largest stablecoins pegged to the dollar’s value, tumbled to 87 cents late on Friday, and is dancing around the 96 cents level as we write this. It turns out that USDC issuer Circle had $3.3 billion of its cash backing USDC parked in SVB. Here’s a seven-day chart of USDC’s value against the US dollar:
But for us, the more pressing question is: How could a decades-old bank surrounded by the presumed financial genius of Silicon Valley’s venture capitalists and startup founders have been so poorly run?
Part of the answer is the free-money contours of the post-2008 financial landscape, which were enhanced by the COVID pandemic, with its fintech-enhancing lockdown and stimulus payments. It became way too easy for banks like SVB to borrow money at close to no cost, while the venture capitalists and their portfolio companies put more of their deposits into SVB. The bank’s deposits tripled in a couple of years before 2021, growth that is way out of whack for most American banks. When the toggle switch for “risk on, risk off” investing switched sometime toward the end of 2021, corresponding with the Federal Reserve’s intention to begin raising interest rates and the dawn of the latest “crypto winter,” it became harder for SVB and other institutions to raise capital so cheaply. And simultaneously, the startups who relied on SVB drew down their cash, prefiguring the classic bank run that eventually slew SVB.
Are a lot of other US banks in a similar position? In late February, the FDIC issued a report saying that:
Unrealized losses on securities totaled $620.4 billion in the fourth quarter, down 10.1 percent from the prior quarter. Unrealized losses on held–to–maturity securities totaled $340.9 billion in the fourth quarter. Unrealized losses on available–for–sale securities totaled $279.5 billion in the fourth quarter.
That number is high, but going down, which suggests that no larger banks than SVB are likely to go under soon.
But beyond that, there is also evidence that, at least recently, SVB was a badly managed company. Obviously, the level of risk SVB took on was too high; while many reports have emphasized SVB’s investment in Treasury securities that it had to sell at fire-sale rates, perhaps a bigger problem was a reported $80 billion investment in mortgage-backed securities. Moreover, SVB leadership left critical positions open. According to Business Insider:
The company's Chief Risk Officer Laura Izurieta, who would have been responsible for preventing the type of crisis that ultimately doomed SVB, stepped down from the role in April 2022 shortly after selling nearly $4 million worth of company stock. For the better part of a year, the company was without a chief risk officer and the position wasn't filled until January of 2023.
Harder to quantify but screamingly significant is the groupthink that exists in Silicon Valley. SVB was so incestuously tied to the biggest Valley players that it’s clear many did not want to examine its books. Consider this: On Wednesday, Moody’s issued a devastating note downgrading SVB to “negative.” It highlighted
the deterioration in the bank's funding, liquidity and profitability, which prompted SVB to announce actions to restructure its balance sheet. These balance sheet actions include a capital raise of $1.75 billion of common equity in addition to mandatorily convertible preferred stock, and sale of investments in order to shift the balance sheet to an asset sensitive position.
Yet despite that, there were major players in the fintech ecosystem asserting as late as Friday morning that everything with SVB would be fine. Restive Ventures, for example, put out a remarkably defensive email, stating:
we believe SVB remains sufficiently capitalized to weather expected loan and asset losses. Furthermore, the bank continues to appear to have >100% liquidity / deposit ratio, which by definition means it has the ability to make all of its depositors whole.
Oops.
And even Rippling, the payments company that dropped payroll services to Olumi and so many others, is captive to the whole Silicon Valley mindset. Its investors include Kleiner Perkins, Sequoia Capital, Y Combinator, and many others who were intimately tied to SVB, and thus probably never thought twice about any possible runs on the bank.
So what happens next? As of this writing, the bank is in the hands of the FDIC, which is seeking a buyer. According to Pitchbook, SVB’s assets include a $73 billion loan book, about 20% of which is venture debt. Especially on top of SVB’s high-flying client list, that should be attractive to some larger financial entity; JPMorgan Chase is said to be a leading contender. There should be more information on Monday.
New York Declares ETH a Security
It’s been such a hectic week that a potentially influential regulatory development was mostly overlooked. On Thursday, New York State attorney general Letitia James filed a lawsuit against crypto trading platform KuCoin, charging it with failure to register as a securities and commodities broker. This is the latest such “you didn’t register” crypto smackdown, and it won’t be the last.
But what makes this particular action stand out is that the lawsuit formally says that the ETH coin, which is one of the world’s most popular cryptocurrencies with a market capitalization of more than $180 billion, is a security. This is significant, because at least some federal regulators this week have said that ETH is a commodity. FIN remains skeptical that the current Congress has much will or ability to pass comprehensive crypto regulation; this official split only makes the regulatory task harder. And in the wake of Silvergate’s demise this week, it could be argued that the crypto industry more urgently needs not clarity on the security/commodity question—as welcome as that might be—but more a change in banking regulations to allow more US banks to easily hold crypto. Of course, this will not happen any time soon.
FINvestments
🦈Number of the Week: This week the debtors of FTX filed a lawsuit against Greyscale Investments, charging the company run by crypto king Barry Silbert with charging exorbitant fees and preventing shareholders in its crypto funds from redeeming their shares. A press release thundered: “The FTX Debtors are seeking injunctive relief to unlock $9 billion or more in value for shareholders of the Grayscale Bitcoin and Ethereum Trusts.” Doing their job, no doubt, but this seems like something of a desperate move.
🦈Sustainable construction is an attractive field. This week Banyan Infrastructure announced a $25 million Series B round to advance its platform that helps finance sustainable projects.
🦈The problem of American student debt will not go away in our lifetime, and continues to spawn startups. This week, Candidly announced a $20.5 billion Series B round to help people pay off their debt.