Silicon Valley Bank: A Cautionary Tale on Risk and Investment
Silicon Valley Bank was once considered a top-performing bank, until it became the latest victim of the global banking industry’s precarious nature. What caused the bank’s failure? Many factors were involved, but the key issue was risk. Risk is an essential part of investing and banking, but it’s also tricky to manage. When you try to avoid one set of risks, you may end up exposing yourself to another, and that’s what happened to Silicon Valley Bank.
The bank’s troubles began with its wild success. Many of its tech company customers were raking in money during the early pandemic, and Silicon Valley Bank was just flush. Its deposit base tripled between 2020 and 2022, with billions and billions of dollars flowing in. A lot of those billions had come from all of the risks the bank took, lending money to start-ups and companies that couldn’t get loans at other banks. Those risks paid off.
However, Silicon Valley Bank took all of those billions it earned from taking those risks and stowed them into what is supposed to be the least risky investment around: US government bonds. Bonds are like a little loan you give 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 for that loan, plus a little interest. US bonds are considered to be the safest investment on the planet. The U.S. always pays back its debts, and they are often called a riskless asset.
The downside of bonds is that they don’t pay out a lot. Super safe, but not super profitable. Longer-term bonds (like 10-year bonds) typically pay out more at the end than the 3-month or 1-year bonds, which makes sense: long-term bonds mean you agree to lend the government your money for years. You get more yield — a bigger payoff — for that wait. Silicon Valley Bank wanted a bigger payout, so it reached for longer-term bonds.
Silicon Valley Bank locked billions of dollars away into 10-year bonds, not realizing the risks involved. The bank was caught off guard by three primary risks. First, access — those billions were now locked up for years, and it wouldn’t be easy to get that money in an emergency. Second, interest rates — when interest rates started going up, the market value of Silicon Valley Bank’s bonds went down. That’s because the bank bought its government bonds before interest rates started going up. The price you get from bonds is directly tied to interest rates. When interest rates go up, the market price of older bonds goes down because new bonds pay out higher interest rates. When rates started climbing quickly, the price of Silicon Valley Bank’s bonds tumbled. Third, rich customers — when rumors started up about the bank, customers panicked and started pulling their money out. Because they were rich individuals and companies, that meant multi-million, even multi-billion dollar accounts cashing out all at once. Silicon Valley Bank needed a lot of cash fast. But, of course, a lot of its cash was locked up in 10-year bonds. Now it had to try and sell those now to get cash.
That’s where the interest rate risk bit Silicon Valley Bank: trying to sell those second-hand, low-interest rate bonds at a moment when all the new bonds being issued paid out far more was not easy. Silicon Valley Bank took huge losses selling off its bonds, and more investors panicked and pulled out their money. It was a bank run on a scale the U.S. hadn’t seen since the Great Depression. In a single day last week, depositors knocked on the door and pulled 41 billion depositor
