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You’re listening to a frequency podcast, network production in association with City News.
Jordan Heath-Rawlings
You didn’t have to have your own money at stake. You only needed a memory that goes back to 2008 to have that oh, moment. It was fast and furious. Customers withdrew 42 billion US dollars from Silicon Valley Bank in a single day last week. Thousands of small and medium sized tax. Sector companies, the majority of SVBs customers stood to lose billions of dollars in deposits when the bank failed on Friday, the second largest bank failure in American history. All customers who had deposits in these banks can rest assured they’ll be protected and they’ll have access to their money. As of today, no losses will be born by the taxpayers. Silicon Valley Bank was pretty big. More than that. The people with their money in this bank were big time player. In the tech industry and the tech sector has already been hit hard this past year, so it’s fair to say there was a lot at stake here, unless, of course, you look at it as a case of incredibly rich people losing money they shouldn’t have had anyway, and a lot of people do see it that way. Of course, there are those on the other side of that equation, looking at it as a case of a woke bank, whatever that is, prove. That that concept won’t work. It’s amazing how the problem here is math, and yet somehow within 24 hours, everyone was talking politics. So what was SVB and why did it fail? What happens now to the money that at least at first disappeared? Why is the US government helping those tech investors stay afloat? And most importantly, for you and me, what message does this send about banks in general and Canadian banks in particular? Is one bank run all this is, or should we be worried about the fallout and the future?
I am Jordan Heath-Rawlings. This is the big story. William O’Connell is a PhD candidate in the Department of Political Science at the University of Toronto. His research includes, among other things, global management of financial crises like this one, and the regulation of cryptocurrency markets. Hello, William.
William O’Connell
Hi, Jordan. Thank you for having me.
Jordan Heath-Rawlings
You are very welcome. I’m hoping you can help the financially illiterate among us, myself included, untangle a little bit about what’s going on this week.
William O’Connell
Yeah, absolutely. I’d be happy to.
Jordan Heath-Rawlings
Let’s start with the very basics, because some of us had never heard of this until, uh, it became an issue. What is, or I guess nearly, what was Silicon Valley Bank?
William O’Connell
Sure. So Silicon Valley Bank was a medium sized regional bank in California, uh, that conducted banking business like any other. Checking and savings accounts from individuals and from businesses. They made loans to individuals, mortgages, and business loans, and they provided kind of investment services to their clients. What makes Silicon Valley unique though is that they were primarily focused on serving the tax sector. Uh, so many of their clients were wealthy venture capitalists, tech startups. Uh, small, medium sized tech firms, which kind of made them have a bit of a different business model than we might associate with most other commercial banks.
Jordan Heath-Rawlings
When we talk about a different business model, like what does that look like? Where were, what were they doing that other banks weren’t?
William O’Connell
So the key difference with a bank like Silicon Valley versus say, uh, a Citibank or a Bank of America or some of these other, um, standard banks, we might think of. Is that their clientele is generally wealthier, um, on an individual level, right? So we’re talking about wealthy, you know, tech firm investors, people in in Silicon Valley, and the companies that they’re servicing and the individuals tend to have a much higher risk appetite than the general population. Right?
Jordan Heath-Rawlings
Right.
William O’Connell
So these are things we associate with tech startups. These are generally quite risky ventures. They fail quite often and are often dependent on kind of consistently rolling over their loans as it usually takes quite a bit of time before most of these companies become profitable. . And so as a result, Silicon Valley spent much more of its business making relatively high risk loans to these types of firms, and also servicing their more kind of unique needs. So in contrast to a large bank, like again, say Bank of America rather than most of their clients being kind of small individuals like you and I who have, you know, A relatively small amount of money in their checking account and their savings account and maybe some investments. These were often corporations or individuals that had very large amounts of money in, uh, in their accounts, and were moving that in and out at a much faster pace than you or I would.
Jordan Heath-Rawlings
And in a sec, I want you to explain to us what happened and why, but first, because. I’ve seen it in a lot of places. Why? Especially if it’s, you know, from the tech sector, why does this keep getting called a woke bank by right wing talking heads and, and that part of the political sector?
William O’Connell
Yeah. So setting aside the idea that, uh, you know, the expression woke has tended to become a, uh, a signal for things that, uh, that these right wing talking heads don’t like.
Jordan Heath-Rawlings
Yeah. Pretty catchall term.
William O’Connell
But in the context of finance, this has been a term that has been used to. Discuss investment in environmental or, you know, socially sustainable governance and the kind of shift within financial markets to thinking about things like climate change or the social impact of what individuals are investing in.
Jordan Heath-Rawlings
Hmm.
William O’Connell
Uh, and in the context of Silicon Valley Bank, this has really been used to kind of signal a general distaste that right wing, uh, talking heads tend to have towards. A tech sector in kind of viewing these as sites of left-wing individuals, people that are kind of more supportive of say, the Democratic Party than other industries that we might think of.
Jordan Heath-Rawlings
Okay, so what actually happened to SVB and how did it happen?
William O’Connell
Sure. So SVB was engaged in a different type of risk than what we might associate many banks being engaged in. So they were taking customer deposits and using them to make relatively long-term, uh, investments. And this ist, this is common. All banks do this. But what brought Silicon Valley Bank down was investing in very long term mortgage bonds and treasury securities a few years ago when interest rates were quite low. So if you bought a 10 year US Treasury security at that, you know, in 2016, 2017, and you get say a 2% interest rate on that after 10 years. If you hold this to maturity, then you make 2%, and that’s great. But since interest rates have gone up quite a bit, if you’re buying a tenure treasury bond, now the interest rate is quite a bit higher than that 2%, which means that if you need to sell the bond that you bought in 2016, you’re gonna sell it at a considerable loss.
Jordan Heath-Rawlings
And so for a bank like, Silicon Valley, those losses are only theoretical until you go to sell, right? This is much like if you, the value of your house goes up, right?
William O’Connell
It only actually matters once you sell your house. So for Silicon Valley, there was a large tech boom in around that time, around 2015, 2016, 2017, and they had a large influx of business from tech firms, from venture capitalists people, um, investing their money in the bank, depositing money and use this money to make these long-term invest. Of course when interest rates go up, not only do the value of those investments go down, but their clients begin to unwind some of their positions, right? They stop investing to the same extent in their companies. They start gradually winding down the, uh, the amount of debt that they’re under. They maybe start withdrawing some of their money, putting in other banks, putting it in other assets. And the result was that Silicon Valley Bank had to start selling these long-term investments that they’ve made at a considerable loss. Now, the difference between Silicon Valley Bank and some other bank that we might think of is, Looking at this client base, right? These are generally wealthier individuals, people that are highly sophisticated and that are capable of reading a bank balance sheet and spotting trouble much faster than the average person would. So once they start realizing these losses, their clients start to smell trouble, they begin pulling their money out at a much faster pace, causing them to have to sell these investments faster, generating bigger losses, and eventually the whole house of cards collapse. And that’s what we call a bank run.
Jordan Heath-Rawlings
How typical is that, uh, what we saw with S V B for a bank run? Like, you know, how do they usually happen and how contagious are they? So a bank run occurs when, um, yeah, as you said, a bunch of people rush for the exit, right?
William O’Connell
Everybody tries to withdraw their money at once, and of course, banks don’t keep the amount on hand to cover everybody’s checking account. And, uh, eventually things collapse. So the question of how common they are, they become less common over time simply because we have, uh, things like deposit insurance, which I’m sure we’ll we’ll talk about in a moment here. But for some of these smaller US banks, they can still happen relatively frequently.
And in terms of the contagious, there were some knock on effects. Um, signature Bank, I believe in New York, first Republic, which is a San Francisco based bank. They faced some smaller runs as well. And the way these things become contagious is if you’re a client of a bank that has a similar business model or a similar set of exposures as Silicon Valley Bank, even if it otherwise seems fine, you might get a little scared, right? Because obviously you don’t wanna lose your money, and so you have kind of a first mover advantage, right? If you’re the first person to pull your money out, then you might get all of it and you can go put it in a different bank that you think might be safer or you, you can stuff it under your mattress and you’ll be okay. But once a few people start doing this, it starts to become rational as an individual to, uh, do this yourself. And this has kind of a cascading domino effect. And the result is that, you know, one bank starts to collapse and that has a knock on effect on a different bank, and it becomes rational to pull your money out of that bank. And this kind of tends to cascade quite quickly and in a manner that has pretty, uh, pretty serious effects on the real economy. Presumably a number of Silicon Valley Bank customers got their money out at the beginning of the run.
Jordan Heath-Rawlings
What happens to the people who were left holding the bag? What’s at stake for them?
William O’Connell
And, and this is maybe where deposit insurance comes into play or doesn’t.
Jordan Heath-Rawlings
Mm-hmm.
William O’Connell
Yeah. So when a bank fails under a system, like what, uh, is present in the US and in Canada is. The regulators will step in. Once it gets to a point where it’s not going to be recovered, the regulators will step in. They’ll seize control of the bank, which is what happened on, uh, on Friday. . Now, if you did not pull your money out in time, then what that typically means is that over a weekend the regulators will take over the bank, sort out whatever needs to be sorted out and will reopen the bank on Monday for depositors to withdraw their money up to the deposit insurance limit, which in the US is 250,000. In Canada it’s a hundred thousand. So if you have less than that amount, you have full access to it and you can withdraw your money and safely put it in a different bank.
Jordan Heath-Rawlings
You mentioned that a lot of SVB customers had a lot of money in this bank.
William O’Connell
Yes, that’s correct. So the difference within the SVB case is that many of their customers, um, I I believe in their most recent regulatory filing of something around 95% of their deposits were over the $250,000 limits.
Jordan Heath-Rawlings
Wow.
William O’Connell
So that presents a, a pretty serious problem for accessing your money in the aftermath of a failure. Now, The instinct might be to think of this as, okay, well who has more than $250,000 in your bank account? Surely if you have that much money, you’ll be fine and you can afford to lose it. That’s the reaction I’m seeing in a lot of places online.
Jordan Heath-Rawlings
Right.
William O’Connell
You know, let the tech bros lose their money. They shouldn’t have half a billion dollars in the bank anyway, et cetera, et cetera. Yeah, and that makes sense on a surface level, but in actuality, nobody at an individual level would have that much money sitting in a checking account. Clients that would have that amount of money tend to be corporations. So if we think of a medium sized tech firm, um, one example of this could be Roku, right? The tv uh, internet provider. So they were clients of SVB and kept a very large portion of their cash reserves within. Now a company like that needs more than $250,000 just to meet their payroll obligations. And so if their amount in deposits is over that cap, which is quite reasonable for a company of that size, then suddenly a bank failure limits their ability to pay their employees on time. They might have to issue furloughs, issuing temporary layoffs, or the companies could go bankrupt themselves. And that’s the knock on effect that we see here, and that’s why we saw regulators step in and guaranteed deposits over that cap. It wasn’t necessarily to bail out, you know, individual venture capitalists because those were not the people who had more than $250,000 in their savings. Uh, it was kind of medium sized corporations that might have had payroll obligations to meet this week that needed access to money over that cap to prevent a wind down in the real economy and to prevent, you know, individual workers who had nothing to do with this from losing their jobs.
Jordan Heath-Rawlings
So the US administration is going to take care of those immediate needs. What applies to Canadians here? Are Canadians at risk? Are, are there clients of S V B in Canada?
William O’Connell
Yeah, so SVB had a single branch in downtown Toronto. And all over the weekend, uh, as the, uh, US authorities seized SVB in California, the Canadian authorities actually seized the property of the SVB branch in Toronto. Now the difference for this Canadian branch is that they were not taking deposits from individuals or from corporations in Canada. They had no Canadian depositors on their balance sheet. Okay? So instead, this branch was primarily making loans to tech firms in Canada. And so for those firms, instead of paying SVB, they would. Temporarily be paying the federal government until the federal government decides what to do with those assets. And in all likelihood, they’ll probably sell ’em to another bank or another company that will then own, own those loans. So if you’re a company that has a loan as standing to SVB, probably not very much will change.
Jordan Heath-Rawlings
How does this whole saga impact us? And by us, I guess, I mean Canada, but even uh, north America more generally. Like are we talking about loss of investor confidence? You know, we talked a little bit about whether a bank run could be contagious. Like what is this signal to you?
William O’Connell
So there were some, as we talked about, some cascading knock on effects, there were some smaller runs at some smaller banks, but that seems to knock wood, seems to have stopped, uh, at this point, and it seems like perhaps we’re out of the worst of it. For Canadians, it is less clear what the implications are because the banking system in the US is very different from the banking system in Canada. There are very large US banks of course, but there are a much higher number of these smaller banks that service particular sectors or that operate in particular states. And that doesn’t really exist in Canada. The vast majority of Canadians bank with PD or RBC or these large national banks. And as a result, the likelihood that one of these banks will be allowed to fail in the first place is quite a bit lower. And so the incentives to run for the exits are, uh, are much, much less in Canada than they are.
Jordan Heath-Rawlings
If you’re a US Bank customer in, in one of these medium sized banks, what will you be watching for in terms of continuing fallout in the coming days and weeks and, and what could it imply?
William O’Connell
Yeah, so there’s kinda a short view, a medium view, and a long view here. So the short view is just, Continuing to monitor whether the bleeding truly has stopped. It’s possible that we might get new information about some of these other banks that might lead to our new panic. Um, that’s possible. It seems unlikely to me at this point, but certainly possible. In the medium term, we will hopefully see some renewed calls for regulating these smaller banks. Uh, so as it stands, the, the largest banks in the world are subject to much tighter regulation than they were before 2008. But these smaller regional banks in the US and especially in Europe, tend to be subject to pretty shaky regulatory regimes. And in the US you know, there’s divisions between federal and state regulators that make. Relatively difficult to be fully sure what these banks are up to at, uh, at any particular point in time. So I think it’s very likely that in the medium term we’ll see some legislation in the US that will try to, to tighten up this regulation in the long term. What I would be looking at is whether we start to see a decline in these smaller regional banks in the US because one possible consequence of this is that corporations, individuals might lose confidence entirely in the sanctity of their deposits and their investments in some of these regional banks and. So we’re already starting to see people gradually start to pull their money out of banks, like of a similar size as SVB and put it in, you know, JP Morgan, Citibank or some of these banks that are very clearly, too big to, to be allowed to fail. So we might see kind of a, a concentration of the banking system in the US and that has its own set of consequences.
Jordan Heath-Rawlings
We mentioned, uh, at the beginning, calling it a woke bank. We mentioned the sentiment from the more liberal side of, you know, let these tech pros lose their money. They deserve it. And I guess I’m just trying to figure out who’s on what side.
William O’Connell
Usually, I would imagine the folks on the right would be against a bailout. It seems the opposite way around this time. Like many things, the reality is much more complicated than how it tends to be portrayed by politicians. Um, sort of arguing over which, which policies should be enacted. And in this case, I think it can be particularly divisive because We have to be clear over what constitutes a bailout and what doesn’t constitute a bailout. So in 2008, when we think of bailouts, these were situations where taxpayer money was being put up to rescue these banks. And the management of those banks did not face any meaningful consequences and not just kind of meaningful legal consequences, but they didn’t lose their jobs. They didn’t really meaningfully lose any money. And the shareholders of the banks, the bond holders, the banks didn’t suffer the losses that they should have based on the risks that they took. And I think we need to be very clear that that is not the case in this instance. If you’re a shareholder of S V B, you are losing your money.
Mm-hmm.
William O’Connell
If you’re a bond holder of S V B, you are taking a haircut, you’re losing some amount of your money. When the federal government seized SVB, they fired the management and took it over. And so in that respect, the individuals that are being bailed out, and I’m hesitant to use that word, but the individuals that are receiving a backstop are not individuals that were responsible for creating this situation. The individuals who are responsible are losing their money. And that’s a very important distinction. And the money that’s being paid out through the deposit insurance is backed by tax money, but it’s not actually tax money. This is money that’s paid through premiums by the banks themselves. And so I think if we think of the kind of long-term political challenges, And the division, it’ll really come down to the ability of policy makers and regulators to articulate that distinction to the public. That this was not an instance of, you know, bailing out the tech sector and making these finance bros whole and doing these things that we might consider distasteful. That this, in fact, was a matter of trying to. Save jobs and keep individual people from paying for the costs of, uh, of bank failures. But of course, it’s much easier to make this out to be a much worse policy response than it is, you know, there, there are plenty of reasons to, uh, to criticize government policy.
Yeah. Are you telling me it’s nuanced?
William O’Connell
Yeah, of course. There are plenty of reasons to, uh, criticize policy towards elite actors or, you know, to make the, the world out to be very unequal. We don’t need to twist this one into evidence that there’s plenty of other, uh, evidence we can point to. William, thank you so much for this, uh, really insightful, understand the issue a lot better now.
William O’Connell
Great. Thank you for having me, Jordan.
Jordan Heath-Rawlings
William O’Connell from the Department of Political Science at U of T. That was the big story. You can head to the big story podcast.ca for all of our episodes. You can hear everything we have to say on Twitter at the big story. F P N. You can tell us anything you have to say by emailing us hello at the big story podcast.ca, and if you just want to talk, you can in a very one-sided way by calling 4 1 6 9 3 5 5 9 3 5 and leaving a voicemail. Thanks for listening. I’m Jordan Heath-Rawlings. We’ll talk tomorrow.
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