Over the past week Silicon Valley Bank (SVB) was forced to close its doors due to a classic run on the bank. Over $43 billion was requested to be withdrawn last Thursday representing a significant percentage of its $175 billion deposit base. Selling its investments to pay out this request would create significant losses due to the decline in value from higher interest rates in its holdings of long-duration assets and mortgages. That shortfall could not be made up by the bank’s reserves, thus causing a panic by uninsured depositors.
Selected Observations and Commentary:
- There is no reason to deviate from your long-term asset allocation for your investment portfolio.
- Your investment accounts are safe with the custodian of your brokerage accounts.
- Custodian accounts are safe from a run on the bank. Custodians are the keepers of investment securities. Those assets are assigned to individual client accounts and are segregated assets, not the assets of the bank. As such, custodians like Charles Schwab do not place the segregated assets of brokerage accounts at risk.
- Conditions are nothing like the financial crisis of 2008-2009. During that period there was a massive overextension of credit (loans) to the real estate sector without adequate oversight.
- Silicon Valley Bank is a unique situation because:
- It grew extremely fast with asset growth of 86% in 2021.
- They invested a significant amount of those assets in long duration mortgages which fell in value due to the general rise in interest rates. These losses would only be realized if they had to sell assets to meet client redemptions.
- A great deal of asset redemptions occurred because the vast majority of its deposits, roughly 75%, were above the FDIC insured level of $250,000 per account. These accounts will not be made whole by the FDIC, thus they caused a run on the bank. By comparison, the Charles Schwab’s bank has over 80% of its assets backed by the FDIC $250,000 limit. The bank business model works well as long as everyone does not ask for their money at once as happened with SVB.
- Major banks like JP Morgan, Bank of America, Wells Fargo and nearly all other banks do not have the unique challenges of Silicon Valley Bank. They are very well capitalized.
- The FDIC as of Monday, March 13, is making funds available to all individual accounts valued at $250,000 or less for clients with Silicon Valley Bank.
- The unprecedented aggressive fiscal and monetary policies adopted over the past several years created many unintended consequences. In addition to inflation, this is another example. The rapid rise in interest rates caused a decline in bond values, especially longer maturing bonds. An inconvenience for some, a business failure for others.
- As we wrote in the January 2023 piece, be aware of future fallout from the ending of free money. The shift in monetary policy of the Federal Reserve has had a massive impact on the economy. As Warren Buffet has said, “Everyone is covered while swimming in money, but those who were taking unnecessary risks will be exposed when the tide recedes… Only when the tide goes out do you learn who has been swimming naked.”
The process of slowing the economy by raising interest rates can be painful to those businesses that were overly dependent on low cost money or were not effectively managed to withstand a period of higher interest rates. The good news is that these actions will be another force to slow the economy and slow inflation.
Stick with your long-term plan. Over the past week bonds have again acted well as a portfolio diversifier, moving higher with the heightened uncertainty from stocks.
Please contact your advisor if you have further questions.