When trouble struck, Silicon Valley Bank had to sell US Treasuries at a loss. : NPR

Risk. It’s hard. Try to avoid one set of risks, you may end up just exposing yourself to another. That’s what happened to Silicon Valley Bank.

“Silicon Valley Bank was a very good bank … until it wasn’t,” said Mark Williams, a finance professor at Boston University and a former banking analyst for the Federal Reserve.

A victim of his own success

Williams says the problem at Silicon Valley Bank really began with its runaway success. Many of the tech companies’ customers were hoarding money during the early pandemic.

“Silicon Valley Bank was just on a roll,” he says. “Its deposit base tripled between 2020 and 2022, with billions and billions of dollars coming in.”

Much of those billions had come from all the risks the bank took lending money to startups and companies that couldn’t get loans at other banks. Those risks paid off.

And Silicon Valley Bank took all those billions it made from taking those risks and put them into what’s supposed to be the least risky investment: US Treasuries.

Bonds: The risk-free asset

Bonds are like a small loan that you give to 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 the loan, plus a small interest. US bonds are considered the safest investment on the planet. The US always pays back its debts. They are often called a risk-free asset.

The downside? Government bonds don’t pay much. Super safe, not super profitable. But some of these bonds are a bit more profitable than others.

Longer-term bonds (like 10-year bonds) typically pay out more at the end than 3-month or 1-year bonds, which makes sense: Long-term bonds mean you’re agreeing to lend your money to the government for years. You get more profit – more profit – for that wait.

“Essentially what happened was that Silicon Valley Bank wanted a bigger payout,” said Alexis Leondis, who writes about bonds for Bloomberg. “So they basically wanted to get into longer-term bonds because, I think, they felt that what they would get out of shorter-term bonds was kind of a joke.”

Risky business

Silicon Valley Bank locked up billions of dollars in 10-year bonds. But there were risks he didn’t see.

Risk #1: Access. Those billions have now been locked up for years. It won’t be easy to get that money in an emergency.

Risk #2: Interest rates. When interest rates began to rise, the market value of Silicon Valley Bank’s bonds fell.

That’s because the bank bought its government bonds before interest rates started to rise. The price you get from bonds is directly related to interest rates. When interest rates rise, the market price of older bonds falls because the new bonds pay higher interest rates.

When interest rates began to rise rapidly, the price of Silicon Valley Bank’s bonds fell.

Risk #3: Really, really rich customers. When rumors spread about the bank, customers panicked and started withdrawing their money. Since they were wealthy individuals and companies, this meant multi-million, even multi-billion dollar accounts withdrawn at once.

Silicon Valley Bank needed a lot of money fast. But, of course, much of his money was locked up in 10-year bonds. Now he had to try to sell them to get money.

Fire sale of government bonds

That’s where interest rate risk bit Silicon Valley Bank: Trying to sell those low-interest second-hand bonds at a time when all the new bonds being issued were paying much more, wasn’t easy.

“Now that same bond and the yield would be about 20 times higher,” says Mark Williams. “So to encourage investors to even consider your old bond, you’re going to have to discount it.”

Fire sale discount.

Silicon Valley Bank took huge losses selling its bonds, and more investors panicked and pulled their money. Williams says it’s a bank run on a scale the US hasn’t seen since the Great Depression.

“In one day last week, depositors knocked on the door and withdrew $41 billion for depositors,” Williams says. “That’s about a quarter of their total deposits. No bank, no matter how strong, could survive that kind of withdrawal… that kind of pressure on the bank.”

The remaining depositors at Silicon Valley Bank were bailed out.

Guilt by association

Mark Williams says that even though Silicon Valley Bank made a bunch of very specific mistakes, people across the country got scared and started pulling money out of smaller banks.

“That means these smaller regional banks are potentially destabilizing,” Williams says.

Where are these nervous investors putting their money? Williams says a lot of it is deposited at big banks, which customers think are safer. Also, many people put their money in US government bonds.

Demand increased throughout the week for the risk-free asset.