The Silicon Valley Bank failure was a failure due to the myopia which has been such a Silicon Valley staple.
Silicon Valley Bank sounds more like the place where a sitcom character works than a real financial institution, yet it was a real bank and has really failed. The bank was, as the lacklustre name implies, heavily tied to the American tech capital and I suspect the spells tougher times ahead for not just its clients and other financial institutions, but also for the wider Valley. How did the US’ 16th largest bank fail, and how might that impact the tech economy?
Silicon Valley Bank (SVB) was uniquely focused on San Francisco’s cornucopia of tech start ups and would open accounts and lend money to start ups which gave it a unique profile, and which caused some unique issues for the bank. Silicon Valley is built on Venture Capital (VC) financing which is when investors buy ownership stakes in very early start ups with the intention of helping the start up making it to the public markets where the VC would then sell its stake for a much higher price than it bought it for. High risk means a steep discount in valuation and since a lot of star ups fail there is a very high risk in VC investing. The flip side is of course that the rewards for a successful exit is intensely lucrative; if the rewards were low no one would bother. The VC backed Valley economy worked well for SVB as VC investment rounds often raise tens if not hundreds of millions of dollars which needs to be stored somewhere. If you’re the first bank a start up opens an account with chances are good that you’ll develop a lasting business relationship with that start up. Banks at their base make money by taking deposits which are lent at a higher interest rate than the depositor gets for depositing their money. In a post-2008 ultra-low interest environment that’s a great business if you can find profitable ventures to lend your cheap deposits to.
That’s where the trouble was for SVB as it had much more deposits than it had loans which it made up for by buying bonds. The idea is sound at first glance, bond coupons create and income stream and American government bonds are very liquid meaning that they would be easy to sell if the depositors wanted their money back. The problem with SVB’s strategy is at its core myopia. Any banker knows that the price of a bond rises when interest rates fall and rises when interest rates rise. With interest rates in the basement there was no upside in bonds if the Federal Reserve was to change course, but plenty of downside. That same myopia seems like a common ailment in the Valley where tech firms like Uber and Netflix have effectively subsidised private consumption in order to reach a scale where the business is big enough to raise prices, missing the fact that demand is elastic. People travel in Ubers and watch Netflix because it is cheaper than the established actors so if they were to raise prices consumers would take the bus or watch TV instead.
SVB failed because like many firms in Silicon Valley it was built on the assumption that the age of ultra-low interest rates were the new normal rather than an aberration created by misguided central bankers in the wake of the Great Recession. The tech economy can survive losing the deposits firms lost on SVB’s failure, but I’m not convinced it can survive the return to normal interest rates. When keeping money in the bank actually pays messianic tech gurus like Adam Neumann and Elon Musk will find it far more difficult to get the stratospheric equity valuations their business models operate on.
SVB’s failure is tragic in they way that all bank failures are. Losing your money or being let go because of myopic bank managers is a shame and a waste. But the return to normalcy will be worth the failure of SVB and useless start ups like Uber for forklifts. Just like the failure of Lehman Brothers signalled the end of an era, so too does the failure of SVB signal the end of the post-2008 era. But endings are also new beginnings, and a world where money has value should produce more growth and less fishing for high valuations.
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I've always been interested in politics, economics, and the interplay between. The blog is a place for me to explore different ideas and concepts relating to economics or politics, be that national or international. The goal for the blog is to make you think; to provide new perspectives.
Written by Karl Johansson
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