To paraphrase Tolstoy, all happy banks are alike, but all unhappy banks are unhappy in their own unique ways. The story of the $212-billion run on Silicon Valley Bank (SVB), the second-largest in US history, was clearly highly specific to its particular context. The question is whether the fallout will be equally contained. Initial signs are not looking promising.

It is worth considering what made SVB unusual. In many respects, it was a back-to-front bank run. SVB had a glut of deposits from its cash-flush tech clients, but as a small bank it had limited capacity (or perhaps appetite) to do what most banks do, which is lend to aspirant homeowners and businesses. Rather, it decided to do what was deemed safest — lend to the risk-free US government. Of course, in the ultra-low interest rate environment of 2021, to attain a relatively decent return in treasuries meant lending longer, so the bank bought roughly $120-billion of long-term, fixed-rate, government-backed debt securities.

In hindsight, this was not a good idea, as it made SVB especially vulnerable to rising interest rates. On the asset side of the balance sheet, higher rates decrease the value of those long-term debt securities. On the liability side, depositors demanded more compelling yields from their savings accounts, incentivising them to shift funds to money market products.

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Tighter monetary conditions also meant less money flowed into tech, and as such, there was a lower supply of cheap deposit funding. When interest rates were hiked the bank’s business model collapsed. As tech commentator Matt Klein has written, “This was more a case of a ‘bank-run by idiots’ rather than a ‘bank run by idiots’.”

However, while SVB might be a particular case, it risks triggering a perilous shift in US and global financial conditions that has been presaged by higher rates and inverted yield curves. The collapse of SVB and concerns about other banks provide a powerful incentive to shift deposits out of banks into traditional money market funds. The economic incentive (yields of 5% versus deposit rates of 0%) was already there. Now, fear is giving clients no alternative.

The Financial Times reported that already, large US banks and money market funds are being inundated with requests from customers trying to transfer funds from smaller lenders. While the package of measures unveiled by US regulators on Sunday, including a new Federal Reserve lending facility for banks, appears to have passed its first test for now by staving off the failure of a third bank, if continued these flows will be unsustainable.

The fear of contagion rapidly spread through markets. Treasury yields duly collapsed on Monday, with the US 10-year experiencing one of its most extreme moves in history. In two days the benchmark bond yield dropped by an extraordinary 50bps. Yields on two-year Treasuries — which are most sensitive to interest-rate changes — tumbled by as much as 65bps in a move that surpassed even the period surrounding Black Monday’s stock market crash in 1987.

Global financial stocks — including in the vulnerable eurozone and Japan — have been smashed, shedding $465-billion in two days. Smaller regional lenders that are deemed “not systemically important” were obliterated. San Francisco-based First Republic was down 76% in hours.

Impossible conundrum

Caught between the Scylla of financial contagion and the Charybdis of rampant inflation, central bankers face a truly impossible conundrum. Fed Chair Jerome Powell has been hiking rates in the hope that the Fed will strangle inflation before breaking the economy and financial system. The opposite now seems likely to happen.

History will judge the effectiveness of monetary policy over the past three years, but from early evidence, these central bankers have not covered themselves in glory. In hindsight, the coronavirus pandemic did not really need more quantitative easing and free money. It needed vaccines. Everything that is happening in financial markets today — rampant inflation, skyrocketing interest rates, gyrating yields and collapsing tech lenders — is a consequence of that.

SVB, and its smaller contemporaries Silvergate and Signature, are the first casualties of the Fed’s disastrously irresponsible policies of the past three years. However, we are only at the beginning. They will almost certainly not be the last. What is more, they are the most immediate victims; one can only surmise what the second- and third-level effects will be and just how calamitous things will get. We have been saying for some time things are going to get interesting. That moment has arrived. DM/BM