Panic in the Valley

Original Source : Pánico en el Valle by @Enrique de la Rica 

Things are getting chaotic at Silicon Valley Bank! After 40 years in operation, California authorities have had to intervene. How did it all start? In true American fashion...during a game of poker! Bill Biggerstaff and Robert Medearis originally had the idea to finance the companies in which venture capital had invested, but they ended up providing financial services to the investors themselves. Things went well for them, and they eventually captured 26% of the market share in Silicon Valley, becoming the largest bank in the region.

However, all good things come to an end. The COVID pandemic hit the economy hard, and central banks started printing money like crazy. As a result, everyone took advantage of the opportunity to get cheap loans, and venture capitalists were no exception.

There was a lot of money flowing around, and the pandemic made tech companies more popular than ever (while brick-and-mortar businesses were closed, digital businesses like Netflix, Zoom, and Microsoft were thriving). Hundreds of startups raised significant rounds of funding, but what could they do with all that liquidity? They deposited it.

Silicon Valley Bank received an enormous amount of deposits in a short amount of time (doubling in just one year). However, there was no way to invest or lend out all that money at such a fast pace! These deposits also generated costs for the bank (paying interest to depositors, branches to serve them, staff, technology, etc.). So the bank's executives decided to invest most of those deposits in government-backed bonds. While these bonds were an excellent guarantee, the interest rates were very low.

But then inflation started to skyrocket, and central banks raised interest rates to try to control it. As a result, the bonds that Silicon Valley Bank had purchased lost their value. Who would buy a bond with a lousy interest rate of 1.56% when they could buy a new bond with more than double the yield? It wasn't a big problem for the bank if the bonds lost their value, except they had to sell them before the 10-year term.

After the pandemic, everyone realized that the expectations placed on tech companies had been excessive. Many of the big companies started downsizing (Twitter, Facebook, Netflix, etc.), the valuations of publicly traded companies dropped, VC funds slowed down, and startups that had deposited their funding rounds in Silicon Valley Bank began to withdraw their money to cover their operating expenses. Deposits were being withdrawn quickly, and new deposits were being created slowly. As a result, rumors of "liquidity problems" started circulating in the Valley in early March.

The rumor was a prelude to the news. Silicon Valley Bank had no choice but to sell some of its assets to ensure liquidity. That's right; they had to sell the bonds they hadn't planned to sell for another ten years because no one would buy bonds with such a low return. They sold them for 80% of their original value, losing $1.8 billion in the process. The market panicked, and the bank's stock plummeted.

On Thursday, March 9th, the bank's CEO, Greg Becker, tried to calm the situation, but it backfired. Investment funds started recommending that their portfolio companies withdraw their funds from the bank. That day alone, $42 billion was withdrawn from the bank, leaving a shortfall of nearly $1 billion. That was the last straw.

And on Friday, the intervention came! What a mess! Hundreds of startups that had their money in Silicon Valley Bank would be left without liquidity this week. If they couldn't pay their employees or suppliers, they would have to suspend their service supply (such as SaaS platforms) to their customers (many of whom are large companies).

On social media, they are mocking entrepreneurs for not keeping their money in multiple accounts that do not exceed $250,000, but for many startups, maintaining eight accounts is an administrative nightmare that consumes resources that could be used to develop technology, write code, generate traction, raise more money...

It has been a weekend of panic in the Valley... and beyond... because the domino effect could be huge. That's why, this weekend, the Joe Biden administration has succumbed to the evidence that the collapse of the country's sixteenth largest bank by assets risks spreading to the entire US... and global financial system.

So, overcoming their previous reluctance, the authorities have announced that all bank deposits are guaranteed by the state, including those exceeding $250,000 (which is formally the maximum amount covered by the authorities). Additionally, the Federal Reserve launches what is, in practice, a covert bank bailout by creating a financing window that will accept a series of bonds whose value has plummeted due to last year's interest rate hikes as collateral.

Let's hope that this episode is just a "wake-up call" for operators to opt for a more gradual tightening of interest rates and a more intense monetary relaxation once inflation in the USA is under control.

But we cannot forget that in 2008, everyone thought that the first signs of subprime were just that... "wake-up calls".