The Silicon Valley Bank Became Bankrupt
Silicon Valley Bank, SVB for short, was ranked number 63 in 2021 according to the USA’s top banks. In 2022, it skyrocketed to number 16, an insane feat. In 2023 however, it became bankrupt within a span of 2 days. Here is how this all happened.
In March 2020, Covid-19 hit. During this recession, the Federal Reserve System, or Fed for short, lowered interest rates to 0%. The US government was forced to print out a ton of money. They printed out a total of 5.9 trillion dollars and handed out $3,200 to each adult and $2,500 to each child. Since the median American savings amount was only $11,700, this was a lot to them. However, a demand chart can help us see what problems this would cause.
Above is a picture of the demand curve. In this graph, P stands for price, and Q is quantity. S is the curve for supply. In other words, when the price rises, the producer would make more of it because they will earn more money. The other lines (D1 and D2) represent the demand curve, representing what the customers want.
There is an intersection between the two lines, and that intersection is the ideal price that companies should set their products to get the most income. The issue is, during the recession, S shifted left, which increased the ideal price. This is called inflation. Inflation is when the value of money decreases because too much money is in circulation.
Because of the pandemic, people deposited a lot of money, and SVB suddenly had a lot of cash. They decided to invest their money in something, and they decided to use long-term bonds, an investment generally considered very safe. However, that was the fatal blow. While moderate inflation isn’t too bad, high inflation can negatively influence the economy. Central banks can use interest rates to control inflation.
You might know John Brian Taylor. He is an economist, best known for creating the Taylor Rule. The Taylor Rule is a formula used for determining the ideal interest rate. The formula is below:
Nominal interest rate = Neutral rate + (0.5 x Inflation Gap) + (0.5 x Output
Gap)
The nominal interest rate is the target interest rate of a bank. The neutral rate is the rate of interest that doesn’t encourage nor refrain economic growth. The inflation gap is the difference between the target inflation rate and the actual inflation rate. The output gap is the difference between actual output and potential output. Output refers to the level of economic activity.
The US government had calculated that interest rates should be high, mainly because of the huge inflation rate that occurred from too much money being printed. As a result, interest rates have spiked. When this happens, bond values actually decrease, because people would be more likely to put money into normal banks instead. This is when SVB made the error. The bank sold the bonds for less money than when they bought it. In total, 1.8 billion dollars were lost. SVB also had to get money back to repay the withdrawals that customers wanted. SVB also sold a lot of the shares of stocks they held.
When investors found out about this, they knew something was up with SVB. They figured that they had to take out their investments, which meant they were running out of money. In just one day, 42 billion dollars were withdrawn from the bank, and the stock declined by over 60%. The next day, the Federal Deposit Insurance Corporation took over.
The FDIC tried to save the SVB by bailing out the bank, which basically means getting financial support to avoid bankruptcy. However, the FDIC was unsuccessful, and SVB was bankrupt, torn apart in 36 hours.
