Silicon Valley Bank – What happened, and why is it so crucial for the markets?

On the weekend of March 11-12, it became known that the American Silicon Valley Bank (SVB) had become officially bankrupt. The collapse happened so quickly that it was hard to believe the reality of what was happening. At the beginning of March this year, SVB was recognized as the best bank in the category ‘Bank of the Year.’

Before SVB, problems began with Silvergate Bank, which was considered a kind of cryptocurrency bank. Meanwhile, Silvergate Capital Corporation announced its liquidation on March 9-th, triggering a collapse in the cryptocurrency market (Bitcoin fell 9.3% in one day).

What's happening with the US banking sector, and why is it so crucial to the markets? All about it is in our article today

Prehistory – Nothing new

Nothing is new, and history repeats itself. With economic history, this is more relevant than ever. Also, as with the subprime crisis, the beginning of the current situation with Silvergate and SVB banks, and quite possibly others with similar business schemes, was set in a period of monetary abundance. During the plunge, the US Federal Reserve took unprecedented measures to stimulate the economy - the key rate was lowered to almost zero (+0.25%). At the same time, the Fed began to stimulate actively, pumping liquidity into the market through QE. As a result, the money supply in the U.S. skyrocketed.

Picture 1. The US money supply M2

By the way, in addition to this, the US launched several other stimulus measures, such as ‘helicopter money’. In general, the printing press was launched.

In the 2000s, Greenspan's prolonged stimulus policy created the possibility of prohibitive speculation in the real estate market. Debt securitization and financial engineering to maximize profits in the financial sector led to a pyramid scheme, culminating in the collapse of Lehman Brothers and the global crisis. However, the US was on its way to this crisis for several years. Silvergate and SVB reached the crisis faster - about 2.5 years. Firstly, the market infrastructure has changed - more accessible, and HYIP instruments appeared - cryptocurrency and NFT.

Secondly, many startups that created and promoted these instruments appeared, which refers to the earlier dot-com crisis at the beginning of the 2000-s, when adding .com symbols to a company's name could significantly influence its market capitalization.

Understandably, a pool of crypto-banks, which gained access to significant and "cheap" money, stood behind the servicing of such companies. SVB was one such crypto-bank. Since the system’s liquidity level is relatively high, cryptocurrency banks have little incentive to lend, which would balance the attraction of new capital. At the same time, the opportunities for placement of raised funds are significant. SVB chose to invest conservatively in UST.

So a great window of opportunity to get money out of thin air (just like the real estate market in the 2000s) - raising funds at 0%, with simultaneous placement at a non-zero rate. What's not arbitrage?

One of the reasons the scheme broke down, as it did at the beginning of the subprime crisis, was that the Fed switched from a stimulative to a restrictive policy that collapsed the banking portfolio.

The second reason was a competitor's attack.

SVB pre-crisis financial conditions. ‘We found our Enron’?

According to the bank's latest annual reports, the allocation to ‘long’ capital market instruments for 2022 was $120 billion.

Picture 2. SVB’s investments

Thus, more than half of the value of the bank's assets was placed in various debt instruments. At the same time, most of the 120 billion was set in Mortgage-Backed Securities (MBS).

Over the last four years, the net profit of SVB Financial Group grew at an average of 14%. At the same time, the bank showed a bond revaluation of -2.5 billion in year-end statements. It was a pre-declared risk that could be taken into account by investors.

Picture 3. SVB’s net income details

The risk might not have materialized if the bank's clients had not rushed to take their money. But who provoked them to these actions?

Economists cite JP Morgan Chase and Peter Thiel's The Founders fund as the main initiators of the bank collapse, convincing customers to withdraw money from SVB and thus turning the company's unrealized loss into a realized loss. Therefore, Michael Bury's tweet about the new Enron found cannot be justified entirely.

The consequences of SVB collapse

The collapse of the bank caused panic in the market. Shares of most US and European banks are rapidly falling in price.

Picture 4. Barclays Bank. daily TF

The following bankruptcy candidates include the American First Republic Bank, Pacific Westerns, and Western Alliance.

At the same time, the dollar also began to devalue as the market doubts that the Fed will raise the rate further. According to the CME Group, the 0.25% chance of a rate hike at the next meeting has risen from 60% to 97%.

However, it is too early to expect the crisis to move to the phase of a full-scale collapse.

During the weekends, US officials have already clarified that the situation is manageable.

Treasury Secretary Janet Yellen: 'US government won't bail out Silicon Valley Bank' further, she tried to reassure that one bank's failure would not cause broader problems.

So, for now, the only problem for the markets is much volatility, which could shake up the traders' wallets. This means that until the dust settles, it is advisable to stay away from financial sector stocks and be very careful when trading in the foreign exchange market.

By the way, this does not exclude the fact that severe problems in the U.S. economy are still present, which means that it is naive to expect the stock markets to resume growth for now.

Conclusion

Times of crisis are always times of opportunity. The impossibility of determining the fair valuation of the company can be compensated by the possibility of speculative operations on the market.

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The main thing is to let these opportunities become a reality!