The World Didn’t End, Again: A Banking Catastrophe Put Into Perspective

Photo by Luca Bravo at Unsplash.com

In October 1987, I was a new father. I was also new to financial markets. The October 19 collapse looked so much like 1929 that I was sure the world would never be the same and that I had to take action to protect my new family. I was far from alone in my thinking.   Just about everyone felt the same panic I did.

In 1989, Russia defaulted on its debt and markets fell roughly the same number of points as they had in 1987. But the market had risen so much in the intervening time that 500 Dow points was a smaller percentage drop than in 1987. Oh, and the world didn’t end again.

A few years later, thousands of savings and loan associations across the country either failed or were closed by the government. And the world didn’t end.

The 1990s saw at least two dramatic failures: Long-Term Capital, a Connecticut hedge fund with nearly $1 trillion in liabilities, and the Chinese currency panic. Oh, and we survived both.

Next was the World Trade Center attacks on 9/11. The markets were actually shut for a week. And soon after came the dotcom bubble wiping out tech fortunes.

And then came the biggest catastrophe of all—the Great Recession and the Financial Crisis.

We survived all of these things—and the pandemic.

Long before the sun burns out, humans will either leave this planet or simply cease to exist. When that happens, long after you and I have left the scene, the world will actually end. Everything will change. Nothing lasts forever.

So let’s put the failure of Silicon Valley Bank and Signature Bank with the list of things that are catastrophes but not the end of the world.

Each of the catastrophes of the past did change the world, and the failure of these banks will likely do the same. We simply don’t want the same mistake to proliferate, so we try to make new rules to prevent that.

But for now, certain things remain true. A well-invested portfolio in high-quality investments is a good place to have your money. And through the last few hundred years, whenever the future has looked doubtful, it’s been time to invest more money.

No one can say for sure that this time will be like previous times and prove to be a great time to invest, but it seems pretty likely.

It is the conundrum of investing that the best time to invest is when investments go on sale, and they normally only go on sale when everyone thinks that things will be terrible for a long time to come. Put another way, you only get good prices when everyone is afraid. I suggest you write that down and tape it to the corner of your computer screen.

The recent bank failures came about due to stress on the banking system. The rapid rise in interest rates has created stress for pretty much all banks. Because of 2008, most banks today are much stronger due to regulations aimed at keeping another 2008 from happening.

The biggest piece of regulation, known as the Dodd-Frank Act, required banks with $50 billion or more in deposits to meet more stringent guidelines than smaller banks. In 2018, the Trump administration increased the $50 billion threshold up to $250 billion. Silicon Valley Bank immediately jumped on this, increasing their deposits from $50 billion to $200 billion in just two years.

A lot of these deposits were from small tech companies that came under stress and needed their cash. But Silicon Valley was unable to deliver. The reason has to do with a simple investment mistake.

When a bank takes your deposit, they don’t just put it in their vault—they invest it. They make loans and they also buy U.S. Treasury bonds. Silicon Valley Bank bought a lot of U.S. Treasuries. The problem was that because interest rates were very low, they bought long-term treasuries because they paid more interest.

That was their big mistake. When you have a large amount of money to invest in bonds, the trick is to invest some in short-term bonds and some in long-term bonds so that you always have some bonds maturing. Because Silicon Valley bank did not properly manage their bond portfolio, they got caught in a cash squeeze. In order to meet their customers’ demands for cash, they were forced to sell some of their treasuries, which, due to the rapid rise in interest rates, were now worth less than they had paid for them. To make a bad situation worse, they dumped all the bonds they needed to sell at once, guaranteeing an extra-bad price on the sale.

Word of their losses got out, and the next day customers withdrew $40 billion in deposits. The day after that, Silicon Valley Bank was out of business.

You could say they were put out of business by stresses in the economy. While that would be somewhat true, it’s really not what happened here. It was just very bad management.

There is a worry that the same stresses weigh on much of the banking system. But we only need to worry about stupid portfolio and crisis management. Silicon Valley Bank was truly exceptional in the quantity of it.

 

Hal Masover is a Chartered Retirement Planning Counselor and a registered representative. His firm, Investment Insights, LLC is at 508 N 2nd Street, Suite 203, Fairfield, IA 52556. Securities offered through, Cambridge Investment Research, Inc, a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Investment Insights, Inc & Cambridge are not affiliated. Comments and questions can be sent to hal.masover@emailsri.com These are the opinions of Hal Masover and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal. Past performance is no guarantee of future results.

Indices mentioned are unmanaged and cannot be invested in directly.