Mid-March brought some unpleasant news for customers of three banks and for the financial world as a whole. Silvergate Bank, Silicon Valley Bank and Signature Bank all collapsed within a week of each other. The reasons for each bank’s demise differed.
Silvergate Bank
This San Diego-based bank had a miserable first quarter of 2023. Its stock was down more than 70% by early March, largely due to losing customers. The bank had been an early and vigorous supporter of the cryptocurrency industry, counting the massive cryptocurrency exchange FTX as one of its largest customers, and focusing so heavily on digital currencies that it became known as “the crypto bank.”
When crypto experienced higher-than-normal volatility and FTX declared bankruptcy, the bank not only lost a large customer in FTX, but many more crypto customers that began withdrawing their assets out of fear of the bank’s now-shaky financial standing.
The death blow came on March 1, when the bank announced it was “currently analyzing certain regulatory and other inquiries and investigations that are pending with respect to the company.” In the wake of that revelation, Silvergate stock dropped by more than half its value that day and what few crypto customers it had left quickly pulled out. By March 8, it was all over; Silvergate announced it was shutting down and liquidating its assets.
Silicon Valley Bank (SVB)
This bank found itself too heavily invested in older bonds which carried lower interest rates than those currently being sold by the Treasury, resulting in their sale value being significantly lower than anticipated.
Meanwhile, the bank’s tech startup clients found venture capital harder to come by, meaning they had to withdraw funds held in SVB accounts, requiring the bank to raise capital by selling investments.
The Wednesday before the collapse, the bank revealed it had sold a large amount of securities at a loss and was hoping to shore up its finances by selling $2.25 billion worth of new shares. That sparked a classic run on the bank as depositors became fearful they’d lose their money, which caused SVBs stock to enter a near freefall when markets opened on Thursday. That quick drop in stock value caused clients to withdraw tens of billions of dollars simultaneously.
The plunge was so severe that trading in its shares was stopped by Friday, which is when government regulators stepped in and shut it down.
Signature Bank
This bank’s failure can be directly tied to Silicon Valley Bank’s failure. Signature customers withdrew over $10 billion from the bank in a single day after becoming fearful the just-revealed SVB collapse would spread throughout the banking world.
Although executives of the bank disagreed, government regulators determined the bank’s extreme instability posed a threat to the banking system as a whole, so they shut it down two days after the panic.
The Need for Diversification
Now that we understand what happened, it’s important to know why it happened. Regular readers of this blog will be familiar with the idea of diversification. Diversification is a way to insulate yourself from risk caused by any one asset or asset class.
We have a natural tendency to want to put all our eggs in one basket. If we see an opportunity to invest in a company that has historically performed well and shows no indication of faltering in the future, there’s a natural temptation to put all of our investable money into buying shares of that company. If you’re lucky, that strategy will work; the company will continue to do well and you will make money.
But what if you’re not lucky? What if, three months after you buy in, the company experiences unexpected setbacks and goes out of business? Because you put all your money into that company, you’ve now lost it all, whereas if you’d put some of your money into that company and the rest into many other investments, you’d only lose a portion of your investments.
Diversification for the individual investor’s portfolio is clearly important, but that rule applies to investments made by companies, like banks, as well! Silvergate and Signature both invested very heavily into cryptocurrencies. They built their “portfolio” on a foundation of intense risk.
Cryptocurrencies have been exceedingly volatile since their invention. I went into the reasons underlying that volatility in much greater detail in a past blog, but suffice it to say, crypto is volatile because its value is based entirely on what people perceive it to be in the moment. As that perception fluctuates up and down, so does the “value” of cryptocurrency.
Basing such a large percentage of a bank’s fortunes on something that volatile is very risky. They’ll make a lot of money if everything goes right, but in finance, as in other areas, it’s important to remember that Murphy’s Law exists for a reason. Things rarely go right 100% of the time.
Silicon Valley Bank, meanwhile, is a lesson in how even “safe” investments can be risky if you have an unbalanced portfolio. SVB was heavily invested in Treasury bonds, which are considered safe because they’re guaranteed by the government not to lose principal value. So how did SVB lose money on them?
There are two main ways to handle bond investments. You can buy them, hold onto them until they mature, then get paid for their value plus interest.
Or you can buy them, then sell them to other investors for more than you bought them for because the other investors will factor in interest and know they’ll make more than they paid. That strategy works well when interest rates are dropping; you sell the bond you bought at a higher rate and make money, and the investor who buys it from you enjoys a better interest rate than they can get by buying one directly from the government.
But thanks to the Federal Reserve’s efforts to fight inflation, interest rates aren’t dropping; they’re rising! SVB had $21 billion in bonds with an average yield significantly below 2%, but today’s bond rate is nearly 4%. SVB’s bonds simply weren’t competitive with bonds being offered today, which is why they had to sell at a loss to fund their depositors’ massive withdrawals.
In the cases of all three failed banks, poor diversification played a major role in their downfall. That should serve as a good reminder that your portfolio must be diversified if you want to lower your risk exposure.
There’s another lesson to be learned from the collapse of these banks: Pay attention to FDIC insurance levels! If your bank is a member of the Federal Deposit Insurance Corporation, your deposits in certain accounts are covered up to $250,000 per account per bank.
This means if the bank fails, and you have $250,000 or less in a covered checking account, savings account, CD or money market deposit account, the FDIC will pay you — you won’t lose your money. However, in general, if you have more than $250,000 in a covered account, only that first quarter-million is covered. You risk losing the rest.
That didn’t happen in the cases of SVB and Signature because the FDIC took the unusual step of agreeing to reimburse beyond the normally covered limits. The government feared these few collapses would trigger a widespread banking panic as people rushed to withdraw non-insured funds, so they acted to calm potentially anxious depositors in other banks.
That is not something you should count on, however! If you’re fortunate enough to have more than $250,000 to put into a bank account, consider putting the money into more than one account and, if necessary, at more than one bank.
Shortly after the banks collapsed, I spoke with a client who who was concerned because he’d just deposited significantly more than $250,000 into a CD account. He was naturally concerned about the FDIC insurance limit should these collapses turn into a full-on panic that could spread and impact his bank.
I told him what I tell many who become nervous about the safety of bank deposits in excess of FDIC limits: Cooler heads will likely prevail and prevent a widespread crisis, but at the same time, don’t be the last one out the door because that can become a problem! Spread that deposit into as many places as it takes to be fully covered. That’s inconvenient, but the minor hassle is worth it when weighed against the risk of losing money.
Lessons Learned
The main lesson to take away from these bank collapses is that as a depositor, you are not the bank’s customer, but their product! Typically a bank’s first obligation is to its stakeholders. They use your cash to make money for their shareholders and investors.
A bank will often be happy to take a deposit that exceeds FDIC limits, whether or not it’s the best plan for you, because larger deposits mean more profit for the bank and its stakeholders. It’s important for depositors to remember that even a bank which by all accounts appears to be stable can suddenly become unstable if enough depositors demand their money at the same time.
Banks have an inherent weakness in that there are no surrender charges for withdrawing your money. This means you can take your money out without paying anything to do so, which in turn means there’s no financial barrier to withdrawing all of your money if you choose to do so.
That’s great for you as an individual account holder, but if panic sets in and a run on the bank should occur, there aren’t any surrender charges to act as safeguards to stop it. The purpose of the FDIC is to provide stability by guaranteeing you’ll still get your money even if the bank collapses; without it, banks would have a much harder time convincing people to store money with them!
As such, take full advantage of FDIC-provided stability by not exceeding insurance limits because as a depositor, that’s the only real guarantee of stability you’re going to get. The collapse of three banks within one week is a sobering reminder that risk must not be taken lightly, and it’s a good idea to consider balancing it whenever you can.
At Asset Preservation Wealth and Tax, we regularly help our clients balance their financial structure to account for risk. Proper diversification is a key component of a good financial plan, whether for a bank or an individual investor.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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