Takeaways from the Silicon Valley Bank collapse
March 21, 2023
SEC and U.S. Justice Department investigators are expected to convene in a series of probes into the recent implosion of Silicon Valley Bank and the regulatory gaps exposed by its collapse. USC experts are available to discuss what went wrong and what America’s second-largest bank collapse means for the future of the U.S. and global economies.
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3 things that went wrong at Silicon Valley Bank, according to an expert in consumer psychology
“Consumers don’t see much difference across various banks, so brand loyalty is weak. Consumers perceive the money in their account as ‘their’ money; they own it, it belongs to them, and they believe that they should be able to take it out of the bank whenever they want,” said Valerie Folkes, an expert in consumer behavior and professor emeritus of marketing at the USC Marshall School of Business.
“Because most consumers understand little about the banking system, rumors of a collapse can motivate them to remove their money. People hate to lose money. If a consumer sees other consumers queuing up to remove funds, this apparent social consensus merely substantiates their own fears. Assurances about insured funds mean little to the customer,” she said.
“Many people’s experiences with insurance reimbursement is that it is time consuming, delayed and inadequate. They want their possession, their money, now!”
Dodd-Frank rollbacks laid the groundwork for bank failures
According to Rodney Ramcharan, a professor of finance and business economics at the USC Marshall School of Business, seeds of the crisis began with the 2018 rollback of the Dodd-Frank Act, a piece of legislation enacted in the aftermath of the 2008 economic crash to improve transparency in the marketplace and reduce risk to American consumers.
“If the Basel rules on the net funding stability ratio had been in place for SVB, the bank would not have been allowed to use so much uninsured deposits to fund its activities. But in our democracy where money shapes politics, banks like SVB were able to persuade congress and the Trump administration to roll back these rules,” he said.
“Once they eviscerated the Dodd-Frank rules, SVB and other smaller banks quickly expanded amid an environment of low interest rates. This allowed them to borrow cheaply and invest in higher yielding long term bonds — they took on a lot of term risk. Once rates rose, that risk came home to roost.”
Ramcharan emphasized that it’s important to put the situation in context: “Whenever the Fed rapidly increases interest rates, the banking system generally suffers. This is in part how the economy works. It is not pleasant, and it can be chaotic, but this is the nature our system.”
What’s going on in banking…in 36 seconds?
“A few years ago, banks would invest in ten-year treasuries: investments that had no chance of default, or at least we thought they had no chance of default at the time. Treasuries were paying 2%, but banks could lend at the time at nearly nothing. So they made a spread of 200 basis points while having to put away basically none of their own capital,” said economics expert Richard Green in a recent Twitter post.
Regulators made the mistake of thinking these were risk-free investments, he said.”The federal funds rate is above 5%. [Banks] are having to borrow at 5%, but they’re receiving 2% on these investments. They’re losing money.”
Green holds the Lusk Chair in real estate and is a professor in the USC Sol Price School of Public Policy and the USC Marshall School of Business.
Controlling the narrative is harder now than ever before
“Controlling the narrative has become a whole lot more challenging in the Internet Age,” said Kristen Jaconi, an expert in risk management and an associate professor of the practice of accounting at the USC Marshall School of Business.
“Late Wednesday, March 8, SVB released a mid-quarter update describing its strategic actions to shore up its finances. The bank had sold its available-for-sale securities portfolio at a loss and intended to raise capital through stock offerings. By the next day, depositors, spurred on by ominous emails, texts, and social media posts, and the ease of mobile banking, attempted to withdraw $42 billion. SVB was no longer in control of the narrative. Fear was. As in all liquidity runs.”
Startups were hit hard, but came together with surprising resilience
“You can’t ask startups — at least the small ones — to be able to handle diligence on an institution as complicated as a bank. Banks are just supposed to work. Startups should be focused on how to serve their customers, build their teams, and improve their product. Not needing to worry that your bank will collapse is a positive — and at least in the U.S., it’s assumed not to be worth worrying about,” said Paul Orlando, an expert in start-up incubators and disruptive entrepreneurship
“That said, I loved that we saw people who did well in the startup world — founders who had big exits — coming forward to help other startups out: Helping temporarily take care of payroll, providing other temporary funding sources. That’s probably a path to resilience, rather than only advocating for government bailouts in these situations. Opportunities emerge in difficult times. There’s an opportunity for a financial institution to come in to take the spot opened up.”
Orlando serves as director of the USC Incubator Program and an adjunct professor for the Lloyd Greif Center for Entrepreneurial Studies at the USC Marshall School of Business.
(Photo/AdobeStock) (Video/USC Lusk Center)