What happened to Silicon Valley Bank?
It is a classic bank run. Like all banks, SVB has short-term liabilities (deposits) and long-term assets (in this case, many of them super-safe government bonds). Over the past year, both sides of the balance sheet were getting squeezed. Depositors, concentrated by mostly younger firms in the tech sector, faced a difficult economic environment and needed to withdraw unusually high levels of cash. On the asset side, rising interest rates reduced the value of the government bonds. Once the scale of the stresses became known, large uninsured depositors (above the FDIC limit of $250,000 per account) quite rationally tried to get their money out as quickly as possible.
How is this different than what happened in the global financial crisis?
There are of course many differences. Most importantly, bank capital levels are much higher than they were 15 years ago, and the asset side of bank balance sheets does not have anything equivalent to subprime mortgages. But we should not be overconfident. The fundamental mismatch in the maturity of bank assets and liabilities—which is the very nature of banking itself— means that we are always at some risk. Banking panics have happened at regular intervals for hundreds of years. While the specific causes vary, the common theme is that panics occur when there is legitimate concern about bank solvency. The FDIC recently reported that there are about $620 billion of unrealized losses currently at banks. That’s a lot! If interest rates continue to rise, then those asset values will fall even more. And if the economy goes into recession, that would be another blow to both sides of the balance sheet.
Banking panics have happened at regular intervals for hundreds of years.
What does this mean for the Federal Reserve as it tries to bring down inflation?
The Fed is in a tough place. The employment report released yesterday looks strong. In the absence of these banking concerns, I would have expected the Fed to continue to aggressively raise interest rates, probably by 50 basis points at their next meeting. Most of the commentary about Fed policy revolves around the desire to stop inflation without tipping us into a recession. But it seems much more likely to me that the constraint on the Fed will come from financial stability. It may be possible to raise interest rates up as high as 6% without causing a recession, but by that point we may see many more banks having the same problems as SVB.