Silicon Valley Bank has failed and been taken over by the FDIC

Yes, people will often talk about "bailouts" generally and don't make distinctions.

Stockholders losing everything is what you'd expect in a bank failure. That's what stockholders are for. Repaying the stockholders would be a bailout.

Depositors getting their money back (or at least most of it) is generally a good thing and is what a bankruptcy is supposed to do.

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Thanks for posting this, it's a great look at the why of what's going on while remaining clear and readable.

In terms of the business loans, since I was reading with your question in mind, I noticed this passage - but it's quite easy to miss in a fairly long article:

Again crudely stereotyping, corporate loans often have floating interest rates and shorter terms, while bonds have fixed interest rates and longer terms. None of this is completely true — there are fixed-rate corporate loans and floating-rate bonds, traditional banking tends to involve making lots of loans (like mortgages) with long-term fixed rates, you can do swaps, etc. — but it is a useful crude stereotype.

[Edit] Also, this is bang on:

Also, I am sorry to be rude, but there is another reason that it is maybe not great to be the Bank of Startups, which is that nobody on Earth is more of a herd animal than Silicon Valley venture capitalists.

[...]

But if all of your depositors are startups with the same handful of venture capitalists on their boards, and all those venture capitalists are competing with each other to Add Value and Be Influencers and Do The Current Thing by calling all their portfolio companies to say “hey, did you hear, everyone’s taking money out of Silicon Valley Bank, you should too,” then all of your depositors will take their money out at the same time.

From Monday's column:

SVB is, I think, an unusually clear case of a bank that

• was almost certainly insolvent, on a mark-to-market basis: By Friday, if not earlier, its assets, at their current market value, were probably worth less than its liabilities[10]; and
• could probably have muddled through and been profitable if people had just kept their money in the bank: Its maturities were laddered, its deposit rates weren’t going up that much, it did have a positive net interest margin even this quarter, it did have various ways to make money, and if people had just kept their money in, the bonds would have matured and been replaced by higher-earning bonds and SVB would have been fine.

And so if SVB had gone to the Fed and been like “hi we have $120 billion of Treasury bonds and stuff like that, will you lend us $120 billion against them,” and if the Fed had said yes, it probably could have muddled through. But that $120 billion of stuff had a market value of only $100 billion.

The FDIC and other banking regulators spent the weekend trying to sell SVB, apparently with no luck. The goal of that sale would be to have some other bank buy SVB’s assets, business, franchise, etc. and assume its deposits, without necessarily paying anything to its shareholders or bondholders. I think the regulators’ preference would have been to leave the depositors intact and zero the shareholders and bondholders. They did not get there yet.

[...]

Silicon Valley Bank is gone, but the next bank with bonds that it bought for $100 and that are now worth $80 can go to the Fed and borrow $100 against them

[...]

One way to think of this is that US banks — especially SVB, but not only SVB — have had huge mark-to-market losses on their bond portfolios as interest rates go up, but it is traditional for banks to ignore those losses. In traditional banking, rising interest rates are a matter of opportunity costs and net interest margin, not of large mark-to-market losses.

But in the modern world — of more pervasive financial markets and more sophisticated accounting and faster-moving information — the banks and their customers were unable to ignore those losses. So the Fed stepped in and said: Look, we are best positioned to ignore those losses, so we will. The service that the Fed is providing to the banking system here is ignoring that rates went up when it values banks’ bonds. That service is incredibly valuable. Historically banks’ retail depositors provided it, but now only the Fed can.

From Matt Levine's Tuesday column:

What lessons will rational actors take from this? I mean:

• If you are a depositor — in particular, a business that needs more than $250,000 of cash to operate efficiently — you should be much less concerned about risk-taking by your bank, because if your bank fails the government will probably rescue you.
• If you are a bank executive or shareholder or probably bondholder, you should be more concerned about risk-taking by your bank, because you have seen that it can lead to executives and shareholders and bondholders getting zeroed, and that the government won’t rescue you if that happens.

And so the question is: Is that moral hazard? Well, not for shareholders and executives and bondholders. I suppose it is moral hazard for depositors, and a resolution of SVB that left depositors with losses would force depositors to pay closer attention to the risks their banks are taking. (Cliff Asness on Twitter: “The moral hazard here is we’ve greatly reduced the incentive for depositors of any size now … to actually give a moment’s thought to the riskiness of where they’re putting their money.”)

But I think the modern bank-regulatory view is that the point of a bank deposit is that you shouldn’t have to worry about it, and that it is a failure of bank regulation if depositors of any size have “to actually give a moment’s thought to the riskiness” of a bank. (Bank deposits are meant to be “information insensitive.”) There are vast areas of life where we don’t worry about moral hazard. We don’t say things like “the moral hazard of food safety regulation is that we’ve greatly reduced the incentive for consumers to give a moment’s thought to the riskiness of their supermarket’s supply chain.” That’s not a thing you’re supposed to think about!

Similarly the riskiness of a bank’s asset/liability mix is absolutely a thing that lots of people — bank executives, bank directors, bank regulators, bank shareholders, bank derivatives counterparties — are supposed to think about. But not, generally, in 2023, depositors. Opening a bank account, for an individual human but also for a business that needs more than $250,000 in cash to conduct business efficiently, is not meant to be a high-stakes investment decision that requires extensive due diligence. It’s a bank account! It’s just supposed to work.

This is not a universal view. In the olden days, bank depositors did think more about their bank’s creditworthiness [...]

Still, there really is a moral hazard in banking and in information-insensitive deposits. [...]

This is all true of all banking, to the extent that deposit insurance and lender-of-last-resort mechanisms exist, but certainly it is more true when the government expands its protection of depositors. But it is true of all banking, which is why there is so much bank regulation. Because the standard solution to this problem is regulation and government supervision: The government says to banks “look, we all understand that you are effectively making bets with government money, so we are going to keep a close eye on the bets you are making to prevent you from losing our money.”

The modern view that bank deposits should be safe and information-insensitive kind of goes along with a modern view that banks are public-private partnerships, that a bank is sort of a business partner with the government in taking deposits and providing credit, and that the way the partnership works is that the bank’s executives make the day-to-day decisions but the government has a lot of input into and oversight over those decisions.

On that view, you should probably draw two related conclusions from SVB:

1. Regulators and supervisors probably should have stopped SVB from taking dumb risks, they missed something, and changes should be made so they don’t miss those same things again.
2. The regulators’ response to SVB — guaranteeing all depositors, but also the Fed’s Bank Term Funding Program to finance other banks’ bond portfolios at par — increases the value of other banks’ optionality, which encourages them to take more risk, because their deposits are safer. (I suppose this is the real moral hazard concern.) And so there should be more regulatory and supervisory changes to tamp down the other banks’ risks.

(There is more about what to do about other risky banks, but I've quoted enough.)

As I understand it was a profit maximisation strategy more than an existential necessity. Nothing’s ever quite that simple: having customers is an existential necessity, and for that you need to pay somewhat competitive interest rates on deposits, but the market cap of the bank itself (i.e. what the business was worth over and above the money they were holding for others) peaked at $40B so it’s not like they were pushed into that decision as a desperate measure or anything.

It’s also interesting that many commentators believe they actually were still solvent, and not just in some bullshit subprime mortgage “this random derivative scribbled on a napkin is definitely worth a billion dollars” kind of way. Their assets likely did cover or come very close to covering total deposits, although that $40B of additional valuation for themselves was indeed wiped out.

The collapse happened because they weren’t liquid - the money was (apparently) safe, but locked up in fixed term instruments that they couldn’t reasonably access right now - and even a sniff of that fact led to everyone‘s quite rational self interest kicking in and causing them all to pull their money out just in case. Which massively exacerbated that short term cash problem, became self fulfilling, and the whole thing snowballed.

None of that is to say they or the system that incentivised them were right, especially given the driving forces behind their decisions - just maybe that they were also a bit less wrong than the dramatic collapse would suggest.