The recent collapse of Silicon Valley Bank (SVB) has shaken the financial world and made many investors nervous. If an ounce of prevention truly equals a pound a cure, then smart decisions made today by average investors could protect them against the worst risks that exist in our banking system.
Let’s explore some details.
How did the collapse happen?
To understand this, let’s take a quick look back at the past couple of years. Silicon Valley Bank is popular among tech companies and startups (it’s one of the top 20 commercial banks in the country), and the financial ecosystem for these companies generally has been good since the pandemic.
During 2020, the combination of low interest rates, people spending less and receiving money from the federal government created a situation where money was cheap and investors were looking for places to spend it. A lot of this money found its way into SVB as investors supplied startups with cash.
It was so much money, in fact, that SVB’s total deposits of around $60 billion in early 2020 grew to over $200 billion by the end of 2021.
The bank did what all banks do, and invested this cash. SVB chose to take what seemed like the safe choice, purchasing primarily long-term U.S. treasuries and government-backed mortgage securities, as well as some stocks. The SVB portfolio grew from $27 billion in the first quarter of 2020 to about $127B in less than two years.
A combination of factors has led to an economic downturn in the U.S., with the Federal Reserve raising interest rates pretty aggressively over the past year or so. One unfortunate downside of higher interest rates is that existing securities, like the treasuries SVB was invested in, decrease in value. After all, who wants an old bond at 1%-2% when they can have a new one at 3%-4%?
As capital started drying up for many tech companies, they began to lean on their bank balances more heavily. Silicon Valley Bank was forced to sell a bunch of their investments at a loss to cover these account balances. They announced the move on a Wednesday, which set off a panic among venture capital firms, and by Thursday afternoon there was an old-fashioned run on the bank.
Friday morning, the bank was placed in receivership and trading in SVB shares was halted. Other banks, notably Signature Bank, started to fall too. To many, it felt like 2007 all over again.
How can I advise my clients?
While it initially looked like the fall of SVB would set off a domino effect, taking out many other banks in its wake, the panic has largely subsided. Silicon Valley was a very large bank. Other banks which are affected by the same type of decision making are too small to threaten the banking system at large.
In other words, most banks are still stable and client accounts are relatively safe, or at least as safe as they were before the fall. In fact, the FDIC will make all depositors in SVB whole, despite its promise to only insure $250,000 per account. So, for those who invested in any of the affected tech companies, essentially nothing has changed.
To help your clients avoid being affected by such a catastrophic failure in the future, here are six tips.
- Keep cash on hand to $250,000 or less — Personal accounts are insured by the FDIC at $250,000 per account per person. In the case of joint accounts, with a spouse or someone else, each person gets $250,000 in coverage, for a total of $500,000. If your clients have more money than that in their bank accounts, consider splitting the cash between banks, so that no account holds more than $250,000.
- Have a plan in place — If a bank fails, it may take a day or two for the FDIC to restore the funds. This could leave your clients in a tricky situation if they need access to money immediately or their paychecks are delayed. Create a plan for how they could get by for a few days if needed.
- Get a backup credit card — Having two cards from two different banks can provide some safety. If one bank fails, a credit card or ATM card may not work for a few days. (A widespread power outage or severe weather event could cause the same problem. If customers empty an ATM, trucks could have trouble getting in to refill them.)
- Watch investment and retirement accounts — Similar to the FDIC, the SIPC covers up to $500,000 of securities and cash per customer (sometimes more depending on the types of accounts and whether they are jointly held). If your clients' IRA or brokerage accounts have higher balances than that, consider splitting them so that a single firm does not hold all their investments.
- Be aware of uninsured investments — While the SIPC will cover many investments, such as stocks, mutual funds and securities, it does not cover everything. For example, it does not insure interest in gold, silver or other commodity futures. It does not cover fixed annuity contracts, currency, or any unregistered contracts or limited partnerships. Make sure clients are informed about the risks when they decide whether to invest.
- Support small banks — Competition is good for the economy and good for consumers. Supporting smaller and newer banks can spread some of the power—and risk—keeping any one institution from becoming too powerful.
Is it possible to avoid these problems in the future?
The fall of Silicon Valley Bank has illustrated some of the moral hazards in the financial system.
The concentration of power is a concern for many. Monopolies are never good for consumers. While SVB is not a monopoly per se, having a large concentration of power in the hands of a few big banks is a quasi-monopolistic condition. Power will always tend to concentrate over time, so it’s important that it is easy for new institutions to be created to continually challenge the big boys.
Other experts are pointing to the long-term hazard of bailing out depositors. This sends a clear message to other banks that the federal government will pick up all the pieces of their failures, essentially incentivizing poor decision-making. Federal intervention was a factor in the mortgage-focused meltdown of 2007-2008 as well.
Some are calling for the Fed to lower interest rates at this point, because the long-term bond portfolios of many regional banks are going down in value, making them vulnerable. The government has an interest in protecting the financial system at large from collapse, so intervention seems likely.
The upshot is that market volatility is extremely likely, and wise investors will recognize this reality and prepare accordingly. Financial advisors, accountants and other business consultants should help their clients protect themselves with wise risk management, adequate insurance and financial education.
*This article is for educational purposes only and should not be considered financial advice.
Jennifer Stott is the Marketing Coordinator for 401GO, which provides quality 401(k) retirement plans for any small business.
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