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welcome to the best interest podcast where we believe Benjamin Franklin's advice that an investment in knowledge
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pays the best interest both in finances and in your life every episode teaches you personal finance and investing in
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simple terms now here's your host Jesse Kramer hey guys what's up this is Jesse
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Kramer speaking from the best interest welcome to episode 51 of the best interest podcast
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let's see I'm recording this on Monday March 13th and over the weekend I got a
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lot of questions some from listeners some from readers some from clients about Silicon Valley Bank if you haven't
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seen Silicon Valley Bank in the news that's what we're going to be talking
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about today we're going to break it down in simple terms it's going to be pretty
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educational even just something as basic as how exactly does a bank work because
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I think that most people including myself up until you know a couple years ago I didn't really understand the
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business model of banks so we're going to talk about that we're going to talk
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about what made Silicon Valley Bank unique in some ways and how that uniqueness led to its failure we're
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going to try to keep you as up to dat as possible on what's been happening over
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the last say 48 Hours again I'm talking to you right now it is 143 p.m. eastern
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time on Monday the 13th by the time this comes out on Wednesday the 15th or by the time you listen to it on the 16th or
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17th or maybe over the weekend things might have changed we'll see I've got an
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article on the best interest that's an article on the blog that I'm trying my
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best to keep it up to date so as things come out I'll try to throw some little
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updates in there and explain exactly what it means to you but let's get into
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the good stuff let's talk about what happened with Silicon Valley [Music] [Applause]
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[Applause] Bank okay so you're seeing Silicon Valley Bank in the news people are
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comparing it to the great financial crisis in 2008 right banks are failing what is going on so we're going to talk
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about Silicon Valley Bank in simple terms and we're going to start with how do banks even work it's a very simple
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question but it's fundamental that we understand that before we can get into
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the specifics of Silicon Valley Bank all banks have assets and liabilities now you're probably familiar
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with both those ideas even if you don't realize it the liabilities are deposits
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just like the money that you deposit in your savings account you are a depositor
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at a bank I am a depositor at a bank and since the Bank owes us that money back plus interest it's a liability on the
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bank's balance sheet now the bank also has assets to offset those liabilities
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they come in two forms loans and securities so we'll break each of those down banks give out personal loans
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business loans mortgage loans Etc they charge a higher rate to to the loan borrowers say 6% then they pay to their
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depositors say 1% so that difference which in this case was 5% that's called
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the net interest margin or n the Nim and that's the main way that Banks make
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money right they take in my and your deposits and they pay us a small interest rate but then they take our
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deposits they loan them out to someone else and they charge a higher interest rate that difference that Nim some
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people call it the spread that's the way that most banks make money okay but
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Banks outside of making loans they can also choose to buy Securities using that money right security is just a synonym
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for a stock a bond a Reit those are all Securities most commonly the Securities that Banks buy take the form of
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short-term high quality bonds just like a three-month or a six-month us treasury
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bill now most banks perform better when interest rates rise and the reason why is because they're
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able to increase their Nim and make more money off of their loans and therefore generate more profit so the more a bank
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relies specifically on loans the better that bank does when interest rates rise but if a bank relies heavily on
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Securities specifically on bonds then the opposite is true Rising interest rates hurt bond prices and the bank's
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Bond portfolio will also drop when interest rates rise and this this is worthy of a quick aside quick
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explanation why do bonds drop in value when interest rates rise simple explanation let's go through it let's
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say that you own a bond right now it comes due in a year and it's paying you
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2% great well guess what guys I could go out right now and buy a a one-year Bond
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on the open market that's yielding 4 and a half% so my question would be why would
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I buy your bond that's yielding 2% if I can just go buy a new one that's
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yielding 4 A half% clearly in this case your bond is worth less to me than a new
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Bond it's just simple math right it's it's just we get at supply and demand it
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just makes sense your 2% bond is not as appealing to me as a 4 and a half% bond so if you're holding 2% bonds and then
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you see interest rates rise to three four 5% everyone's going to want a new Bond they don't want your old Bond
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that's yielding a lower amount that happens to Banks if a bank is holding a big Bond portfolio and maybe those bonds
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don't come due for years in the future and then interest rates rise the bonds
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that the bank currently holds are going to be worth less than when they bought them granted the way that bonds work
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you're always going to get your money back at the end of the bond term bond pricing is kind of intricate I'm not
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going to get too much into the details right now but suffice to say the reason why Banks tend to hold shorter term
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bonds is because they're less interest rate sensitive right let's say I buy a$
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thousand Bond and it's yielding 3% but it comes due in a month well I'm only
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going to get to capture that 3% interest for 30 days I'm only going to capture
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really like a 12th right one month out of a year I'm going to capture a 12th of
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that interest and so what if in the interim interest rates rise to 4% my bond really isn't that much affected I'm
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going to get a little bit of interest and then collect all my money back the the ,000 I put in I'm going to collect
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that back at the end of the month but if a bond has a 10-year term well all of a
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sudden it's pretty interest rate sensitive because when rates rise from say 3% to 5% that 2% difference is going
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to be expressed over 10 years of the bond term not just one month so Banks tend to if they hold bonds they
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generally the cautious thing to do is to hold shorter term bonds okay but let's
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talk now about Silicon Valley Bank specifically so Silicon Valley Bank it's specialized in helping tech companies
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really startups um some biotech Lifey science type companies Silicon Valley digital tech companies and the bank
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itself it's grown rapidly especially in recent years because of that focus it
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was you might have seen in the news the 16th biggest bank in the country it's a
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serious bank now most tech companies many tech companies in recent years have raised large sums of cash through say
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Venture Capital private Equity or by going public and then they have to deposit that cash somewhere a lot of
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those deposits have gone to Silicon Valley Bank being cash heavy those tech companies didn't necessarily need loans
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from Silicon Valley Bank so Silicon Valley Bank they've got lots of cash deposits they don't necessarily have a
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bunch of loans that they need to be making so what are they going to do with that extra money they decided to buy
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Securities it's what banks do however the percentage of loans and the percentage of Securities that Silicon
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Valley Bank held was a bit different than most banks most banks tend to be loan heavy most of their assets are on
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the loan side side svb Silicon Valley Bank was unique in that it was Securities heavy okay that makes a
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difference so as interest rates Rose over the past year a lot of the easy money and Venture Capital private Equity
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it dried up so many of silicon Valley's customers its depositors those tech companies they stopped making new
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deposits into the bank if anything they actually started taking money out of the
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bank right I'm sitting on A10 million but I got to run my business I'm not
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getting any more venture capital so I'm going to start pulling on that $10 million at Silicon Valley Bank to make
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payroll to run my business all that kind of stuff if anything you guys might know
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this early stage tech companies they go through a lot of cash right they Hemorrhage cash by their nature so if
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new money from venture capital or private Equity isn't coming in then it means that Silicon Valley Bank their
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total deposits must have been decreasing pretty rapidly that was true over the past 10 years Silicon Valley Banks
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concentration in tech companies it's been really helpful for their business it meant tons of new deposits were
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flowing into the bank but that concentration is a double-edged sword and over the past year those deposits
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have only been leaving the bank so now remember those deposits they're not sitting in dollar bills in a safe at the
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bank instead those deposits have been deployed they've been used as loans to
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other bank customers and they've been used to buy Securities if too many depositors need
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too much of their money back from the bank all at the same time the bank might be in trouble they're going to need to
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take drastic action to raise that cash and that's what svb Silicon Valley Bank
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needed to do last week they needed to raise cash and what they did was they sold 21 billion that's billion with a B
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they sold $21 billion of their bond portfolio last Wednesday March 8th now interest rates spiked early last week
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after Federal Reserve chairman Jay Powell he had a press conference and that interest rate Spike what does that
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do to bond prices that hurts bond prices right so that lowered the value of Silicon Valley Banks bonds they had to
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sell them anyway to raise cash and they sold them at an estimated $1.8 billion loss in other words they purchased the
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bonds for about $23 billion weeks and months ago then they sold them last week for $21 billion now a $2 billion loss
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obviously that's a ton of money but especially for a bank which is generally
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considered a safe business model that's a full year of profits probably more
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than a full year of profits for Silicon Valley Bank so for them to lose that much money intentionally by selling
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their bond portfolio it raises a really scary question how much trouble does Silicon Valley Bank how much trouble are
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they in to do something so drastic and then last week in another attempt to raise money Silicon Valley
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Bank they tried selling some of the shares of their common stock right the company itself owns shares of its common
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stock and they attempted to sell about 30% of the bank's total value out into
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the market which again that dilutes current shareholders ownership by 30% that in itself is another drastic
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measure that caused Silicon Valley Bank's stock price to crash even further than it already was crashing and that
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attempt to raise more cash It ultimately failed and it begs again a similar question to the one we just asked why
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would Silicon Valley Bank sell these shares of stock now at about $200 per share when they tried last week instead
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of last year when the bank was valued at600 or $700 per share it reeks of desperation now that desperation that
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weakness that caused a tital wave of about $42 billion in attempted withdrawals last Thursday March 9th
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alone so as of close of business on March 9th Silicon Valley Bank had a negative cash balance of 900 58 million
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with an M $958 million it owed depositors $ 958 million dollar that it didn't have now this is
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the way that bank runs tend to work I saw a really good analogy from Ben Carlson in an article I read today he
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goes imagine if you went to Planet Fitness and every single member of the gym showed up at the same time you'd
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have a pretty big problem there at the squad rack right the way gym memberships work is they only expect I don't know 5
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10 20% of their members to be there at any given time and that's the way that
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everybody gets to use the gym Banks work the same way they only have a small percentage of the actual cash deposits
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on hand everything else is being loaned out everything else is in the form of Securities if everyone comes at once
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demanding their cash the bank might be in some trouble that's a bank run you
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might have seen this scene from It's a Wonderful Life it's a great Learning
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lesson I'm going to play the audio for you right here the money's not here well
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your money's in Joe's house that's right next to yours you're lending them the
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money to build and then they're going to pay it back to you as best they can what
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are you going to do four close on them I got $242 in here and $242 isn't going to
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break anybody but my husband hasn't worked in over a year and I need money how am I going to live until the bank
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opens I got dror bills to pay I need cash I can't keep back kids on fa when depositors lose confidence in a bank
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they want their money back this compounds the bank's problems even further it's exactly what happened to
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Silicon Valley bank now in the Great Depression many banks completely failed and it left their depositors hung out to
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dry and that's when the federal government decided to step in and they passed the Banking Act of 1933 which
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created the Federal Deposit Insurance Corporation or FDIC the FDIC ures Bank deposits up to
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$250,000 so you me every American with money at a bank is insured up to $250,000
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the FDIC they stepped in on Friday March 10th and they took over Silicon Valley Bank depositors at svb they are safe up
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to $250,000 recently on Sunday the 12th the federal government said you know what
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not only are they safe up to $250,000 they're also safe basically in full the federal government is going to
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make depositors whole we're going to get into why they did that here in a second
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but it's important to realize the Federal government is not bailing out the bank itself the bank is going to
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cease to exist it is not going to be operating if you ran the bank you are out of a job if you owned the bank's
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stock you are not going to get your money back if you owned one of the banks bonds you are not going to get your
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money back the federal government is only helping out the depositors at the bank it is not keeping the bank in
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business so there just a Nuance there when it comes to the term bailout when a bank fails the way that Silicon Valley
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Bank failed there are two ways two traditional ways that a rescue might occur the first one we kind of already
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talked about it is that the federal government steps in in some way perhaps steps in above the $250,000 limit
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perhaps they step in and actually give the bank money to stay in business that's what happened in the great
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financial crisis when about $200 billion was given and or loaned to Banks to ensure that the banks themselves stayed
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Alive Now on Sunday March 12th treasury secretary Janet yelen said that the federal government would not pursue that
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course of action meaning the federal government is not going to step in to keep Silicon Valley Bank itself in
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business right just to reiterate that they are stepping in as we found out at around 6:30 on Sunday March 12th they're
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stepping in to fully protect all depositors who as of today Monday March 13th had full access to to their money
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and no losses associated with the resolution of Silicon Valley Bank would be borne onto the taxpayer that's
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another thing interesting point here the federal government is planning on raising money via an assessment against
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other Banks basically saying hey everyone in the banking industry you have to chip in to make silicon Valley's
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depositors whole I'll be honest with you guys I'm not really sure how this is
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going to play out because if I was running a healthy bank and I was doing everything right I wouldn't feel great
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about having to chip in some fund that keeps Silicon Valley Bank alive they screwed up why is it my problem anyway
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that's something for the federal government and banking Regulators to figure
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out but let's get to a second possibility a way that Banks could be bailed out and we'll see what happens
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this week with Silicon Valley Bank it might still be possible where a private institution steps in and agrees to buy
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Silicon Valley Bank likely at you know Pennies on the dollar at a steeply discounted price this is what happened
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during the great financial crisis in a few different ways famously Warren Buffett stepped in he injected cash into
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Goldman Sachs and into Bank of America in exchange for a large ownership share of those two Banks right similar to the
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way that Silicon Valley Bank really needed cash last week golden Sachs and Bank of America really needed cash
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during some parts of the great financial crisis and Warren Buffett stepped in and
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said sure you can have my cash in exchange for ownership and that turned out to be a wonderful investment for
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Warren Buffett now famously Warren Buffett said no to Leman brothers and he said no to AIG Leman Brothers failed
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completely and AIG ended up getting US Federal bailout money but here's a good
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clip of Warren Buffett talking about saying no to lhan and to AIG uh this goes back a little before the Panic
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Leman was looking for money at that time and they approached birkshire I came down to the office uh
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at night made these little notes on here of things that were red flags and you'll
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see a number of pages here and you had to get to page 150 or 200 but there was there was clearly a lot of trouble uh
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there by the time I got through I decided that that uh we were not in a position to mondy to lemman I was still
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wondering what was going on obviously with AIG in New York but there was nothing to be done AIG uh was just going
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to run out of money big time uh in the next day or two and uh Leman was going to go under unless something was
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happening that I didn't know about the important point is that Silicon Valley
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Bank depositors and by proxy American depositors as a whole are made to feel confident that they'll receive 100% of
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their deposits back because let's get into this idea of what happens if no sort of bailout were to occur there's
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really no good answer you know should the federal government have stepped in to bail out Silicon Valley Bank in some
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way shape or form giving it money to make its depositors whole it's a hard question because if the government does
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bail out Silicon Valley Bank which we we saw that they did to some extent it reinforces the following precedent hey
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American Banks do whatever the heck you want be irresponsible cut corners squeeze profits out of your customers
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overc concentrate your business if you screw up we'll have your back you'll pay
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no consequences okay that's a dangerous precedent to set it's called moral
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hazard it's the lack of an incentive to protect against risk but if the government does not bail out Silicon
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Valley bank then it sends this message hey attention all banks attention all depositors all looners all investors in
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Bank stocks you are on much thinner ice than you previously assumed and that outcome could cause a crisis of
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confidence where perfectly healthy banks are called into question as Warren Buffett said fear is extraordinarily
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contagious right how do I know that my bank isn't the next Silicon Valley Bank
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maybe I should go to my bank and pull out all my money so then maybe a second run on a questionable Bank occurs and
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then a third and a fourth one but maybe on some safer Banks next thing you know boom boom boom the dominoes are falling
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and banks are failing all over the country this would be so-called Financial contagion an outcome that
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would be far worse than any single Bank failing avoiding that Financial contagion that's a must and it's 100%
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the reason why the federal government stepped in in 2008 and it's a big reason
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why we saw the federal government step in yesterday to save the depositors at Silicon Valley Bank so now an important
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question are other banks in trouble I'm sure some might be but as we noted earlier Silicon Valley Bank is unique in
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a few ways those unique features directly led to its failure most other banks are unlike Silicon Valley Bank
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they're actually stronger today than they were one year ago and remember most
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banks are loan heavy Silicon Valley Bank is Securities heavy it's easier to profit from loans when interest rates
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rise the banks that are loan heavy they're stronger now on average than any time in the past decade unlike Silicon
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Valley Banks concentration in tech company customers most banks have a diverse portfolio of customers they're
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not exposed to the same concentration risk as Silicon Valley Bank on merits alone the US banking system is not in
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trouble the only fear literally the only fear is actually fear itself right any sort of financial contagion that could
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occur it won't be based on banking fundamentals but instead would be caused by the collective fear of American
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depositors our leaders have to ensure that that won't happen and that's why
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they stepped in to save depositors at Silicon Valley Bank to make sure that everybody was made
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whole okay so at this point that is a pretty good explanation of how Banks work what happened at Silicon Valley
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Bank what we might see over the next few days that said check out the article down in the show notes on best interest
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blog check out the blog post if you want to see up to-date stuff as it comes out
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this week thanks for listening guys thanks for tuning in to this episode of the best interest podcast if
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you have a question for Jesse to answer on a future episode send him an email at
00:22:39
Jesse bestin interest. blog again that's Jesse best bestin interest. blog did you
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enjoy the show subscribe rate and review the podcast wherever you listen this helps others find the show and invest in
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knowledge themselves and we really appreciate it we'll catch you on the next episode of the best best interest
00:22:59
[Music] podcast the best interest podcast is a personal podcast meant for education and
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entertainment it should not be taken as Financial advice and is not prescriptive
00:23:11
of your financial situation