The Fed's BIG Response to the U.S. Bank Collapses (Silicon Valley Bank Bailout)

So as you might have seen, last week two big U.S. banks, that being Silicon Valley Bank and Silvergate, collapsed. Silvergate is, or was, a bank focused on cryptocurrency projects with 6.3 billion in deposits as of December 2022. Whereas Silicon Valley Bank is a bank for the venture capital and startup space, and that was the big one with 173 billion in deposits.

On Wednesday, Silvergate announced it would start a voluntary liquidation to try and return money to depositors. It was only two days later that Silicon Valley Bank failed and was shut down by the Federal Deposit Insurance Corporation to best protect deposits. So at face value, it's certainly alarming, and the thing that's getting people worried is that we really haven't seen this stuff happen since the Great Financial Crisis. In the case of Silicon Valley Bank, it's actually the largest U.S. bank failure since 2008 and the second largest U.S. bank failure ever.

So what the hell is going on, and do we need to be concerned? Well, let's start with what's going on. Both of these banks, despite having their own little niche areas—Silvergate operating as a bank in the crypto space and SVB operating in the tech VC startup space—at the end of the day, they're just regular old banks. Banks accept deposits from individuals or businesses wanting to keep their money in that bank, and then they lend out that money for a price to individuals or businesses who need that money for something.

Now, you might ask, how is that allowed? You know, a bank can just take my money and straight up lend it out to somebody else. Well, that's just how fractional reserve banking works. As you can probably already tell, there's one scenario where this system really falls apart, and it's when depositors en masse go into the bank and want to withdraw their money, which of course they're allowed to do at any time. This is called a bank run, and it can cause problems because the bank can very quickly deplete its reserves and then has to start selling down assets to try and fund customer withdrawals.

This is exactly what happened in both cases of Silvergate and Silicon Valley Bank. At Silvergate, the decimation of cryptocurrency across 2022 obviously caused many crypto-related businesses to find themselves tight on cash, and with the implosion of FTX late last year, in Q4 alone, Silvergate saw over 8 billion dollars in withdrawals. Now the problem was, of course, they didn't have the money, so they had to sell 5.2 billion worth of assets just to cover these withdrawals.

At Silicon Valley Bank, the story was different, but the outcome was the same. With the Federal Reserve raising interest rates over the past year, conventional funding methods for startups have become much more expensive. Thus, Silicon Valley Bank clients started withdrawing some of their deposits to meet their liquidity needs. But again, like Silvergate, SVB didn't have enough cash on hand to fund the redemptions, so they sold off 21 billion dollars worth of assets to cover.

Now the problem is, and it was the same with Silvergate, the assets they had to sell to cover the withdrawals were mainly U.S. Treasury bonds. The reason that that's a problem is that these bonds were bought back when interest rates were really low, and as interest rates rise, the value of those bonds will fall. So as interest rates have risen over the past year, these Treasury bonds are now worth less.

Now, these two banks have been forced to sell them at a big loss just to cover withdrawals. It's a really rough situation, and Silicon Valley Bank noted that they recognized a 1.8 billion dollar loss from the selldown, which they then needed to fill with a capital raise. They announced on Thursday they'll need to sell 2.25 billion dollars worth of freshly printed shares to plug this hole. But unfortunately for them, that made investors panic; the shares fell a whopping 60% in one day as investors worried that more withdrawals would cause even more capital raising and the situation would simply get worse.

So that collapsed the stock, but depositors were also spooked. With venture capital firms, such as Peter Thiel's Founders Fund, advising the SVB clients to pull their money from the bank as soon as possible, this started a death spiral that saw customers initiate withdrawals for 42 billion dollars worth of deposits—a quarter of the bank's total deposits—in just one day. Obviously, the bank was unable to meet these requests, and on Friday the FDIC declared the bank insolvent and took control.

And that's how two U.S. banks went bust over the past week. But of course, the two questions that everyone is asking at the moment are: What happens to the customers' deposits, and more broadly, is this the start of another huge banking crisis? Are the dominoes going to start tumbling?

Well, let's talk about customer deposits first. So for those that don't know, the FDIC, or Federal Deposit Insurance Corporation, is an independent agency created by Congress to maintain stability and public confidence in the nation's financial system. The way they do that is they ensure your bank deposits up to two hundred fifty thousand dollars. But beyond that, they also supervise financial institutions, they make large and complex financial institutions resolvable, and they manage receiverships.

So under normal circumstances, what would happen is the FDIC would sweep into, say, SVB. They would firstly pay out the 250,000 dollars of insured funds for each of their customers, and then from there they would work to recover as much of the funds as they could for those depositors, you know, beyond that amount. Now, this is a great rule for, say, JP Morgan or Bank of America, for example, because these banks have millions of just average Joe customers that realistically don't have more than 250,000 dollars in their bank accounts, so it's sweeping protection for the masses.

But the problem with a bank like SVB or Silvergate is they operate in a niche, specifically catering for businesses. So in this case, they don't have millions of individuals with small sums in the bank; their clients are instead a whole bunch of big businesses that generally have a lot more than 250,000 dollars in the bank. In fact, 95% of SVB's deposits were not insured by the FDIC, so this was a big concern, and it was making people wonder if this failure would start to trigger some dominoes.

But very interestingly, on Sunday, the Treasury, the Federal Reserve, and the FDIC put out a joint press release saying they would be taking decisive action and will, in fact, ensure all of the deposits of Silicon Valley Bank, not just the normal 250,000 dollars worth. They said, quote, "Today we are taking decisive actions to protect the U.S. economy by strengthening public confidence in our banking system. After receiving a recommendation from the boards of the FDIC and the Federal Reserve and consulting with the president, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13th."

They also noted that all depositors at Signature Bank will be made whole. This is another cryptocurrency-related bank that went bust on Sunday, and they clarified that shareholders and certain unsecured debt holders will not be protected. So for those thinking that this is a bailout, it definitely isn't. The FDIC is not stopping the bank from failing, so investors will be wiped out. All they're announcing is that those businesses that actually use Silicon Valley Bank will have their deposits protected completely and thus will be able to continue operating.

This is a really interesting move by the Treasury, the Fed, and the FDIC. What they're doing is essentially nipping this issue in the bud with the hope that nobody panics on a wider scale. The thing about bank runs is it's all psychological. Now for us, we're all pretty switched on when it comes to the financial news, but imagine just the everyday people, and all they see is the media reports of two, now three, U.S. banks collapsing. What are they going to think if all they read are the headlines? You know, banking crisis, banks collapsing, it's 2008 again. Yeah, you can bet they're going to start thinking, you know, should I be withdrawing my money or my business's money from the bank?

If you get a situation where the fear snowballs out of control, then all of a sudden, a bank run on two niche banks operating in very specific areas can become a widespread banking crisis. It's all psychological. So what the Treasury, the Fed, and the FDIC are trying to do is basically come in with the bazooka, saying, "Calm down, everyone, we're here, and we're not afraid to do something crazy."

But of course, the question is, what's the reaction going to be? On one hand, you could see this latest move as panic by the government; they're doing something very unusual here, ensuring all 173 billion in deposits. Wow. You know, are they concerned that their banking system is fragile? Or on the other hand, does this settle everyone down? Oh, I was scared before, but look, the government and the Fed are stepping in to make sure the dominoes don't start falling.

Which way it goes right now, that's anyone's guess. But with that said, that is the current state of affairs in the ongoing saga of the bank collapses over in the U.S. So if you found this video useful, guys, please give it a like. I'd really appreciate it. Subscribe if you'd like to see more. But apart from that, guys, thanks for watching, and I'll see you in the next video.