What happened to Silicon Valley Bank, and more importantly will the fall out effect you and if so, what should you do?
Silicon Valley Bank filed bankruptcy on Friday and was taken over by regulators. Those with deposits over the Federal Deposit Insurance Corporation (FDIC) insured limits are at risk of losing their savings. There is plenty of news about what happened, so we are going to focus on why it may matter to you, and what actions you should take.
The biggest question is, could your own bank fail? And if it did, would you lose money or lose access to your funds?
Many analysts say Silicon Valley Bank’s business model was uniquely risky. This is most likely true. We will give further grounds for optimism about the safety of your bank savings at the end of the blog. However, many bank stocks suffered serious price declines on Friday indicating Wall Street is concerned. So, let’s not get complacent. Treat this as a Fire Drill. What if the failure of SVB is the cuckoo in the coalmine and the harbinger of greater financial stress to come? What should you do to protect yourself?
Firstly, most consumer bank deposits are protected by the Federal Deposit Insurance Corporation limits. This means if your bank fails the FDIC will bail you out up to insured limits. However, as the collapse of SVB shows, it is surprising how many people have funds in their bank over the FDIC limits.
So, most importantly, make sure you have no account over FDIC limits at any one bank: $250,000 for an individual and $500,000 for a joint account per ownership category. Also, you can use different “ownership categories.” So, a husband and wife could each have $250,000 in an individual CD and a $500,000 joint account for a total of $1 million FDIC insured at the same financial institution. If you have funds well over these combined FDIC limits, split them between different banks. (There are platforms such as Flourish Cash which will automatically do this for you and find you the highest interest rate currently paying 4.75%. Reach out to us if you would like an invitation.)
Even those under the FDIC limits might want to have two banks. This way if one bank fails and you can’t access your funds for a few days, you can use the other. You might even want to have enough cash on hand for a week or two. The FDIC did an amazing job during the Financial Crisis ensuring FDIC insured depositors at failing institutions had almost continuous access to their funds; however, there is a first for everything, and right now, even insured depositors at Silicon Valley Bank cannot access their funds this weekend. (The FDIC says they should be able to by Monday.)
For many, especially businesses, FDIC insurance is not enough. There are stories of Silicon Valley start-ups having $100 million on deposit at SVB. In such cases, short term Treasury Bills might be a better solution. Treasury Bills are paying around 4.8% at the time of writing and, most importantly, are backed by the full faith and credit of the US Government. They have five holding periods between 4 to 52 weeks.
Where else is the average saver potentially vulnerable? In recent months, the public has poured money into Money Market Mutual Funds since they provide yields around 4.5% - much higher than the average bank savings account. However, these funds are not FDIC insured and should not be mistaken as such. Although normally stable in value, when a time of great financial stress occurs, be aware that money market mutual funds could drop – although historically speaking this has been exceedingly rare.
Then there are the bond markets:
Compared to stocks, bonds are generally perceived as the safer part of an investor’s portfolio. However, during the covid crisis, the bond markets locked up and prices plummeted. So, the Federal Reserve did something unprecedented and, against its charter, bought bonds in huge quantities to restore liquidity and confidence. Will the Federal Reserve be able to do the same thing again? Who knows? Either way, if investors are concerned, they might want to work with their investment professional to reduce risk in their fixed income portfolio.
What about the stock market?
It goes without saying that stock market investors should always be prepared for dramatic pull backs and should have designed their portfolio to weather such storms and focus on the long term. If you are not ready to weather a dramatic pull back you should revisit your portfolio with your investment professional. Or feel free to reach out to us. In this article, we are more concerned about vulnerabilities of which the average saver and investor may not be aware.
Are there valid reasons for caution?
Many Silicon Valley startups bank with SVB. If they cannot recover a significant part of their funds quickly, they will not make payroll and may have to close. This distress and reduction in employment and investment in a key area of the economy, already experiencing significant weakness and layoffs, could spread to the broader economy.
What about financial contagion?
Financial contagion could result from SVB owing money to other banks that it cannot pay – leading to those banks becoming vulnerable themselves. So far, the story is that SVB’s concentration in Silicon Valley means that it was not fundamental to the broader financial system. So, it’s failure should not have such ripple effects. However, whenever such failures happen in today’s complex system unseen things can happen. Many analysts think Silicon Valley Bank’s problems were unique. But they could be wrong. And they didn’t see this one coming either.
Contagion can also happen when fear itself results in the destruction of otherwise healthy financial institutions and systems; for example, when mass hysteria causes a run on an otherwise healthy bank. This kind of human behavior is extremely unpredictable. Indeed, it is possible that if customers at SVB hadn’t got nervous and started pulling out their funds en masse, the institution would have survived; or would have at least been saved by the FDIC before it collapsed.
At this point it is impossible to say, whether the failure of SVB will lead to panic or stress elsewhere. And if this does happen, a cause for concern is that the Federal Reserve and the government may not be able to pull a rabbit out of the hat in the way it has in the past. The tools it used in the past, largely flooding the system with money, could make inflation dangerously higher. Moreover, they may have run out of ammunition. US government debt is so high, it may be dangerous or impossible to increase debt even further.
This brings us to one other area of traditional safety that might for once be vulnerable: US Treasuries. As mentioned above, these are backed by the full faith and credit of the US Government. However, the impending battle in congress over raising the debt ceiling raises the faint specter of default. If Congress does not raise the debt ceiling – or fails to raise it on time – interest payments may not be paid on Treasuries resulting in a US default. If a US default happens, the failure of SVB will seem minor in comparison.
Most experts believe Congress will never let the US default; however, an investor afraid of a US default should diversify into global government debt markets. This is a complex area and should not be done without the help of your investment advisor.
Let’s end by expressing grounds for optimism.
It is generally considered that as a result of reforms and increased reserves, banks as whole are much less vulnerable than they were prior to the Financial Crisis. In addition, size matters, major national banks are likely to be less vulnerable than smaller banks. This is partly because they are more likely to be subject to reforms called Basel III that were put in place on banks that operate internationally.
This may be the second biggest bank failure (after Washington Mutual) in history, but even if this spreads, the last time banks failed en mass – during the Great Financial Crisis - FDIC insured depositors regained almost immediate access to their funds.
Indeed, since the IndyMac failure in 2008, of the 522 failures, 94% were resolved in a way that covered ALL depositors including the uninsured. So, a little known fact, the FDIC – and therefore the government – has an unspoken commitment to protect even uninsured depositors.
However, the financial system is incredibly complex. Its institutions are run by humans not Gods. They are not all powerful nor are they all knowing. So, it’s still a good time to do a fire drill. If you would like further advice on what to do, please reach out to us.
DISCLAIMER: The above should not be considered as investment advice. Please reach out to your own investment and tax professionals before taking action. Investment in financial markets involves risk of loss.