The Silicon Valley Twist

| March 13, 2023

What we are seeing in California is a traditional bank run with a Silicon Valley twist. I do not believe that Silicon Valley Bank is representative of the banking industry today or that we are witnessing a systematic event. Most large banks are, in my opinion, far stronger than they were before the Great Recession of 2008-2009. There will likely be other bank failures that make headlines though.

The best explanation of what happened comes from Jimmy Stewart in Frank Capra’s It’s a Wonderful Life. Stewart’s Bailey Brothers Building and Loan experiences a run, with depositors demanding their money immediately. George explains that “you’re thinking of this place all wrong. As if I had the money back in the safe. The money is not here. Your money is in Joe’s house, right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others.” How heartwarming it is to reflect on those days when the problem was nice homes for hardworking people. I know, it is only a movie.

The situation with Silicon Valley Bank is less heartwarming. Instead of humility, we are presented with a tale of hubris, greed, and stupidity. Readers of our blog and newsletter may remember that I explained how bank deposits work and the difference between a federal guarantee and insurance. Briefly, bank “deposits” are unsecured loans to a corporation. Small investors do not generally have the capacity to analyze a bank’s ability to pay them back, so we have limited amounts of deposit insurance to protect them.

Large investors should have the ability to judge the creditworthiness of any bank into which they deposit amounts greater than insurance limits. They should know that they also need to limit their exposure to any one bank. Bank officers should know better than to make most of their loans to one industry or interconnected borrowers. They should know enough to match their assets to their liquidity demands, particularly when loans are non-diversified. These mistakes are the Silicon Valley twist. All the “best” people knew all the other “best” people. Who needs traditional financial rules or prudence? In this way, depositors are like the investors in Bernie Madoff’s operation. All anyone needed to know was that the “best” and richest people did business with Bernie. In the start-up world, all the “best” people put too much of their liquid funds with the same bank.

We need not panic but should remain prudent in our investments. The lesson of Silicon Valley Bank comes from a different movie. In Forrest Gump, Tom Hanks reminds us that “stupid is as stupid does.”