American who overturned Lehman Brothers collapse predicts Credit Suisse will be next bank failure

The collapse of the tech-focused Silicon Valley Bank sparked fears on Wall Street that the banking system would be crippled by an unrelenting cycle of rate hikes

Why Did Silicon Valley Bank Fail?

The Silicon Valley Bank had already been hit hard by a rough patch for tech companies in recent months, and the Federal Reserve’s aggressive plan to raise interest rates to fight inflation compounded its problems.

The bank held billions of dollars worth of government and other debt, which is typical of most banks as they are considered safe haven assets.

However, the value of previously issued bonds has begun to fall as they pay lower interest rates than comparable bonds issued in today’s higher interest rate environment.

Such bonds are not sold at a loss unless there is an emergency and the bank needs cash. The Silicon Valley bank that collapsed on Friday had an emergency.

Its clients were mostly startups and other tech-focused companies that needed more cash and started withdrawing their deposits over the past year.

That forced the bank to sell some of its bonds at hefty losses, and the pace of those withdrawals accelerated as the news broke, rendering Silicon Valley Bank virtually insolvent.

What did the government do on Sunday?

The Federal Reserve, the US Treasury Department and the Federal Deposit Insurance Corporation (FDIC) decided to guarantee all deposits at Silicon Valley Bank, as well as New York’s Signature Bank, which was seized on Sunday.

Crucially, they have agreed to guarantee all deposits above the insured deposit limit of $250,000 (£205,000).

Many Silicon Valley startup tech clients and venture capitalists had well over $250,000 in the bank.

As a result, up to 90% of deposits in Silicon Valley were uninsured. Without the government’s decision to stop them all, many businesses would have lost funds they need to do payroll, pay bills and keep the lights on.

The goal of the extended guarantees is to stave off bank runs — where customers rush to withdraw their money — by reaffirming the Fed’s commitment to protecting corporate and individual deposits and calming nerves after a shattering few days.

Also late Sunday, the Federal Reserve initiated a sweeping emergency lending program aimed at boosting confidence in the country’s financial system.

Banks are allowed to borrow money directly from the Fed to meet a potential rush of customer withdrawals without being forced into the kinds of bond sales that would threaten their financial stability.

Such fire sales caused the collapse of Silicon Valley Bank. If everything goes as planned, the emergency loan program may not need to lend much money.

Rather, it will reassure the public that the Fed will cover their deposits and that they are willing to lend big to do so. Aside from their ability to provide collateral, there is no cap on the amount banks can borrow.

How is the program supposed to work?

In contrast to its more Byzantine effort to bail out the banking system during the 2007-08 financial crisis, the Fed’s approach this time is relatively straightforward. It has set up a new lending facility bureaucratically nicknamed the Bank Term Funding Programme.

The program makes loans to banks, credit unions and other financial institutions for up to one year. Banks will be asked to post government bonds and other government-backed bonds as collateral.

The Fed is generous in its terms: it will charge a relatively low interest rate – just 0.1 percentage point higher than market rates – and it will lend at the face value of the bond rather than at market value.

Lending at par on bonds is an important measure that will allow banks to borrow more money as the value of these bonds, on paper at least, has fallen as interest rates have risen.

At the end of last year, US banks held government bonds and other securities with about $620 billion (£509 billion) in unrealized losses, according to the FDIC. This means that if they were forced to sell these securities to cover a rush of withdrawals, they would incur huge losses.

How did the banks make such big losses?

Ironically, much of that $620 billion in unrealized losses can be linked to the Federal Reserve’s own interest rate policy over the past year.

In its fight to cool the economy and bring down inflation, the Fed has been quick to raise interest rates from almost zero to around 4.6%.

This has indirectly increased the yield, or interest paid, on a number of government bonds, particularly two-year government bonds, which were above 5% at the end of last week.

As new bonds with higher interest rates come to market, existing lower-yielding bonds become much less valuable when they have to be sold.

Banks aren’t forced to post such losses on their books until they sell those assets, which Silicon Valley was forced to do. –

How important are the state guarantees?

You are very important. The FDIC has a legal obligation to take the most favorable route when resolving a bank.

In the case of Silicon Valley or Signature, that would have meant sticking to rules on the books, meaning only the first $250,000 in depositors’ accounts would be covered.

In order to break the $250,000 cap, it had to be decided that the failure of the two banks posed “systemic risk”.

The Fed’s six-member board came to this conclusion unanimously. The FDIC and the Secretary of the Treasury also concurred with the decision.

Will these programs spend taxpayers’ money?

The US says guaranteeing deposits will not require taxpayers’ money. Instead, any losses from the FDIC’s insurance fund would be replenished by charging an additional fee from the banks.

But Krishna Guha, an analyst at investment bank Evercore ISI, said political opponents will argue that the higher FDIC fees “will ultimately fall on small banks and Main Street businesses.”

That could theoretically cost consumers and businesses in the long run.

Will this all work?

Mr Guha and other analysts say the government’s response is dovish and should stabilize the banking system, although stock prices for mid-tier banks, like Silicon Valley and Signature, tumbled on Monday.

Paul Ashworth, economist at Capital Economics, said the Fed’s lending program means banks should be able to “weather the storm.”