For the past month the name Silicon Valley Bank has been floating in the economic and financial news like the Lehman Brothers’ ghost. The bankruptcy of the favourite bank of start-ups brings back memories of the 2008 crisis that turned the banking sector upside down on a global level.
The Subprime crisis
References to the 2008 crisis can sometimes appear vague when you don’t know the ins and outs of it. What happened at that time?
When buying a house, buyers often take out a bank loan, also known as a mortgage. Property prices can be very high and so the use of financial aids when purchasing property is commonplace. In the United States, as elsewhere, the principle of a mortgage is simple: the borrower has to repay a sum to the bank each month for a fixed period of time. The monthly payment paid by the borrower is supplemented by an interest rate that makes the operation profitable for the banks.
If the payment is not made, it is referred to as a “default”. The risk of default is different depending on the household: those with the least risk, i.e. borrowers who officially have sufficient income to pay the monthly instalments are called “prime”. On the contrary, households or borrowers who are at the highest risk of defaulting are called “subprime”, and often banks are reluctant to lend money to them.
In the early 2000s, the interest rate on bank loans was low due to a cut in rates by the central bank of the United States (the “Fed”). This encouraged households to take out more loans, especially real estate ones, which, according to banks and investors, offered a certain security: if the loan was not repaid, the bank had the right to sell the debtor’s house.
These collaterals quickly attracted the interest of investors who acquired them in the form of securities – virtual assets with a market value – from banks. As demand grew, banks had to find new borrowers and turned to subprime mortgages. Even though the securities acquired from these high default borrowers were not particularly reliable, credit rating agencies were paid to create the illusion that these securities had a high monetary value. At the same time, real estate prices rose rapidly, making the securities more “valuable” and creating a speculative bubble.
This bubble burst when defaults started to accumulate on the subprime side. At first, it was easy to resell the properties, but the subprime defaults got to a point where nearly $600 billions worth of real estate had to be resold and no buyers came forward. Investors stopped buying the securities that the banks were selling, and these banks were faced with many loans that could not be repaid.
In 2008, the collapse of Lehman Brothers bank sounded the death knell for the beginning of the financial crisis. The banking system is highly interconnected, with banks lending money to each other and the crisis had spread around the world. In the United Kingdom, for instance, the Northern Rock bank went bankrupt after a sudden massive withdrawal of money by customers panicked by the turn of events. Short of liquidity, the bank could not keep up with demand.
But then, why is there a connection between this crisis and what recently happened to Silicon Valley Bank?
What happened with Silicon Valley Bank?
Silicon Valley Bank (“SVB”) is a bank specialising in servicing start-ups, financing innovation and tech and is considered the 16th largest US bank with nearly $210 billion in assets at the end of 2022.
In recent years in the United States, the Fed has applied a Covid policy, which lowered credit rates in order to help households and businesses borrow. However, in 2022, after the end of the pandemic, of the rise in inflation and the war in Ukraine, the Fed raised credit rates again. Start-ups turned to SVB to recover their funds and meet their own obligations such as paying their employees’ salaries.
Short of liquidity, the bank had to sell off some of its financial investments at a loss, which alerted tech investors who in turn warned their clients. A banking panic ensued, as in 2008, and a bank run took place on 9 March 2023, resulting in a withdrawal of around 42 billion dollars in less than 24 hours. This caused the bank to fail as it did not have the liquidity to meet the massive customer demand.
To immediately alleviate the problem, the US government officially took control of the bank to reassure people and try to guarantee their deposits.
Although the current situation of SVB is reminiscent of the 2008 crisis given the similarities between both periods, the risk of a new global economic crisis is currently low. The 2008 crisis allowed for the creation of strong regulation, ensuring that banks build up sufficient liquidity in the event of a crisis to be able to meet customer demand. The situation, despite being worrying, now appears to be under control.
LL.M. Candidate in International Financial Law at King’s College London