52 min
Arnold Kling: We Just Nationalized the Banking System—Now What? The Bob Zadek Show
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- Politics
Arnold Kling holds a PhD in economics from MIT. He has worked at the Federal Reserve and later at Freddie Mac. In 1994, he started a web-based business. He used to blog at EconLog, and now writes at ArnoldKling.substack.com.
Links & Transcript
* arnoldkling.substack.com
* Reason forum hosted by Zach Weissmueller,
* The Big Short
* It’s a Wonderful Life - Bank run scene
How did SVB (almost) Go Under?
Bob Zadek: (01:49): Arnold, let's talk about Silicon Valley Bank, founded around 40-50 years ago—a new bank compared to our first bank formed by Alexander Hamilton around the country's founding.
Silicon Valley Bank was doing fine until recently. It was the 16th largest bank, with plenty of funds and public shareholders. It specialized in startups, especially biotech and tech companies, and was a favorite of venture capitalists in Silicon Valley. Then suddenly, Silicon Valley Bank collapsed.
So far there hasn't been a run on the bank, perhaps because the Fed intervened. But how could a successful, well-established bank fail so quickly? Arnold, tell us how a bank could go from thriving to defunct overnight.
Arnold Kling (03:47): As Ernest Hemingway said, “Gradually, then suddenly.”
I think that captures the story here. They gradually lost money because they held a huge portfolio of long-term mortgage-backed securities and Treasury securities on their books from a couple of years ago before interest rates went up. The value of that portfolio went down.
Then they went bankrupt suddenly because over 95% of their deposits were not insured. The typical customer had $3 million to $4 million that they used to make payroll and other expenses. That's way above the insurance limit of $250,000. Those people saw the bank was underwater, and no one wanted to be the last one left holding the bag. They started a run on the bank.
Bob Zadek (04:56): The public believes that when you deposit money in the bank, the bank somehow keeps it in a shoebox under the counter. But nothing could be further from the truth. In fact, when you deposit money in the bank, you are making an unsecured loan to the bank. Unlike a bank that lends you money with the collateral of your home or car, you are just the lowest form of creditor—an unsecured creditor.
We don't want all depositors withdrawing their funds at once. That's called a "run on the bank,” as Jimmy Stewart explains in It's a Wonderful Life. If everyone who lent you money demanded their money back at once, even if you have assets, they're not in cash. So you'd default. After the Great Depression, the government decided to avoid bank runs by guaranteeing deposits up to $250,000.
The problem was that millions and millions of dollars were deposited in Silicon Valley Bank, but then bad things started to happen. The bank had invested much of their money in federal securities, so it didn't have enough cash on hand to give everyone their deposits back right away. The federal securities that banks invest in are usually very safe. This caused even more panic and worsened the run on the bank. In short, too much money chasing too few safe investments led to a crisis of confidence in Silicon Valley Bank.
Arnold Kling (09:13): In a way, this is a rerun of the savings and loan crisis of the 1970s and 1980s.
If you lent me money for a mortgage a few years ago at 3% interest, you're probably not happy collecting only 3% now that mortgage rates are closer to 6%. On the other hand, I'm delighted to pay only 3% and have no desire to sell my house and take on a new mortgage at 5%. So what's good for me is bad for you as a lender.
Silicon Valley Bank lent heavily when interest rates were low. As a result, the mortgage securities and long-term bonds they purchased declined in value. However, there is no risk of default on my 3% mortgage, so I am happy to repay it. Similarly, there is no way the federal government will default on the 20-year bonds paying one and a half percent interest. You need not worry about de
Arnold Kling holds a PhD in economics from MIT. He has worked at the Federal Reserve and later at Freddie Mac. In 1994, he started a web-based business. He used to blog at EconLog, and now writes at ArnoldKling.substack.com.
Links & Transcript
* arnoldkling.substack.com
* Reason forum hosted by Zach Weissmueller,
* The Big Short
* It’s a Wonderful Life - Bank run scene
How did SVB (almost) Go Under?
Bob Zadek: (01:49): Arnold, let's talk about Silicon Valley Bank, founded around 40-50 years ago—a new bank compared to our first bank formed by Alexander Hamilton around the country's founding.
Silicon Valley Bank was doing fine until recently. It was the 16th largest bank, with plenty of funds and public shareholders. It specialized in startups, especially biotech and tech companies, and was a favorite of venture capitalists in Silicon Valley. Then suddenly, Silicon Valley Bank collapsed.
So far there hasn't been a run on the bank, perhaps because the Fed intervened. But how could a successful, well-established bank fail so quickly? Arnold, tell us how a bank could go from thriving to defunct overnight.
Arnold Kling (03:47): As Ernest Hemingway said, “Gradually, then suddenly.”
I think that captures the story here. They gradually lost money because they held a huge portfolio of long-term mortgage-backed securities and Treasury securities on their books from a couple of years ago before interest rates went up. The value of that portfolio went down.
Then they went bankrupt suddenly because over 95% of their deposits were not insured. The typical customer had $3 million to $4 million that they used to make payroll and other expenses. That's way above the insurance limit of $250,000. Those people saw the bank was underwater, and no one wanted to be the last one left holding the bag. They started a run on the bank.
Bob Zadek (04:56): The public believes that when you deposit money in the bank, the bank somehow keeps it in a shoebox under the counter. But nothing could be further from the truth. In fact, when you deposit money in the bank, you are making an unsecured loan to the bank. Unlike a bank that lends you money with the collateral of your home or car, you are just the lowest form of creditor—an unsecured creditor.
We don't want all depositors withdrawing their funds at once. That's called a "run on the bank,” as Jimmy Stewart explains in It's a Wonderful Life. If everyone who lent you money demanded their money back at once, even if you have assets, they're not in cash. So you'd default. After the Great Depression, the government decided to avoid bank runs by guaranteeing deposits up to $250,000.
The problem was that millions and millions of dollars were deposited in Silicon Valley Bank, but then bad things started to happen. The bank had invested much of their money in federal securities, so it didn't have enough cash on hand to give everyone their deposits back right away. The federal securities that banks invest in are usually very safe. This caused even more panic and worsened the run on the bank. In short, too much money chasing too few safe investments led to a crisis of confidence in Silicon Valley Bank.
Arnold Kling (09:13): In a way, this is a rerun of the savings and loan crisis of the 1970s and 1980s.
If you lent me money for a mortgage a few years ago at 3% interest, you're probably not happy collecting only 3% now that mortgage rates are closer to 6%. On the other hand, I'm delighted to pay only 3% and have no desire to sell my house and take on a new mortgage at 5%. So what's good for me is bad for you as a lender.
Silicon Valley Bank lent heavily when interest rates were low. As a result, the mortgage securities and long-term bonds they purchased declined in value. However, there is no risk of default on my 3% mortgage, so I am happy to repay it. Similarly, there is no way the federal government will default on the 20-year bonds paying one and a half percent interest. You need not worry about de
52 min