Silicon Valley Bank and Bank Runs

In the 1946 movie It’s a Wonderful Life, there is a run on George Bailey’s bank when depositors want to withdraw their money all at the same time.  Since the business model of banks is to loan out the money that customers deposit, when too many customers want to withdraw money at the same time, the bank may not have enough cash on hand because it has been used for things like mortgage loans or investments. 

A bank can go out of business when too many depositors want to withdraw money at once and the bank doesn’t have enough cash available to pay it out.

In the movie, George uses the money he was planning to spend on an around-the-world trip to give to customers.  He is able to convince his customers to take only what they need and not the full amount in their accounts.  The bank was saved.

Similar to the extra cash that George had for his trip, the Federal Deposit Insurance Corporation (FDIC) makes cash available to depositors when their bank fails.  As of last week, the FDIC insured depositors for up to $250,000 per depositor per bank. 

In the FDIC’s announcement last night to cover depositors for both their insured and uninsured deposits after the failure on Friday of Silicon Valley Bank, it would seem that there is no longer a limit.

Silicon Valley Bank Didn’t Make Many Loans

Silicon Valley Bank didn’t make many loans, like most banks do.  Instead, customer deposits were mostly invested in bonds.  The bonds were high-quality Treasuries and Mortgage-Backed Securities, so they didn’t have a lot of credit risk but they wouldn’t mature for 10 or 15 years or even longer.

Bonds can fluctuate in value, but when the maturity date of the bond arrives, the bond issuer will pay out the face value back to the investor.  As the Federal Reserve has been raising rates this past year, existing bond prices went down, even though they are expected to pay out the full amount at maturity.  The prices of bonds that mature in later years have fallen more than bonds that mature sooner.

Most banks have been hedging their interest rate risk for those longer maturity investment with derivatives to protect themselves from price moves.  Silicon Valley Bank did not.

SVB had many accounts well over the $250,000 limit and its customers have been withdrawing money for three reasons:  1) many of the bank’s customers are start-up companies and they are using cash for operating expenses; 2) customers were moving cash to earn higher interest yields elsewhere; and 3) customers eventually became concerned about the amount they had in accounts over the FDIC limit. 

The last reason became a self-fulfilling prophecy – customers clamored to withdraw funds, the bank had to sell bonds at a loss to make cash available and the cycle repeated.  It was a classic bank run.

Government Response

The government announcement on Sunday was designed to restore confidence that cash would be available for depositors, even for amounts over $250,000.  The government may take over the bank, but depositors will get their money back.

Money Market Funds are Different than Traditional Bank Deposits

Your cash at Fidelity is invested in money market funds that pay a higher interest rate than most bank savings accounts.  Fidelity does not use these funds to make loans; they have no legal access to it.  Your money market funds are liquid and can be withdrawn at any time.

The portfolio manager of the money market fund is invested in mostly Treasury bills and other short-term government bonds, but unlike Silicon Valley Bank, the bonds in these funds have very short maturities.  So if a lot of clients withdraw their money at the same time, the investments themselves are short term and are easily sold.

The Difference Between FDIC-backed funds and Government Money Market Funds

During the 2008 Financial Crisis, some money market funds had trouble selling the bonds in their portfolios.  This prompted the regulators to require money market funds to either use government bonds exclusively for their funds or remove the guarantee of $1 per share of the fund. 

In response, many money market funds began using government bonds. 

Some financial companies formed banks and began promoting FDIC-insured funds for client’s cash.  A commercial bank has access to client funds to use for loans or investing, following regulatory guidelines.  The manager of a government money market fund can only invest in short-term government bonds.

Our preference for cash is to continue to use government money market funds because the assets are separate from a bank, and they still pay higher interest rates. 

Here is a link to the money market funds in most of our client accounts:

https://fundresearch.fidelity.com/mutual-funds/summary/316067107

https://fundresearch.fidelity.com/mutual-funds/summary/31617H102

Please let us know if you have any questions and would like to discuss in greater detail.