Bank concerns that began with Silicon Valley Bank have dominated headlines since March 9. Below are suggestions to protect your cash and investments in a banking crisis, including some details about what happened with Silicon Valley Bank (SVB) and why.
How Did the Bank Collapse?
Silicon Valley Bank benefited from the tech boom. It enjoyed a huge increase in deposits following COVID-19. Most deposits came from venture capital-backed technology businesses. The money held on deposit with SVB tripled from 2019 through 2021 to $189 billion. The bank had to put this money to work.
SVB invested deposits in long-term bonds. SVB purchased Treasury bonds with average earnings of about 1.8% plus a large amount of agency-guaranteed mortgage bonds maturing in 10 years or more. This saw positive returns for a while, as the bond earnings were above the deposit rate customers are paid, but it quickly unfolded.
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The Federal Reserve increased interest rates. This caused the amount SVB was paying to new depositors to increase to around 4% per annum. This was considerably beyond the income they were receiving on Treasury bonds. The bank began losing money. And the assets SVB held in long-term agency-guaranteed mortgage bonds fell in value due to the Fed’s rate increases, creating billions in losses.
The downfall of Silicon Valley Bank. SVB tried to create liquidity on its balance sheet. They attempted this by selling long-term bonds. But since the long-term bonds had fallen in value, the proceeds they received resulted in losses. Word of these losses got out within the venture community. People became skittish, and the majority attempted to withdraw their money, more than $42 billion on March 9. Unable to meet all depositor withdrawals, SVB was left with no liquidity and major losses, forcing it to default.
A silent bank run. Overwhelming withdrawal requests from depositors seized operations at SVB. This was a silent bank run with most withdrawals requested electronically. There was not enough cash and liquid assets available for immediate sale to fund deposit outflows, without wiping out their equity capital base. Banks do not hold enough cash to fund 100% of their deposits. According to regulations, they’re allowed to invest around $10 for every dollar of deposits. These investments, which could be in the form of loans to customers or invested in publicly traded securities, such as U.S. Treasuries or mortgage-backed securities (MBSs), are generally longer term in nature and are not always able to be sold at a profit.
This is clearly, as Warren Buffet would say, a ‘see who’s swimming naked when the tide goes out’ moment.
Protecting Depositors
On March 12, the Federal Reserve, the FDIC and the U.S. Department of the Treasury addressed the solvency of insured and uninsured depositors at SVB. And President Biden assured Americans the banking system is sound. At Peak Wealth Planning, we believe the current administration will do everything possible to prevent bank collapses in the United States that hurt depositors. Unfortunately, equity holders and bondholders may not fare so well.
The rapid rise in interest rates has caused short-term losses for the banking industry that are meaningful, bank industry capital levels should be well positioned to weather the storm. The response from the Federal Reserve, the FDIC and the U.S. Department of the Treasury has been coordinated and substantial to ameliorate concerns. Equity market volatility will likely remain elevated, reflecting the uncertainty around the banking sector, but most banks have more diversified sources of funding than SVB, including a higher number of accounts below $250,000, and lend to a wider range of industries.
Protect Your Cash and Investments
For investors, including retirees with near-term cash needs, consider migrating money market funds and short-term bond funds to Treasury-only options. I don’t feel the incremental yield pickup from corporate credit risk — often concentrated in financials — is worthwhile in funds with average maturities inside of a three-year window.
If you have bank deposits, confirm your bank is FDIC-insured. And make sure you are below the $250,000 FDIC insurance limit for individual accounts or $500,000 for joint accounts. If you need to spread deposits across multiple institutions, be sure to keep good records and properly title your accounts if you have a trust.
If you have a brokerage account with cash you need within the next 36 months, ask your financial adviser to invest in a Treasury-only money market or bond fund. You might also consider buying CDs from different banks up to FDIC limits within a brokerage account. Another alternative is using a service like maxmyinterest.com, which spreads your money across multiple online savings accounts below the FDIC limit. For longer-term investors, you may want to consider I bonds as one part of your investment portfolio, especially if you are saving for college.
There are pros and cons to each approach, and your financial adviser can assist you in choosing one that works best for you.
Final Thought
Do you have cash you may need to spend in the next three years? Are you confused by the myriad of options? If you have more than $2 million saved and need help deciding where to invest your cash, the Peak Wealth Planning team can assist.
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