London, Thursday, 23 March 2023
Publisher's Summary, Angelos Tsigkopoulos
The abrupt failure of four US banks in recent weeks raised numerous issues regarding tech start-ups, venture capital, the cryptocurrency market, risk appetite, the overall global capitalist system, and regulations. In spite of all the stricter rules that had been put in place during all previous crises, is this an anomaly or is the US financial crisis of 2008 occurring again? When businesses and banks experience boom-and-bust cycles, does capitalism have an inherent weakness due to its cyclical structure, or do bigger institutions simply absorb smaller ones at a cost?
Who is liable and what should be held accountable when billions of dollars are exchanged and some of them disappear in recent weeks?
Responsibilities
Sudden disasters call for ready-made scapegoats. All eyes were on the leadership roles in those banking organisations after the quick demise of four banks in the US.
Many analysts attributed the turmoil in the crypto market last year to poor management, ineffective leadership, dishonest business practices, and senior executives' inability to foresee its potential effects.
On March 13, President Joe Biden promised that "no losses will be borne by the taxpayers" and reassured Americans that the US financial system and depositors are "safe."
"Investors and the banks will not be protected," he added. Investors lost money as a result of the risk they knowingly accepted that did not pay off. That is the way capitalism operates.
After all, Biden served as Vice President for the Obama administration, which took office after the financial system had collapsed in 2008 and implemented stricter financial rules on Wall Street.
However, according to Adam Smith, a Scottish philosopher from the 18th century who is often referred to as "the father of capitalism" or "the founder of modern economics," "individual ambition serves the common good" is the motto ingrained in capitalism.
"tremendous inequality exists wherever there is tremendous property. The affluence of the few presumes the indigence of the many, he wrote in his renowned book An Inquiry into the Nature and Causes of the Wealth of Nations, which was released in 1776. For every very rich man, there must be at least 500 poor people.
So there are hundreds of failed banks for every good one, right?
The Case
The first US banking institution to announce that it would cease operations due to significant losses in its loan portfolio was Silvergate Bank, which had a strong emphasis on the cryptocurrency sector. This announcement was made on March 8.
Due to FTX's importance as a client of Silvergate Bank, the collapse of the crypto exchange FTX late last year—once the second-largest in the world by daily transactions—was a significant factor in the bank's demise.
Sam Bankman-Fried, the former co-founder and director of FTX, praised Silvergate Bank. He is currently facing 12 charges related to the implosion, and three of his former executives have already entered guilty pleas.
Second, Silicon Valley Bank (SVB) revealed its problems openly on March 8, shocking investors and the US financial community because it was thought to be a well-capitalized institution.
SVB, with its headquarters in Santa Clara, was in the centre of the US's innovation hub. Based on local deposits, it was one of the biggest institutions in the country and the largest bank in Silicon Valley.
It had been a significant source of venture capital, a type of private equity funding for startups -- businesses in their early stages, typically in the tech sector, with enormous upside growth potential, comparable to the entry-level versions of Microsoft, Apple, and Google.
The fallout from SVB, however, began at the end of February when some of the bank's senior officials started selling their shares.
Gregory Becker, the chief executive officer, Daniel Beck, the chief financial officer, and Michelle Draper, the chief marketing officer, all sold shares in SVB Financial Group, the parent business of the bank, for a combined $4.5 million, it was later revealed.
When Becker declared on March 8 that the bank had sold "substantially all" of its securities portfolio after SVB sold its $21 billion bond portfolio at a $1.8 billion loss, fear erupted across Wall Street and the US financial sector.
By the end of 2022, SVB had about $209 billion in assets and about $175 billion in deposits. It was unusual for a well-capitalized institution to fail so abruptly.
The parent company of the bank, SVB Financial, saw its equity price fall more than 60% in less than 48 hours, and due to the company's high volatility, trading was frequently suspended.
The Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation (FDIC) was named receiver by the California Department of Financial Protection and Innovation after SVB was abruptly closed by US authorities.
To protect insured depositors, the FDIC established the Deposit Insurance National Bank of Santa Clara (DINB), and it promptly transferred all insured deposits from SVB to the DINB at the moment of closing.
Since the collapse of Washington Mutual at the height of the financial crisis in 2008, which was caused by the US housing bubble that was initially based on sub-prime mortgages and later gave rise to derivatives like toxic CDOs that overvalued junk-rated assets for greater profits, it was the biggest failure of a US-based financial institution.
Investors were most concerned about SVB's demise because of its possible snowball effect, which could cause other US banks to fail as well. While the US financial crisis of 2008 spread internationally and resulted in a global catastrophe, is SVB a domino that could cause other US banks to fail as well?
Customers started withdrawing their accounts in a panic at New York-based Signature Bank, which has assets worth $110 billion and $8 billion in total equity.
The bank was shut down on March 12, a Sunday, by the New York State Department of Financial Services because it had demonstrated that it was unable to better its financial situation before Monday morning.
The fourth US bank, First Republic Bank, a full-service bank and asset management firm, saw its shares drop more than 20% on March 15 as the panic escalated into a full-fledged fire sale.
Eleven of the largest US banks, including Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs, and Morgan Stanley, contributed $30 billion in deposits in less than 24 hours to save First Republic Bank.
The FED’s Role
In fact, there have been a number of banking crises in the US over the past 100 years, each of which saw larger banks or companies eat up smaller, bankrupt private institutions.
When the New York-based Lehman Brothers, which once had assets worth over $600 billion, filed for bankruptcy in September 2008, British global bank Barclays bought out its investment banking division.
Let's quickly go back to the Great Depression of 1929.
According to a piece written by David Wheelock, senior vice president and special policy adviser at the Federal Reserve Bank of St. Louis, "between 1929 and 1933... about 7,000 banks failed."
The US Federal Reserve, which regulates the global supply of US dollars, has made two significant moves in the past three years: first, injecting $5 trillion into the US economy all of a sudden during the coronavirus pandemic, which led to high inflation, and second, raising interest rates too quickly to lower inflation, which reached a 40-year high.
With the Fed's aggressive monetary tightening, interest rates rose by a total of 425 points on seven separate times last year. Then, on February 1, the target range for its federal fund's rate was raised by another 25 basis points, making it the highest since October 2007.
Many economists strongly believe that the Fed moved too quickly and aggressively in raising interest rates, taking too much cash out of the global dollar supply and leaving the US economy with insufficient liquidity for new investments, particularly in the tech sector.
Purchasing Treasury bonds that are insured by the US government is the best and most common investment strategy used by banks during periods of extreme monetary tightening. They have a fixed interest rate but a modest return because there is little chance that the US government will default on them.
However, as a result of declining ad-based revenues, tech start-ups were in desperate need of cash last year. As a result, venture capital financing was drying up, which exposed banks with significant technology investments, like SVB, to increased customer withdrawals of deposits.
Any bank ultimately starts selling its own assets to meet customer withdrawal demands as withdrawal requests get bigger. As a result, SVB was compelled to sell its supposedly safe bonds at a loss, and when those losses added up, it caused SVB to go into insolvency, which occurs when a bank's liabilities exceed its assets and it cannot pay back its depositors.
So Where is This Going?
The Great Depression of 1929, the Great Recession of 2008, the collapse of the dot-com boom in 2000.
Companies, banks, and other private institutions vehemently demand Adam Smith's "invisible hand" -- private actors acting for their own self-interest in a free market without any government interventions, advocating it would be better for the entire society -- despite the fact that all crises demonstrated the need for additional regulations and stricter government control.
Investors' insatiable appetite for risk and desire for huge returns on a small initial investment can sometimes lead to sudden failures like the most recent bank crashes.
Although immediate action is needed to address the present banking crisis in the US and stop it from spreading to other countries and regions, the main issue is much bigger.
The solution we arrive at should eventually deal with more basic causes and effects in order to serve as a lesson for capitalism and enhance the preeminent economic system for the twenty-first century.
Despite all the ups and downs over the past century, we are unable to do away with the modern, interconnected, global economy and borderless financial system because it caters to our immediate consumerism requirements and our excessive dependence on it.
New technology, start-ups, dangers, and opportunities will always exist. The struggle between the human appetite for risk and the rules that are required to maintain equilibrium will continue to exist.
Despite all the ups and downs over the past century, we are unable to do away with the modern, interconnected, global economy and borderless financial system because it caters to our immediate consumerism requirements and our excessive dependence on it.
New technology, start-ups, dangers, and opportunities will always exist. The struggle between the human appetite for risk and the rules that are required to maintain equilibrium will continue to exist.
(Research and edit by: The Decision Maker - Finance editors, Jonathan Davies, David Ramirez // Angelos Tsigkopoulos contributed to this article)
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