Silvergate, Silicon Valley Bank, and the Threat of Contagion

Silvergate and Silicon Valley Bank

It’s high time I write more about finance on this blog. Unlike the last time, when I wrote about the GameStop short squeeze of January 2021, I now have actual skin in the game. For the past three months, I’ve been getting into stock trading, and it has been both a blast due to the learning experience and a stressful experience due to the initially losing trades. I knew what I was getting into, but I didn’t know that I was going into a market that was scarred by the ravages of 2022. Let’s talk about bank runs and the ongoing nightmare of the 2023 market.

The biggest thing I learned through these three months is why people who do this can’t seem to shut up about it, like vegans and CrossFitters. It’s exciting, especially when you have your own money in it. I’m sure I was making people’s eyes roll in January and February — and still do — because I can’t help it. It has been great fun absorbing as much knowledge and experience as I can, and I still have a long way to go as I still don’t completely understand the wackier stuff like options. But I’ve been quite pleased with my progress thus far, all things considered.

Although it seems I entered this world at an interesting time. The market has been bearish after the crazy high year of 2021 and the subsequent comedown of 2022. Also, crypto is still dealing with the aftereffects of the collapse of Celsius, Terra, and FTX. Maybe if I entered in 2021, the bull market would’ve instilled me with false confidence that would’ve doomed me later on. But I don’t really know that right now as I’m only a beginner looking to learn more about something that requires one to check their own ego constantly.

Meanwhile, plenty of people have been tearing their hair out and gnashing their teeth as things have been spiraling out of control. Whoever thought of buying the dip then saw another dip, and then an even bigger dip. The charts look like a long and meandering stairway to hell, and it doesn’t look like things are going to calm down just yet.

NOTE: I write these blog posts to consolidate what I’ve learned thus far in a certain topic. If there are factual inaccuracies and mistakes in my writing, please inform me in the comments section or message me through social media. You can even call me an idiot for it. Thank you.

Silvergate Bank

Silvergate Bank was a California-based bank that recently went defunct, having operated from 1988 to 2023. It was the larger of the two US banks that let crypto exchanges cash out for US Dollars. As it became obvious that its existence was coming to an end, Silvergate declared voluntary liquidation, thus ending a 35-year run.

They worked closely with FTX, which meant that they were caught in the blast of FTX’s disastrous implosion. Not only did they lose a gigantic sum of money, but they also couldn’t properly respond to questions by federal authorities about their role in the FTX fraud and why they didn’t notice it right away, which heavily implies complicity in the scheme.

As a decades-old bank, it meant Silvergate didn’t always provide cryptocurrency-related services. Silvergate only entered the crypto market in 2016, when it was just about to peak. But three years after going public, concerns about the health of the bank were raised when FTX, one of their biggest clients, went bankrupt and its CEO became public enemy number one.

Brief History of Silvergate

The bank was co-founded as a savings and loan association in 1988. Eight years later, it was recapitalized and reorganized as a bank by founders Dennis Frank and Derek J. Eisele. At first, it stayed small as a community bank in the San Diego region with just three branches.

In 2013, CEO Alan Lane personally invested in Bitcoin and led Silvergate to an initiative in serving cryptocurrency clients. This led to a growth spurt, reaching $1.9 billion in assets by 2017. They then had their initial public offering (IPO) in November 2019 at a share price of $13, which rose to $219 two years later when the cryptocurrency bubble of 2021 was at its peak.

What Led to the Collapse

All of this became known when Silvergate delayed filing their 10-K report, which had to be done every three months. The reason they gave for missing their latest report — when translated to layman’s terms — essentially meant, “We have a problem with our internal system that keeps our employees from committing fraud.”

It was related to losses incurred by the collapse of FTX, which was one of their biggest clients. They either accidentally did something that could be seen as fraud or they deliberately committed fraud. Whatever they did or did not do, they had a pretty good reason for doing it at that time as FTX was the second largest crypto exchange and was throwing big money everywhere. They stood to benefit greatly from that client.

But when the whole situation with FTX and Sam Bankman-Fried hit the headlines in November 2022, that was the beginning of the end. The federal government made a statement on how banks having close ties with crypto exchanges is a very bad idea and they should exit such relationships as soon as possible. Authorities know that when things go south, they’ll be called upon to bail them out, and cryptocurrency being involved makes it extra ironic.

The Securities and Exchange Commission (SEC) has had a track record of being incompetent in the last decade and a half due to the 2008 housing crash, Bernie Madoff, and now FTX. Fresh off those L’s, authorities are now looking to salvage their reputation by rallying hard against crypto, deeming them a “risk to economic stability”.

While it can be said that regulatory issues may have allowed Silvergate to take the risks they did, their financial decisions are what really put them six feet under. From what I’ve read, the downfall followed this timeline:

  • Bank invested deposits into 10-year Treasury Bills
  • Federal Reserve increased rates very quickly to address inflation
  • People went from 10Y T-bills to shorter ones like 1Y that provided 4% yield
  • Value of 10Y T-bills tanked as a result
  • Customers started withdrawing billions due to fears spurred by regulatory issues
  • Silvergate (SI) began to sell its T-bills at a discount, yielding massive losses
  • Those losses caused more people to withdraw, leading to even more losses
  • The Federal Home Loan Bank (FHLB) told SI to pay back its $4 billion secured loan
  • Even more billions gone down the drain as more assets are sold at a loss to stay liquid
  • After the loan recall by FHLB, SI couldn’t produce a balance sheet to file their report
  • Auditors wouldn’t sign off on their financials, hence speculation of SI being bankrupt

If Silvergate put their deposits into shorter duration T-bills to begin with, perhaps they could’ve sold those at a much lower loss and stay solvent amid such emergency situations. In any case, Silvergate can now rest, but not in peace just yet.

They sold $718 million in assets at a 14% loss to raise cash, which wasn’t enough to prevent their demise. They were in a hole so deep that it didn’t take long for them to realize that it was all over.

Silicon Valley Bank

The sixteenth largest bank in the US, Silicon Valley Bank (SVB), had its shares ($SIVB) tumbling down last Thursday in a sudden freefall. It turned out that the days leading to the disaster, insiders were withdrawing their funds from the bank as soon as they could. I’ve learned that Thursdays tend to be the worst day of the week for stocks and crypto, and things came to a head for SVB, especially after Silvergate went down.

The Tech Startup Bank of Choice

Silicon Valley Bank is somewhat unique compared to most other banks as its deposit base consists mostly of tech startups and small companies fueled by venture capital, who were attracted to the low interest rates. Startups tend to not qualify for loans since they tend to burn through cash while trying to get off the ground and not have significant fixed assets that can be put up for collateral.

As a result of the sketchiness, most of those deposits were uninsured, making it even riskier. Also, while they got money as deposits, it wasn’t going out as loans due to the nature of how they did business as a bank for tech startups, which was why they went with investing in bonds. When things started going south, interest rates rose and investors responded by pulling out, thus dwindling SVB’s cash flow.

Having been awash in cash from venture capital, private equity, and so on, Silicon Valley Bank made investments in ten-year hold-to-maturity (HTM) treasury bonds. Personally, five years is as long as I’m willing to go for with bonds and time deposit, so I can’t imagine keeping money locked away in something for that long.

It’s also puzzling that they put money in those bonds at 1.56% interest. That’s such a low rate for such a long time. They might as well have kept that cash in their vault. Perhaps that’s all they could get at that time, but it’s still quite a head-scratcher since such a sizable financial institution chose to keep it all there for a whole decade.

From now on, whenever I have decision anxiety, I’ll remind myself of this case and be assured that even I wouldn’t settle for anything that dumb.

With rising rates, plummeting value of securities, and cash being burned away by all these startups and early-stage businesses, what SVB sorely needed was a vault full of cash. But since they put theirs away in bonds, they essentially flew too close to the sun and had their wings burned and melted away by the intense heat.

Dead Within 48 Hours

Now that the bank has been caught with its proverbial pants completely down and it has no arms to pull them up, its vulnerability is clear for all to see and they have no other choice but to throw their nonexistent hands up in surrender. Never mind the CEO of the bank because he had a pretty sweet payday when he sold his shares. While it’s not billions and perhaps he sold it at a loss, it’s still life-changing money that can then be grown into generational wealth.

This is the largest bank collapse since 2008 and the second in all of US history. It’s not just an incident in the periphery, but a complete disaster that culminated within 48 hours with $209 billion going down the drain. The only one that surpasses it is the 2008 collapse of Washington Mutual, which had around $307 billion in assets.

Whoever has been banking with SVB has just lost the shirt on their backs. You have tech entrepreneurs with millions of dollars in limbo while regulators have taken over.

What of Silicon Valley Bank Depositors?

Deposits that are insured by the Federal Deposit Insurance Corporation (FDIC) will get their money back on Monday morning. However, that constitutes only 7% of the $161 billion in deposits as the other 93% — a staggering number — was uninsured. Whoever kept more than $250,000 in their accounts is now in agony.

Big wigs like Peter Thiel got their funds out way before things went south for Silicon Valley Bank, likely thanks to insider info. Meanwhile, most other shareholders have been cleaned out. If they didn’t get their money out on time, it’s now all gone.

Companies who banked with SVB are now reportedly struggling to pay their employees. Notably, the human resource management company Rippling had their payments go through SVB. Companies that have been using their payroll services for managing their workforce are now experiencing delays in salary payments.

For now, as of this writing, it remains to be seen whether other banks are also at risk due to SVB’s collapse. SVB already sold their available-for-sale (AFS) portfolio to get some urgently-needed cash, but their HTM bonds are burning gigantic holes in their books. From what I’ve been reading, they’re not the only ones as banks are holding around $620 billion in unrealized losses in their AFS and HTM portfolios.

The Threat of Contagion

Many say the collapse of SVB could start a cascade, like how the fall of Silvergate may have contributed to its closure. Others say since its situation is unique in both its particulars and its severity, it may not be as much of a canary in the financial coal mine as feared.

However, as of this writing, there’s news of the First Republic Bank being hit hard by the SVB collapse. That means there could indeed be a chain reaction, which will likely be more evident in the coming weeks. If the First Republic Bank gets into big trouble and leads to other banks and financial establishments finding similar trouble, we have ourselves a contagion.

In finance, a contagion is the spread of an economic crisis from one market or region to another. This can occur at both domestic and international level. In the case of this dual collapse of two prominent banks, it’s leading to more crises in establishments like First Republic, Western Alliance, Charles Schwab, and so on.

Tangent: DeFi Crackdown

I wanted to add this since cryptocurrency is in the mix. This is what’s happening now as of this writing. The US government is now looking to regulate cryptocurrency and decentralized finance (DeFi). There’s also word that the Federal Reserve will adopt cryptocurrency by 2025, giving way to the digital dollar. China already has a digital yuan, so they’re just playing catch-up.

Many crypto traders responded to the situation by finding arbitrage opportunities in stablecoin trading, buying up whatever got depegged by the chaos and trading it with something that’s still pegged, then securing those gains before everything goes to crap. Most notably, USD Coin ($USDC) went below a dollar, and more vigilant users traded their $USDC to Tether ($USDT) on decentralized finance (DeFi) platforms en masse.

Things did eventually go to crap as the crackdown has finally started.

Two of the concepts that gave birth to cryptocurrency are decentralization and deregulation, so to have centralized regulation of it runs counter to its very existence. Never mind that it was created by a bunch of cyber-hippies looking to upend the financial world that had become corrupt and tyrannical after the 2008 recession — the government wants to control crypto because it’s basically finance on meth. They can’t pass that up.

What Now? Do We Just Lie Down and Die?

Silvergate is definitely out since they voluntarily gave themselves to liquidation. Meanwhile, there’s a case for Silicon Valley Bank getting a bailout as those HTM bonds have a lot of other people’s money locked away in a pocket dimension. However, there’s the argument that a bailout should not be in the cards as their portfolio makes their irresponsibility and unethical risk-taking obvious to all.

There’s also the now-common sight of policymakers rescuing yet another failed financial institution, especially during the administration of who used to be Barack Obama’s vice president. It always seems like America doesn’t care if you suck, as long as you’re privileged.

On the other hand, SVB clients are now having trouble making payments due to the bank closure. For instance, Etsy has delayed payments to creators, which is certainly the last thing you want to see as either a creator or a customer on that website. If businesses that banked with SVB can’t operate because of this, it can soon potentially cripple whole sectors.

Roku and Roblox also had money in Silicon Valley Bank. Then again, why should we care about Roblox? lol

What of Crypto?

As of this publishing, most crypto prices have somewhat recovered, especially after Justin Sun offloaded $100 million worth of USDC to create a liquidity fund for the crypto exchange Huobi Global. He did this after the exchange’s Huobi Token took a nosedive in a flash crash that saw its value drop 93% in a matter of minutes, then recovered just as quickly. Crypto is wild.

The one crypto I can see that still hasn’t recovered is Avalanche ($AVAX), which had significant exposure to SVB. They dodged the Silvergate bullet, but not the SVB cannonball.

EDIT(15MAR2023@12:45AM): $AVAX is now recovering, although it’s still trying to reach $18.

EDIT(10AUG2023@4:40PM): $AVAX never fully recovered. The last time it ever went above $20 was in 18 April. As of this update, it’s at a dismal $12.35, which means whoever rode the Avalanche train as late as early this year definitely lost money.

I bought Bitcoin, Ethereum, and Apecoin during the dip (before the dip after that other dip) just after news of Silvergate’s troubles came about. It was midnight here when prices started going up, and I’ve since earned enough to reach my next milestone, but spirits were pretty low in the days prior. Now I can truly say that trading cryptocurrency isn’t very good for mental health.

Ongoing Disaster with Banks Around the World

The fallout of Silicon Valley Bank is continuing to affect the markets as we speak. Meanwhile, there are speculations of further bank collapses by the likes of Robert Kiyosaki and Peter Schiff. Their alarmism is not totally unfounded as there had been other banks that got shafted in recent years, either due to market conditions or by their own greed like Credit Suisse.

Another recent example is Signature Bank, which Coinbase, Celsius, and Paxos reportedly had their funds in. Never mind that Celsius was built upon distrust of banks since they still needed to put their money in a bank anyway. There could be even more companies that have funds in banks that are now compromised by this situation.

Whether it’s due to unchecked greed or getting caught in the waves of financial tsunami, it does seem like 2023 is not going to be a very good year for the financially challenged. Perhaps describing it as 2008 all over again may be a bit too presumptuous, especially since all I knew about the effects of that recession back then was that I was getting a lot less writing jobs.

Whether there really is a contagion or not and if we’re in for yet another global recession, only time will tell. For now, you best pray, especially if you don’t have a safety net.

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