With so much money rapidly coming in, Silicon Valley Bank had to invest the funds somewhere. It couldn’t find enough new loans to make. So the bank’s managers chose to buy long-term Treasurys and mortgage-backed securities. These were considered safe assets that paid a little bit more money than what the bank had to pay on its deposits.

This seemed like a relatively safe practice until inflation hit the economy and the outlook changed radically.

From early 2020, the Federal Reserve was keeping rates at very low levels to help the economy and financial markets recover from the pandemic.

Startled out of a complacency when inflation soared, the U.S. central bank sprang into action to fight inflation and started an aggressive tightening campaign, ultimately raising its benchmark interest rate by 4.5 percentage points in a year.

As a result, the bonds that had been purchased and held by Silicon Valley Bank were worth less because they paid a low interest rate compared with new bonds that the U.S. government was issuing. The bank’s bond portfolio was “upside down.”

SVB
SIVB,

was not alone in this condition. But Silicon Valley Bank had grown so quickly that its problems were worse.

By late October, Wall Street started to notice, and there was a story in The Wall Street Journal about trouble at the bank.

Pressure continued to build. Last week, SVB tried to raise capital through a stock sale run by Goldman Sachs
GS,
+2.86%.
But this turned out to be the equivalent of throwing blood in the water in a pool of sharks.

That’s because SVB depositors were “clubby clientele of Silicon Valley start-ups and the venture-capital and private-equity firms that fund them,” in the words of Adam Lashinsky, a former reporter who covered tech since 1991, in an op-ed in the Washington Post.

Sensing trouble at the bank, the “club” exchanged text messages and many of them rushed to take their money out of the bank at once.

It was a classic old-fashioned bank run — like in the 1930s, a la Jimmy Stewart in “It’s a Wonderful Life.” A run like this can be very damaging for any bank because they don’t keep so much cash on hand.

Apparently fearing that the run of depositors would pick up steam, regulators moved in and closed Silicon Valley Bank in the middle of the day on Friday.

That same day, the government said that all depositors under the $250,000 insurance cap would be made whole. But the fate of depositors in excess of the safety net was not made clear. That uncertainty was felt most by the startup and venture capital clients at the bank, whose deposits were much larger than the insurance cap threshold.

Over the weekend, many well-known investors like Bill Ackman said the government needed to explicitly guarantee all deposits at the bank to prevent a run on other banks.

Late Sunday evening, regulators moved. In what has since been described as a “double barreled bazooka,” the Treasury Department, Fed and Federal Deposit Insurance Corp. said that all depositors at Silicon Valley Bank would be made whole. Regulators used this power to close a second bank — Signature Bank.

In addition, the Fed put in place an emergency loan program aimed at stemming the contagion that appeared to be spreading to other regional banks.

Under the new program, banks can pledge their bonds at face value to the Fed in return for cash. That means banks don’t have to mark these assets to the market price.

Roger Altman, a former top Treasury official who founded the investment bank Evercore, said that the intervention by regulators did “stabilize” the banking system.

But the “breathtaking” nature of the government actions raises its own questions and concerns.

Essentially, the government seems to be guaranteeing the deposits of the entire U.S. financial system — not just the “little guy.”

And it highlights the fragility of the financial system in the digital era.

President Joe Biden put a brave face on the crisis in comments at the White House. He said Americans should “breathe easier” as a result of regulatory action and that the banking system was safe.

Where will it end?

Ian Katz, a financial industry analyst at Capital Alpha Partners, said regulators likely expect at least a few banks to come under pressure from depositors wanting to leave.

“If we can limit this to a couple more banks, then good. If it gets worse than that, it is bad news,” Katz said.

Regional bank stocks are under pressure.

The government continues to look for a buyer for Silicon Valley Bank.