Silicon Valley Bank And The Troubling Dilemma of Bank Bailouts: Lessons Learned and “Unlearned”

Watching the 2015 film The Big Short in AP Macroeconomics class, I was especially struck by the unsettling reality underlying its resolution. As Mark Baum, one of the shorters, ruminates about the immorality of a taxpayer bailout and Wall Street’s full awareness and indifference to the consequences of its actions, there is a brief interlude when a voiceover states that Baum was wrong. The heaviness suddenly lifts, juxtaposed with a jaunty tune and air of celebration, as a montage plays: hundreds of bankers and executives were sent to jail; the government split up the big banks and restructured the SEC. And then the glass shatters, the audience’s momentary relief returning to outrage. Because, of course, none of that happened. Baum was correct. In the aftermath of the 2008 financial crisis, bankers made personal gains through the relief funds, scapegoated immigrants and the poor, and only a single banker went to jail. It is a harsh reality check.

But after detailing the glaringly unscrupulous and reckless lending practices across banks, rating agencies and mortgage brokers for two hours, the disconcerting question still persists, how could they all possibly get away with it? When attempting to grasp the sheer magnitude of interconnections and convoluted nature of the system, the aftermath becomes foreseeable, if not easier to accept. Moral hazard and the distribution of blame made it near impossible to pin on individuals. The offenses were not easily able to be prosecuted, sometimes because they were not clearly illegal. Government deregulation policies had stripped crucial funding from critical agencies like the SEC and FDIC, debilitating enforcement and investigation. Furthermore, mortgage bonds, thought to be safe and stable, were a low priority for regulation. Set up like cascading dominoes, in retrospect, the 2008 housing market collapse seems in some ways inevitable—exactly what the shorters capitalized on. Through deregulation, the government enabled the rise of the subprime mortgage market, giving banks full rein to practice high-risk lending and influence rating agencies, ultimately leaving America’s financial system—and by extension, the world’s—vulnerable. 

Blaming the bankers seems logical—or even the rating agencies, investors and brokers—for their greed and complicity. But ultimately, the whole system should never have been left in that position, unsupervised and trusted to determine risk at its own discretion, while being tempted by prevalent loopholes. The Great Recession, like the Great Depression, was preceded by a decade of laissez-faire policies. Both were then addressed through broad fiscal policies, based on Keynesian theory, and legislative banking regulation reforms to avoid future financial disasters. Congress’s passage of the Dodd-Frank Act in 2010 enacted major banking reforms, increasing oversight and creating the Consumer Financial Protection Bureau. However, alarmingly, significant portions of those preventative regulatory and consumer protection measures have been cut back once again after the Trump administration’s 2018 Dodd-Frank rollback. This deregulation has largely provided banks a free pass to return to their pre-2008 practices. 

And that is why, after hearing about the recent news of the collapse of Silicon Valley Bank and subsequent federal protection, I was overcome with a sense of déjà-vu and the uneasy notion that even if the situation wasn’t inevitable, it was still highly predictable. To be clear, Silicon Valley Bank (S.V.B.) had certain unique and inherent flaws: As a bank mainly appealing to tech companies and venture capitalists, S.V.B. did not have a diverse portfolio and most of its deposits were uninsured (the FDIC only insures deposits up to $250,000), leaving it especially vulnerable to changes in a sector well-known to be volatile. From a behavioral economic standpoint, as a group, the nature of tech investors and venture capitalists is less risk-averse, and group psychology convinced many companies to trust S.V.B. due to its ties to the tech industry. With interest rates low and deposits skyrocketing over the pandemic, S.V.B. invested in longer-duration Treasury bonds, yielding higher profits in the short-run, when interest rates were low. But as the Fed increased rates to curb inflation, the value of these long-term bonds plummeted. S.V.B. was doubly affected, as tech investors, also discouraged by the rising interest rates, stopped making deposits, reducing its influx of cash. When depositors started pulling out funds, the bank was forced to sell off some of its bonds before maturity at a massive loss in the tens of billions. As S.V.B. stock fell drastically, more depositors began withdrawing their money and as word rapidly spread on social media, the situation frantically spiraled into a bank run. 

Given that the vast majority of S.V.B.’s deposits exceeded $250,000, the federal government stepped in to ensure that all deposits would be insured. Many of these deposits were of businesses (including many climate start-ups) which would have had to close or lay off large parts of their workforce to survive the months-long process of regaining their deposits without federal intervention. This decision was also spurred by fears of systemic risk—that the collapse of S.V.B. would lead depositors of other midsize banks to panic, triggering bank runs across the country. A key distinction from 2008 is that any money required beyond the assets of S.V.B. will come from an FDIC fund paid for by the banks, unlike a taxpayer bailout; S.V.B no longer exists as an entity, its employees will be fired. 

Yet it is difficult not to feel as if this whole situation could have been avoided. The 2018 repeal of the Dodd-Frank Act deregulated the banking industry in critical ways; for example, it significantly reduced liquidity and capital requirements. Additionally, periodic stress tests became only required for banks with assets greater than $250B, rather than $50B. With assets around $200B, S.V.B. narrowly missed this threshold which would have subjected it to tougher stress tests, including ones for spiking interest rates which would have most likely revealed S.V.B.’s dangerous trajectory and mandated changes as a result. The hypocrisy is that S.V.B. was one of the very banks lobbying for reduced regulations due to their medium size—which, they argued, made them less risky. But when banks recognize that their risk of contagion allows them to rely on government intervention, what is their disincentive to make riskier, more profitable investments? In this new era of alarmingly swift digital bank runs, how can the government determine when the need to interfere and prevent greater economic collapse outweighs the consequences of increasing moral hazard?  Traced to its root, like the 2008 housing market crisis, the collapse of S.V.B. stemmed from poor high-risk decisions, and a lack of federal oversight. 

And so, fifteen years later, many of the big questions remain: For a system which subsists on aggressive risk-taking for profit, where is the line drawn? How does the moral calculus pan out? When does systemic risk make a bank “too big to fail”? One thing seems clear: Regulation may hinder some economic growth, slowing efficiency and limiting profits; but the trade-off is incomparable. Because after all, as is history’s precedent, it will largely be the American people who will have to pay the price.