After spending two fun-filled weeks in Japan, you can read all about it here . It looks like I may have missed one or two bank collapses. Don’t worry. I won’t be discussing the pros and cons of a bank bailout or the moral hazard that could result.
Here are eight thoughts about “risk.”
The riskiest time is when everything appears perfect.
Silicon Valley Bank was founded on October 17, 1983. Two years ago, the business boomed. Venture funding has exploded in recent years, after a brief dip in deal flow following the Covid shock. Companies raised a record amount of $344B by 2021.
Silicon Valley Bank was the biggest beneficiary of the VC bull-market. Its deposits grew from $49.9B in 2018 to $102B by 2020 and to $189B at the end 2021. The bank’s share price increased 6x from $100 to over $700.
Silicon Valley Bank was a perfect place. Then, everything came crashing down within a blink of an eye.
Second: The conditions that produce prosperous outcomes often plant seeds for their own demise.
Silicon Valley Bank was a ‘cool’ bank during the largest venture-funded bull run ever. Interest rates declined steadily, funding rounds, valuations and valuations increased, and a large portion of the newly-raised cash for startups went to one place. Why would it not? Who else would offer founders mortgages below market rates and provide steak dinners during the South by Southwest Conference in Austin? These tactics worked. 88% of Forbes 2022 Next Billion-Dollar Startups were SVB customers.
This concentrated customer base, which was so valuable during a bull-market, was vulnerable as market conditions changed. When fundraising slowed down, startups all over the country were forced to withdraw money to pay rent and employees. When one customer needed cash, thousands needed cash. Minimum diversification results in correlations approaching 1 both up and down.
The same factors that lead to large wins can also cause huge losses.
The third risk is that it happens quickly.
Consider a turkey who is fed daily. Each feeding reinforces the belief of the bird that being fed by a friendly member of the human species “looking out for their best interests” is the rule of life. The turkey will experience an unexpected event on the afternoon of Wednesday, the day before Thanksgiving. “It will cause a change in belief.” – Nassim Telleb
Silicon Valley Bank’s business boomed for years, and the stock price rose, and then rose, and then rose. Then, in just a few days, it all collapsed.
We use words like “crash” and “collapse” to describe failures that happen faster than progress. It is especially true in an internet-age where investor memos warning founders to withdraw cash can spread on social media within hours and a bank that appears healthy can see $42B in withdrawals in one day.
Risk happens fast.
Fourth, boredom is not always a bad thing. It’s not a bad idea to leave money on the table if you have a margin of error.
The decision of the management to invest in mortgage-backed securities with long maturities at a time when interest rates were 1.7% was a key factor which accelerated Silicon Valley
The bank’s reasoning was straightforward: the yields on these securities were higher, and since the Fed didn’t plan to increase rates any time soon, the bank could earn more by
Every undergraduate student of finance knows that bond prices plummet when rates increase, and the Fed’s decision to raise rates multiple times in 2022-2023 has decimated SVB
If the bank had maintained larger positions in short-dated, lower-yielding securities, they would probably have survived rate increases. They were trying to increase profits, but their forecast was wrong.
It’s great to make higher profits, but the tide will turn if you aren’t prepared. Outsized profits come at a cost.
A cautionary note went viral and caused a panic, causing an increasing number of companies withdrawing their cash. This caused thousands to tweet about the possible collapse of SVB, which The internet, and individuals’ ability to spread fear via Twitter, was the only way that this information could be shared so quickly.
Silicon Valley Bank’s decision to invest in mortgage-backed securities with a long maturity date was another reason for its collapse. But the bank did so because the yields on fixed income
The Great Financial Crisis caused the Great Financial Crisis. ….
See where I am going with this? Silicon Valley Bank would not collapse if one of these dozens things had never happened. All of these things happened, and the result was a bank collapse.
The biggest risks are not predictable by nature.
In 2019, the biggest global macroeconomic concerns were a trade conflict with China, the development of nuclear weapons in North Korea and unrest throughout the Middle East. In 2020, an unknown virus caused millions of deaths, and the world was put on lockdown for several years.
Covid-19 was not on any bingo cards.
After every crisis, we take steps to prevent it from happening again. These steps were taken with Covid-19 and included the development mRNA vaccines. During the Great Financial Crisis these steps included a regulatory overhaul of banks and rating agencies.
We have never seen an investment bank that specializes in startups fail due to a fixed-income security paying 1.70% after a pandemic recession. It was impossible to find a historic example that management could point to, and say “We better not do what the did!“.
I can assure you that this next crisis will not look the same as the previous one.
7th, if you’ve already reached “success”, no tail risk, regardless of probability, is worth it.
Warren Buffett said: ” It is insane to risk your assets and needs for things you don’t need.
I have written about my SPAC trading experience during the Covid Bubble several times. At one point , I turned $6,000 into over $400,000. In the beginning, I could have argued that taking bigger risks was a better idea. Losing $6,000 isn’t a big deal in the scheme of things.
The same trades I made with $6,000 a year earlier, with $400,000, went horribly wrong. I lost around $250,000 since my peak.
In the 1980s, Silicon Valley Bank had just started and high risks were understandable. Who cares if a bank that is only a year old and has no name fails? Whatever.
In 2023, Silicon Valley Bank would be one of the biggest financial institutions in the nation and an important part of the startup scene. Now, risky activities had exponentially greater consequences. SVB did not need take on extra risk. They were already winners. The game was over. As their deposits grew, they played dumb games and won stupid prizes.
No matter how unlikely they may seem, terminal tail risks should not be taken if the losses exceed any gains.
The biggest risks are always obvious after the fact, but we don’t see them in advance.
In the past two weeks, hundreds of articles have been published about Silicon Valley Bank and its numerous red flags. Funny that these problems only became evident after the bank collapsed.
Predicting the next crisis before occurs is not so easy. That’s another matter.