I still remember my earliest memories of going to a bank. Every weekend, my mom and I would walk several blocks to the local branch, where she would make her deposits and withdrawals.
I would watch, enthralled by the paper deposit slips, the bank tellers behind the glass windows, and on the rare occasions when we would drive, the ultra cool deposit box tube sucker upper thingy. You know what I’m talking about.
At the time, I never gave much thought to how the banking system worked. I figured that the money we deposited just went into a giant vault behind closed doors, like you see in the movies.
I had no idea about the complexities of the banking system, and certainly no idea about the many layers of banking and how banking ties into the greater economy.
If you’re reading this, you’ve likely heard about the collapse of Silicon Valley Bank (SVB), the 16th largest bank in America, and the largest bank to fail since the 2008 financial crisis.
Even if you have never been a customer or investor with Silicon Valley Bank, and even if you’d never heard of it until recent headlines, it’s worth taking a moment to dig in, understand what’s going on, and start to wrap your mind around the potential ramifications and ripple effects of this major collapse.
In this article, we’ll walk you through everything we know about the events that have unfolded in the wake of the Silicon Valley Bank collapse, what this could mean for the greater economy, and lessons you should take away from this situation for your own personal financial and investing strategy.
How One Of The Largest Banks In America Collapsed Overnight
The Story Of What Happened
First, let’s start with the story behind what actually happened and why it’s so important to understand.
Silicon Valley Bank provided banking services to nearly half the country’s venture capital-backed technology and life-science companies, and to more than 2,500 venture capital firms. This included major tech companies like Roku and Etsy.
For several decades, while many startups were doing well, SVB did what many banks do – kept a small portion of its deposits in cash and used the rest to buy long-term debt, including treasury bonds and mortgage-backed securities.
A Sudden Influx Of Deposits
In 2021, SVB experienced what seemed like a really good problem to have. All of a sudden, its clients were flush with cash, due in part to government stimulus from the COVID-19 pandemic, as well as the ensuing tech boom.
Due to this surge, the bank’s total deposits exploded from $62 billion to about $124 billion, according to data compiled by Bloomberg.
While on the outside, this 100% growth seems like the best thing ever, it also led Silicon Valley Bank to make the investment decisions that ultimately led to the bank’s downfall.
SVB’s Investment Decisions
As deposits grew at this alarming rate, the bank could not grow their loan book fast enough to generate the yield they needed to earn on the capital they were taking in.
As a result, they made the decision to purchase $80+ billion in mortgage-backed securities and treasuries, leaving relatively little liquidity.
As a side note, the Dodd-Frank financial regulatory package was put into place after the 2008 financial crisis for this exact purpose – as a way to have more government oversight and regulations for banks, including requirements for liquidity and frequent stress testing – to prevent a collapse of this magnitude.
However, in 2018, a bank deregulation bill was signed, which removed many of the liquidity and stress test requirements, thus giving banks like SVB the ability to make the investment and financial decisions that ultimately led to its collapse.
Selling At A Loss
Anyway, back to the story. While the long-term debt investments were great while interest rates remained low – providing steady and modest returns – they quickly lost value as interest rates started and have continued to rise over the last year.
This normally wouldn’t be an issue, because the bank could just wait for those bonds to mature. However, because there’s been a slowdown in venture capital and tech at a broader level, in part because of rising interest rates, deposit inflows slowed, and clients started withdrawing money, putting SVB in a tight cash crunch.
As a result, the bank decided to sell $21 billion of their securities, incurring a $1.8 billion loss.
Widespread Panic And A Run On The Bank
As this loss was announced, both depositors and investors panicked, leading to a run on the bank, as well as a free fall in stock prices.
As panic spread via the Twitterverse, depositors rushed to withdraw their funds, pulling out tens of billions of dollars within a few short hours.
With no way for the bank to satisfy all the withdrawal requests, the FDIC stepped in shortly thereafter, and the collapse was official.
Of course, events are continuing to unfold, and the full ramifications will continue to play out in the months and even years to come, not only within the banking industry, but also in the tech and startup industry, as well as the broader economy.
Will More Banks Fail?
One of the first questions all of this may bring to mind is whether there will be a domino effect with other banks, and thus whether your personal capital is safe.
At the end of 2022, Silicon Valley Bank was the 16th largest bank in the US, with $209 billion in assets. And while that sounds like a whole heckuva lot, it actually represents less than 1% of all banking assets in the US.
Because this is such a small amount, relatively speaking, there is little risk that this collapse will spill over to other banks, particularly those that have strong cash positions and are well diversified.
That being said, this collapse does bring to light the risk that many banks may have in their investment portfolios, especially in this rising interest rate environment.
If interest rates continue to rise, many banks may see the value of their investment portfolios decrease. Nothing to be alarmed about, just something to be aware of.
Because again, if the banks have the liquidity to hold on to their investments until they mature, the lower yields aren’t as big of an issue. It’s only when a bank might be forced to sell that these losses come into play in a big way.
What About Interest Rates?
Given everything that’s happened, many experts are predicting that the Federal Reserve will temporarily pause on their rate hikes, as things stabilize a bit.
There will likely continue to be some increases, though the Fed may choose to hold off amid the chaos, to help things settle down a bit.
Goldman Sachs predicts no rate increase in March, followed by quarter-point increases in May, June, and July, bringing the rate to 5.25% to 5.5%. Others, including Barclays, have made predictions in line with this as well.
So given all this, what now? What can or should we do in the wake of this story and this news? Well, as with any major event, particularly in the financial sector, we like to take a close look to examine the potential lessons we might take away for our own investment decisions and portfolios.
Even though you’re not investing billions of dollars at a time, it’s worth it to extrapolate some lessons from Silicon Valley Bank’s investment strategy and its ultimate demise, so we can fortify our own investment strategies.
Lesson #1 – Diversify Your Income Sources
For Silicon Valley Bank, one of the biggest dominos that led to its collapse was the lack of diversification in its funding sources, given that a large majority of its client base were tech startups.
Even though this may not seem to apply to you, it absolutely does. Take a moment to think about your own funding sources. In other words, where does your income come from?
If you currently have only a single source of income (aka, the paycheck from your day job), then you’re in some ways in the same boat as SVB. If you were to get laid off or otherwise lose your job, you would be in the same position as SVB and faced with a potentially drastic shortfall and ensuing cash crunch.
If, however, you were to diversify your income sources through multiple streams of income – including both active, passive, and residual income – then you’re better prepared when a single source of income pauses or fails.
Lesson #2 – Make Sure You Have Ample Liquidity
The second major issue Silicon Valley Bank faced was lack of adequate liquidity. Because the bank had invested the vast majority of its funds, it was suddenly in hot water when massive amounts of depositors all started withdrawing their funds at once.
For you as an individual, a similar thing could happen. While it’s unlikely that you’ll suddenly have thousands of people taking your money all at once, it’s very possible that you could experience a sudden unexpected event that could leave you tapped out.
For this reason, we always advise you NOT to invest if you’re doing so with your last $50,000. Especially with all the economic uncertainty at the moment, you need an emergency fund, as well as ample reserves to weather any potential storm.
With the properties in our portfolio, we are similarly ensuring that we batten down the hatches and stock up on reserves, to prepare for any potential challenges or difficulties ahead.
As you think about your overall financial picture and investment decisions, make sure that you have ample liquidity on hand so you don’t need to pull out of your investments, potentially at a loss, to access the cash you need.
Lesson #3 – Diversify Your Investment Holdings
As with many banks, SVB invested in a lot of paper assets like treasury bonds. And while those investments can be great for the long-term and while interest rates remain low, they can quickly lose value as interest rates increase.
And herein lies the rub with paper assets. Because they’re not backed by physical assets like real estate, they can lose massive amounts of value very quickly. This includes those who invested in SVB, who saw their investments decline drastically overnight.
While there’s certainly value to investing in paper assets, a healthy investment portfolio should also include hard physical assets like real estate, which is a much slower moving financial instrument and holds its value extremely well.
Even if a real estate asset literally goes up in smoke, you still have the value of the land that the property was on. This is a big part of the reason we’re such big proponents of investing in real estate, especially for stable, steady, reliable, and risk-mitigated long term wealth.
Lesson #4 – Monitor Economic Indicators And Trust But Verify
Another lesson we’d like to pull out here is the importance of keeping your pulse on what’s going on. Early in the pandemic, the Fed assured everyone that they would not raise rates. However, given the cycle of every previous recession, the writing was on the wall.
With the level of government stimulus we saw in the COVID-19 pandemic, it was inevitable that we’d start to see inflation and interest rate hikes. Add to that the supply chain issues, which have only exacerbated things further.
Because SVB believed that interest rates would remain low, they made some investment decisions that ultimately led to huge losses. Trust the Fed…but always verify.
While none of us have a crystal ball, it’s important to keep your pulse on the broader economy, take time to understand market cycles, and make investment decisions based on solid fundamentals and within asset classes that you’re comfortable and confident in.
Lesson #5 – Be Proactive, Be Resourceful, And Think Ahead
In a final effort to save the business, SVB launched a $2.25 billion share sale in an effort to raise the capital needed to shore up the bank’s capital base after losing $1.8 billion in the sale of $21 billion in securities.
Unfortunately, rather than help their cause, this only served to further exacerbate the fear and panic, leading to more depositors withdrawing their funds.
Could SVB have sought help sooner? Could they have survived a loss at a different point in the market cycle? We’ll never know for sure.
What we do know, however, is the importance of looking ahead and being proactive, particularly with your personal financial decisions.
For example, as interest rates rise, think about what that could mean for your existing holdings, as well as new investments you’re thinking of making.
If you see a potential cash crunch ahead, are there more sources of capital you could tap – HELOC (home equity line of credit), business line of credit, etc.? Are there expenses you could cut back on to preserve more capital?
Thinking outside the box and being resourceful can help you get ahead of potential tight spots down the road and ensure you have plenty of options available for whatever lies ahead.
Here at Goodegg Investments, we have a variety of options for you to help you learn about and invest in real estate – a great hedge against inflation and rising interest rates.
Through real estate syndications, you can diversify your portfolio and take advantage of the cash flow, equity, appreciation, and tax benefits.
Click here to get started, or check out the helpful resources below.
If you’re accredited and ready to invest right now, we invite you to check out our open deals page to learn more about our current or upcoming opportunities.
If you’re not yet ready to invest but are curious about how all of this works, we invite you to dip your toe in the water with us through our free 7-day email course – Passive Real Estate Investing 101 – or to get a free hardcover copy of our book – Investing For Good.
To learn more about us and our experience, be sure to download a copy of our track record, which shows the projected and actual returns we’ve achieved across all the deals we’ve exited to date.
Connect With Us
If there’s ever anything we can do to help you on your journey, feel free to email us at [email protected] or call / text us at (888) 830-1450.