Let’s discuss the differences between the subprime crisis and Lehman bankruptcy in 2008 and SVB Financial Group's current situation.
How SVB failed and what led to its downfall.
During the post-pandemic period, liquidity flowed abundantly due to government support programs and extremely accommodative central banks. Asset prices tend to inflate (and vice versa) when there is so much liquidity. Therefore, a bank like SVB, which had Silicon Valley startups as its main customers, received a flood of money mainly deposited by its customers. This money represents a liability for the bank, and it invested it in US government bonds, one of the safest investments in the world.
However, starting in 2022, the US Federal Reserve began one of the fastest and strongest interest rate hikes ever (to fight inflation), going from 0.25% to 4.75% in just over a year. As a result, SVB's investments, which fell by 20-30%, declined in value, causing losses. In a normal situation, this would be nothing strange since these government bonds are classified on the bank's balance sheets as "held to maturity." This means that once purchased, and if prices fall, no real losses show up on the balance sheets because it is assumed that the bank will hold this investment until maturity.
However, the liquidity problem came into play when many startups, especially those that weren't making money, needed to raise money in this new environment. And here comes another problem, that of fractional reserve. When a bank receives a deposit of $100, it is required by law to keep only a small fraction of that deposit on hand. Right now, banks have about $3 trillion in cash versus $17.6 trillion in deposits. But most of that cash is just a webpage with an amount written on it. In fact, only about $100 billion is held by banks in the form of physical notes in vaults and ATMs. Thus, the $17.6 trillion in deposits is supported by only $3 trillion in cash, of which perhaps $0.1 trillion is physical cash. The rest is backed by less liquid securities and loans.
So, when people rush to the bank to get their money back, the bank has to sell its investments, as did the SVB, which sold many of its government bonds at a loss of about $2B. Since it didn't have much liquidity left, it tried to raise more money, causing a bank run, and as the demand for cash increased even more, it all blew up.
We see that the SVB situation is different from the subprime crisis and Lehman bankruptcy in 2008. The subprime crisis was caused by lending to people who couldn't repay their loans, which resulted in a wave of defaults that rocked the financial system. In contrast, SVB's failure was due to liquidity issues and not lending to people who couldn't repay their loans. Additionally, the author notes that the fractional reserve system is fragile and vulnerable to bank runs.
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