Explain Like I'm FiveExplain Like I'm Five
- Silicon Valley Bank is a bank.
- It holds money for customers.
- Generally, it loses money when holding customer money, so it needs to lend out at least as much as they hold.
- Most of its customers are Startups with large amounts of deposits.
- in 2020/21, when Jay Powell kickstarted the money printer 🖨️💸, a lot of VC-money poured into Startups and, thus, into SVB.
- SVB didn't know what to do with this money, so they purchased US Treasuries.
- At that time, $100 VC-money = $100 USTs.
- Jay regretted the amount of money printing, as everything got more expensive. 😥
- He pulled money out of the system.
- $100 USTs are now worth $60.
- $100 VC money =/= $60 USTs – uh oh.
- Startups hold bazillions of $$$ at SVB, but Jay only promises them $250,000 if SVB goes bye-bye.
- Startups 🏃♂️💨 ... SVB.
- SVB ☠️.
That's not what happened. If $100 of treasuries were worth $60 there would be a massive arbitrage opportunity to buy them until due date.
Treasuries generally trade between their issuance and issuance+interest. They could fall as deep as ( issuance+interest)- interest of other/newer treasuries.
However, the SIVB is also partly related to the duration missmatch on active and passive side. This could theoretically happen with 100% fractional deposits (which does not exist in reality).
"Duration missmatch", aka "Temporary Loss" is purely playing around with semantics IMO.
The reality is the capital is locked and your treasury is worth less on secondaries. Am I wrong?
(Not sure what they are actually worth, just quickly calculated 4%,delta * 10 years)
EDIT: Okay, it's more like 2.5% yield delta... You get the point
Imagine you were a bank and someone lend you $100
Thats "temporal conguence" aka duration missmatch. They can both turn into the same problem of a bankrun. What's supposed to happen is that you pay out your customers with the 10 and slowly liquidate the 90 to add to what previously was 10.
Doesn't negate anything I said though. Same mechanics, the same fundamental concepts, and slightly different rules.
Also, try explaining this to a 5-year-old. 🥴
How could it happen with 100% full reserve banks? If that's what you're implying.
Yes, illiquidity can happen due to duration missmatch can happen under 100% reserves.
Imagine you're a bank and someone lend you $100. You have no fractional reserves so you invest $0 and put all $100 into government bonds. If whoever lend you the $100 bucks wants to have them back you have all the money. There is completely no problem with solvency at all - but there is a problem with liquidity if the government bonds are not sellable on a liquid market and you to hold them until due date.
This however isn't completely what happened here after the small bankrun on SIVBs there was also a problem with solvency - they had to sell bonds that were not supposed to be sold before due date.
Buying bonds is not 100% reserve. You're confused about these terms.
I would argue that buying government bonds is still investing the money so it's a little misleading to say you invest $0. Yield always comes with some risk.
It's a bit like lending the $100 to your friend and he says he'll pay you back on Thursday when your rent is due on Friday. Yes you are owed the money before it's needed but it's not the same as having the money.
You're not entitled to an opinion on things that are facts. Government bonds are reserves in banking. That's not my opinion, that's how banking works.
https://www.investopedia.com/terms/r/risk-freerate.asp
A quote from that very page...
Are you saying the prices of treasuries never change? Because they do!
Whats happening to Silicon Valley Bank is excactly what you would think would happen to something called Silicon Valley Bank
I think you're fundamentally misunderstanding something here. Treasuries ARE the fractional reserve.
Silicon Valley Banks problems are on the reserve part, not on the fractional part.
What you are describing is more of what happens to Silvergate rn. Or what happened to FTX.
The end.
I somehow like this (and understand it) better 😂
FAQFAQ
Is full reserve banking possible or desirable?
The bank was caught off guard on two fronts:
Selling their Treasuries at a loss to meet the higher than expected customer demands for their funds rekt them once word got out they needed to raise money to cover those losses
I find second point the most interesting, means still a lot of companies with high burn rates who may also get rekt as this thing works its way through system
You forgot one step:
"Silicon Valley Bank CEO Greg Becker cashed out $2 million just before the collapse"
I appreciate this explanation and I'd like to add a point of clarification to #9- #10.
For the five year olds... The less supply of money then the higher the price of money if demand remains constant. The price of money is the interest rate.
There is an inverse relationship between the price of bonds and the interest rate. If interest rates go up then the market value of the bond goes down. There is a duration mismatch between the long term asset (discounted $100 treasury bond) and their short terms cash obligation ($100) to SFB's customers.
The customers would be made whole if they were willing to wait until the $100 bond matures at its face value but their customer needed cash today. The customer's claims on money were not available since they'd been lent out to the US Treasury in order for the bank to receive a yield on their customer's deposits (#3).
This is a classic example of a bank run caused by a fractional reserve banking system.
I think banks are actually thieves and just steal from people
Someone needs to ELI5 this specific bullet
Fear.
Great work
Thank you for splainin. I need it
Thanks for the write up. I'm getting the popcorn ready and keeping my phone handy for smash buys.