Paul Krugman Refutes Four Myths Surrounding the Collapse of Silicon Valley Bank
The collapse of Silicon Valley Bank (SVB) and its subsequent rescue by the Federal Deposit Insurance Corporation (FDIC) has caused some apocalyptic fears in markets, but Nobel economist Paul Krugman believes they are largely unfounded.[0] SVB, a tech-focused bank, failed a week ago and was the largest bank failure since the 2008 crisis.[0] The FDIC stepped in to fully back SVB’s depositors, even those over $250,000, breaking the long standing FDIC threshold for deposit insurance.[0]
President Biden has promised that the policy move was not a bailout and would come at no cost for taxpayers — but while this is a bailout according to Krugman, he said markets are off base in their fears that SVB’s collapse and rescue could lead to economic doom, refuting four myths about the bank’s demise.[0]
SVB’s problems started with the large increase in deposits caused by a surge in startup funding.[1] Stuffed with start-up money, SVB invested heavily in bonds that lost value as interest rates picked up.[2] Had SVB had a different business plan, it may have prevented its fate, but then it would not have been SVB.[1]
Investors are now pricing in a 76% chance the Federal Reserve raises rates by just 25 basis-points next week, and a 24% chance it pauses rate hikes altogether.[0]
Diamond argues that even prior to the 8-K announcement sparking the surge, SVB was near bankruptcy and quickly heading towards collapse.[3] He states that, due to the cost of ‘funding' (or the interest rate paid on deposits) increasing to 4% and higher, they were obligated to give their customers the higher interest rate. However, the return from their bond portfolio, the source of their money, was lower than 2%.[3] In other words, you are receiving less than 2% on your assets while having to pay out 5% on your liabilities.[3] The lack of incoming and outgoing interest meant that SVB was likely to incur significant operating losses.[3]
SVB encountered two key issues of its own creation when it came to Diamond.[3] The initial drop was the value of bonds it held, which had maturity dates far longer than its deposit base, which could be less reliable than that of JPMorgan Chase or Bank of America.[3]
0. “Nobel economist Paul Krugman says the Silicon Valley Bank collapse has led to ‘apocalyptic rhetoric' in markets, but almost none of it is true” Yahoo Canada Finance, 17 Mar. 2023, https://ca.finance.yahoo.com/news/nobel-economist-paul-krugman-says-132330069.html
1. “Silicon Valley Bank's Focus on Startups Was a Double-Edged Sword” HBR.org Daily, 17 Mar. 2023, https://hbr.org/2023/03/silicon-valley-banks-focus-on-startups-was-a-double-edged-sword
2. “Opinion | Credit Suisse and Silicon Valley Bank's problem is an addiction to clients” The Washington Post, 16 Mar. 2023, https://www.washingtonpost.com/opinions/2023/03/16/credit-suisse-silicon-valley-bank-client-control
3. “The economist who won the Nobel for his work on bank runs breaks down SVB's collapse—and his fears over what's next” Yahoo Life, 15 Mar. 2023, https://www.yahoo.com/lifestyle/economist-won-nobel-bank-runs-160025143.html
