Banking on Silicon Valley

Those with capital are beginning to realise that higher interest rates do not hurt the poor alone!

15 years ago Lehmann Brothers collapsed. The outgoing Bush administration served the incoming Obama administration a surprise. Almost the entire Banking sector was about to collapse. 

To save the banking industry, the administration did 2 things. 

 - Took a Trillion dollars of public money and gave it to the banks to save themselves

 - The Federal Bank took the interest rates down to ZERO, which is where it had rested for a good part of the last decade. 

As a financial institution when the federal bank says that the cost of borrowing is zero, that is the figure you consider the risk-free rate of return. Therefore it became easy for banks to outperform that figure. 

For large companies such as Apple, it meant raising debt at a 1% - 1.2% interest rate. For the US government, which has now become a debt machine, issuing bonds was easy.

Every financial institution recalibrated its expectation. This regime of zero interest rates began to undergo slow revision starting in 2016.

Then the Pandemic brought the industry to a standstill. To restart the industry, the government and economists agreed that it was important to make it easier for businesses to borrow. Interest rates went back to zero. Until the war in Ukraine started.

There was a short surge in oil prices and food prices as a deficit in supply was expected. That never came to be. India and China started buying oil from Russia and the Europeans switched to the Middle East. The buyers and sellers changed. Nothing else.

Prices cooled down. 

COVID Labour movement

When the pandemic-induced lockdowns hurt industry many people were laid off. Many never returned to the workforce in the western nations. Here is my hypothesis on why.  

Either way, the shortage of labour has pushed wages higher. The Federal bank had a theory that the higher wages were causing inflation. For the first time in history, labour was being paid more than minimum wage, and nobody was pleased in the corridors of power.

The cause for the inflation was certainly not the $190 Billion in profits that the oil industry made in one quarter.

It was 1 dollar an hour extra that labour was paid.

For the sake of simplicity, say $10 extra per day - it translates to $3650 extra per year (poor people don’t take days off). Even if 10 Million people were being paid this higher wage, it would result in $36.5 billion per annum in higher wages or about $9 billion a quarter. A pittance compared to what the oil industry made.

But, it was certainly the higher wages causing inflation, at least that is the justification that they will publicly offer.

Since the only tool at the Fed’s disposal is the interest rate, they started playing with it. 

When all you have is a hammer everything looks like a nail.

Here is the theory again. When interest rates go up, businesses do not borrow. It is no longer attractive to borrow because you need to make greater returns to justify the borrowing. When businesses stop borrowing, they stop investing which leads to a reduction in job creation. The reduction in job creation makes it harder for people to switch jobs. If they lose their job, they become unemployed. This increases the pool of workers available, therefore lowering wages.

Since 2020, finding workers has become more and more difficult. To add insult to injury, the workers are also unionising in the US at record levels. Unions can negotiate better and ask for higher salaries and benefits. It scares the shit out of the capitalists because they would have to sacrifice some of their Billions in profits. 

Who is being affected by the interest?

Here is the thing - All of the big companies - Tech, Oil, Industrial, and Logistics are all swimming in unprecedented profits. Why would they borrow? They do not know what to do with the money they already have. They are engaging in unprecedented share buybacks. They are not borrowing a dime.

So who might be? Small businesses! They are the people whose backs are being broken, to ensure that the workers become unemployed. 

They want a situation where the labour has to negotiate only with the Tech Cartel (Google, Apple, Meta) or the Retail cartel (Amazon, Walmart, Costco), the Oil Cartel or any other industry cartel. Small businesses should essentially disappear.

But…

Every job report is showing growing employment. Unemployment is at record lows and 300,000 jobs are being created every month.

Rightly, the Fed is feeling rather emasculated. Their hammer yields nothing.

Jerome Powell, the last mistake that Donald Trump made, has embarked on one of the greatest and most aggressive rate hikes in the history of the US. Rate hikes that normally play out over 2 years have been undertaken in 2 quarters.

What do you suppose happens to those who must pay the interest?

Enter Silicon Valley Bank

Silicon Valley Bank (SVB) was a commercial bank headquartered in Santa Clara, California. SVB was the 16th-largest bank in the United States at the time of its failure on March 10, 2023, and was the largest bank by deposits in Silicon Valley. It was a subsidiary of the bank holding company SVB Financial Group. As a state-chartered bank, it was regulated by the California Department of Financial Protection and Innovation and was a member of the Federal Reserve System.

Source: Wikipedia

Started in 1983, SVB expanded tremendously over the last 20 years. This was helped by their willingness to provide a safe haven to companies that were based overseas but had US investors.

“All startups registering in the US require a social security number to operate with any bank. SVB was the only bank that allowed very early-stage startups, particularly in the SaaS sector, to open an account without a social security number. With SVB, they will not be able to move their money at all,” the cofounder of LogiNext Dhruvil Sanghvi said.

Source: Inc42

They were also the only ones willing to lend to venture-funded startups that were still not profitable. This made them the go-to partner for all venture-funded companies in the US and abroad. 

VC funds have been investing incredible amounts of monies into startups over the past 10 years. The pandemic funnelled even more money into their hands than ever before. This led to more and more inflated investments over the past 3 years. What this did was…

SVB’s deposits grew from $60 billion in 2020 to nearly $200 billion two years later as the tech industry grew during the pandemic. The bank then invested in debt like U.S. Treasuries and mortgage-backed securities, but as the Federal Reserve increased interest rates to combat inflation over the last year, the firm’s investments began to fall. SVB sold assets amid a surge in withdrawals, which created $1.8 billion in losses. The bank’s collapse—highlighted by a 64% plunge in share prices overnight—affected other banks and cryptocurrencies before it was closed by a California regulator.

Source: Forbes

This is where we bring back the Fed’s decision to raise interest rates. The investments/assets that SVB was holding assumed that the 0% regime would continue. They produced low yields of 1.56%. 

As the interest rates grew, it became more attractive for startups and VC funds to park their monies elsewhere. This resulted in a huge number of requests to draw money. 

Add to that, the current environment of fear has meant that VCs are not making big-ticket investments. This has also meant that startups have had to dig into their reserves.

These factors combined to create a perfect storm. Requests for capital withdrawals started to pour in. The monies were tied up in assets. 

Say you bought a share with a 5-year time horizon on your mind. Between now and then, there could be a spell when the share could be negative. SVB had assets that were negative but could be quickly liquidated. They decided to liquidate the asset to bring more cash into the bank. A trade where over a Billion dollars was lost. 

What happened thereafter can only be described as “fox, fox”. Someone called it and said SVB was out of cash. Everybody rushed to withdraw. This made it look like they actually did not have the cash. A self-fulfilling prophecy ensued.

That write-down caused a bank run and within 24 hours the bank went bankrupt. 

The wild swing made by the Feds had claimed an unexpected victim. They meant to kill the workers but instead took out a bank that exclusively catered to rich people!

The irony is that the rate increase was meant to keep labour in check and help the large conglomerates and their executives profit. The VC capital came from the very same people, executives of those large conglomerates! The bank that exclusively catered to their portfolio is now dead.

This probably is also why the bank was back up and running in 72 hours. How can the political class afford for the capital class to lose money? If the bank held deposits of salaried pensioners, we would still be working on a solution.

The coming days will show the extent to which this bankruptcy will reverberate through the entire startup ecosystem across the world.

All for the sake of taming inflation!