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The 2nd largest bank collapse in U.S. history happened on Friday, and there’s a lot to unravel from this. I’m talking about Silicon Valley Bank, a massive financial institution in California with more than $200 billion in assets.

Many people are blaming Silicon Valley Bank’s management for its collapse, while others are blaming the federal regulators responsible for overseeing the bank. To be clear, both have a LOT of responsibility here. Ultimately it was rapidly rising interest rates which led to the bank’s demise. So perhaps just as responsible are the policies which caused inflation and interest rates to rise so quickly. (The “American Rescue Plan” and ironically named “Inflation Reduction Act” are two that come to mind.)

For those who are interested in the details, here’s a very high-level summary of what happened with Silicon Valley Bank (SVB). I’m oversimplifying some of this for the sake of time.

Many of SVB’s clients were tech companies and startups. From 2020 through early 2022 – essentially during the haze of Covid – many of those companies were rolling in money. These companies had a ton of cash, which meant deposits at Silicon Valley Bank were through the roof.

As we all know, most banks use deposits from one customer to lend to another. They charge interest on those loans, which is how the banks make money. But since most of SVB’s clients between 2020 – 2022 were like Scrooge McDuck diving into a pool of gold coins, those clients obviously didn’t need loans. So for SVB to make money, it had to invest its clients’ deposits elsewhere. Right or wrong, SVB chose to purchase a boatload of mortgage-backed securities – many billions of dollars’ worth.

We’re not going to get into how mortgage-backed securities work, but the bottom line is that when mortgage rates rise, mortgage-backed securities tend to lose value. They’re worth less. You could certainly argue that executives at SBV should have known interest rates would need to rise in response to the out-of-control spending from Washington. You could also argue that federal regulators should have applied more scrutiny to what SVB was doing. Both may be correct, and only time will tell.

However, there was another problem on the horizon…

Towards the second half of 2022, as the Federal Reserve was incrementally raising interest rates, many tech companies and startups also started to see their fortunes turn around. Sales and revenue have declined, and many of SVB’s clients are now relying on some of that cash they had stockpiled in order to keep things running smoothly.

Do you see where this is heading?

Banks are required to keep more than enough cash on hand to accommodate even an unusual amount of withdrawals. However, SVB invested a massive amount of its clients’ deposits into assets which have lost value and, in some case, were almost impossible for the bank to liquidate. Meanwhile, more & more clients were needing access to more & more of their money at the bank.

Things hit critical mass at Silicon Valley Bank last week when it reached the point where it did not have enough cash to accommodate some withdrawals. News quickly spread on social media, and within hours there was a “run on the bank” with many clients trying, unsuccessfully, to withdrawal all of their money from SVB for fear it would be wiped out.

Compounding the problem for many of these companies is that their deposits were only insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). Which means everything above $250K is not covered by federal insurance. Over the weekend, however, the U.S. Treasury, FDIC, and Federal Reserve took steps to fully insure depositors at Silicon Valley Bank.

*** However, this is problematic on many levels. Even if this move is legal, it sets a very questionable precedent. Not to mention there are many small and mid-sized banks right here in South Carolina. I find it very difficult to imagine the Biden Administration making those clients whole if one of our banks were to collapse.

Anyway, there’s a lot we still don’t know and a lot that Congress needs to get to the bottom of. This will be a big issue for the Financial Services Committee, on which I serve, in the coming weeks and months.