Stocks ended their worst week so far this year with a fourth straight day of losses, and U.S. Treasuries and gold soared in a flight to quality, after federal regulators closed Silicon Valley Bank (SVB) on Friday in the biggest U.S. bank failure since 2008. Regional bank stocks plunged, with the top S&P regional banking ETF sinking 16% on the week, its worst showing since March 2020 at the start of the pandemic. The turmoil in bank stocks overshadowed the February jobs report, which offered some hints that inflation may be easing, as employee wages increased less than expected. For the week, the Dow Jones average fell 4.4%, the S&P 500 slipped 4.5%, and the Nasdaq Composite lost 4.7%.

US banks are being forced to do something they haven’t done for 15 years: fight for your money. After years of earning next to nothing, depositors are discovering a trove of higher-yielding options like Treasury bills and money market funds as the Federal Reserve ratchets up benchmark interest rates. So in a bid to stem those outflows to better paying options, banks are grudgingly lifting their rates from rock-bottom levels, particularly when it comes to certificates of deposit. More than a dozen US lenders including Capital One are now offering an annual percentage yield of 5% on one-year CDs, a rate that would have been unspeakably high two years ago. 

Future Wealth’s View

The genesis of SVB’s collapse lies in a rising interest rate environment. As higher interest rates caused the market for initial public offerings to shut down for many startups and made private fundraising more costly, some SVB clients started pulling money out. To fund the redemptions, SVB sold on Wednesday a $21 billion bond portfolio consisting mostly of U.S. Treasuries, and said it would sell $2.25 billion in common equity and preferred convertible stock to fill its funding hole. But, the run on the bank had begun. 89% of the bank’s $175 billion in deposits were uninsured at the end of 2022 and despite FDIC coming to support the company, thousands of employees at companies with loans from SVB will find themselves out of a paycheck and likely out of work.

Who is to blame for the collapse of SVB? The answer is – The Fed. The fallout and the wreckage is coming ashore from the effect of Fed’s inaction on interest rates by keeping it low for too long followed by the dramatic turnaround to raise interest rates rapidly. If the Fed does not buy all the securities/debt SVB bank owns at par and instill confidence in the banking system, this could get real ugly. Other regional banks that have escaped the stress tests will find themselves in a hole real fast.

For investors, last week is a lesson on how things can break down when regulatory institutions get it wrong. To think that this too will pass and that the investment portfolios will remain resilient through the turmoil will be akin to the saying “My hair is on fire but my feet are frozen. So, on average, I am comfortable”.