From Tech Startups to Big Banks: Lessons Learned from Recent Financial Scandals

Photo byAaronP/Bauer-Griffin/Getty images

Silicon Valley Bank’s recent collapse has brought the financial industry's vulnerabilities into the spotlight. According to financial journalist Matt Klein, it was not just a bank run by idiots, but rather a bank run by a group of people that made a series of wrong decisions. The reasons behind the bank's collapse, however, were not limited to the mistakes of a few individuals. Instead, it is an accumulation of events that include failed regulations, a failure to hedge against the risk of interest rates rising, and the dangers of viral finance, among other factors.

The collapse of Silicon Valley Bank is the result of a long era of low-interest rates. Silicon Valley Bank specialized in providing banking services to start-ups with little or no revenue, flush with cash, mostly from the Federal Reserve's large-scale increase in the money supply. This led to the bank's deposits growing from $62 billion at the end of 2019 to $189 billion at the end of 2021. As a result, the bank invested in U.S. Treasuries and other long-term bonds, which were the safest and surest of investments in an era of low-interest rates. Unfortunately, as interest rates rose, bond values fell, exposing the bank to interest rate hikes in both its deposits and its investments.

The bank's problems were exacerbated by its inability to hedge or diversify properly. As interest rates rose, start-ups were no longer able to raise money as quickly, so they needed to tap into their cash reserves. This exposed Silicon Valley Bank to interest rate hikes in both its deposits and its investments. Interest rates had been on a downward trend for 40 years, so a rate hike was unexpected. In April 2021, Richard Clarida, then the vice-chairman of the Federal Reserve, stated that the conditions that kept rates low were a global phenomenon expected by forecasters and financial markets to persist for years to come.

The financial economy has been built on the foundation of low interest rates, which is why Silicon Valley Bank's troubles have caused a widespread panic that has engulfed banks with different characteristics. Many institutions are vulnerable because they planned for low-interest rates to continue, and they may be vulnerable now that they're rising.

Another factor that contributed to the bank's downfall was viral finance. According to John Maynard Keynes, picking stocks was akin to a game in which competitors have to pick out the six prettiest faces from 100 photographs. The prize is awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole, so each competitor has to pick not those faces that he himself finds prettiest, but those that he thinks are most likely to catch the other competitors' fancy, all of whom are looking at the problem from the same point of view. This example was used to show that in the short run, the stock market is not based on logical calculations or fundamentals but on trends and popularity. In other words, viral finance can lead to a bubble that may burst at any moment.

The collapse of Silicon Valley Bank is a clear example of the need for better financial regulations. Regulators were aware of the bank's troubles, but they failed to act. Midsize banks, including Silicon Valley Bank, lobbied Congress and the Trump administration to be exempted from the regulations attached to too-big-to-fail banks, but this led to disastrous consequences.

In conclusion, Silicon Valley Bank's collapse was not just a bank run by idiots. Instead, it was the culmination of several factors, including the end of the low-interest rate era, the dangers of viral finance, and failed regulations. The collapse of Silicon Valley Bank serves as a warning that we need to be prepared for the unexpected, and we need to have better regulations to ensure that banks are properly regulated and able to weather economic storms. The lessons learned from this collapse should be heeded by regulators and policymakers alike, to prevent future collapses and protect the economy from systemic risk.

Furthermore, it is important for investors to recognize the potential risks associated with investing in companies that rely heavily on debt financing, particularly in the technology sector. Investors should carefully evaluate the financial health and stability of the companies they invest in and diversify their investments to reduce their exposure to any one company or sector.

Ultimately, the collapse of Silicon Valley Bank serves as a reminder of the importance of responsible financial practices and effective regulation in maintaining a stable and healthy financial system. By learning from the mistakes of the past and taking steps to address the underlying issues, we can work towards a more resilient and sustainable economy that benefits everyone.