Professor Seth Oranburg discusses the many mistakes made leading to the collapse of Silicon Valley Bank and what lessons can prevent more incidents like this from occurring. Produced and Hosted by A. J. Kierstead
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A. J. Kierstead, Host (00:03):
This is the Legal Impact, a podcast presented by the University of New Hampshire, Franklin Pierce School of Law, now accepting applications for JD and graduate programs. Learn more and apply at law.unh.edu. The opinions discussed are solely the opinion of the faculty or hosts who do not construct legal advice or necessarily represent the official views of the University of New Hampshire and UNH Franklin Pierce School of Law.
(00:24):
I'm your host, A. J. Kierstead, and today I'm joined by Professor Seth Oranburg, who teaches both the residential programs and our hybrid JD program. Learn more about our mostly online hybrid JD program by visiting law.unh.edu/hybridjd. Couldn't stay away long, could you? Got you right back on with some more business law news.
Professor Seth Oranburg (00:44):
You know A.J., I told you last time you're going to see more of me because the economy is in for some trouble and when the economy's in trouble, they call the business lawyers. Here I am.
A. J. Kierstead, Host (00:53):
That's great. And we got some big trouble. Last episode, if you check out law.unh.edu/podcast, check out we're talking about Twitter last month, but a week and a half after we started, a couple weeks after we did that recording, Silicon Valley Bank caught extensive headlines. Let's start off with maybe an overview with what happened to Silicon Valley Bank, also known as SVB, if you're checking out the news.
Professor Seth Oranburg (01:21):
Silicon Valley Bank is a business bank and primarily they hold deposits for business companies, which if you've ever tried to set up a business account, you'll find that there are ... It's more stringent than if you try to set up a personal account. They offer various types of loans and they are involved in venture capital finance in ways I'm happy to talk about, but are not particularly related to the meltdown. They do things like issue warrants and offer kind of financing options that appeal to startups and not just normal small businesses. They're kind of the chosen bank of Silicon Valley.
(01:56):
I mean, it's in the name. They had a total meltdown and a spontaneous failure. It was almost like they combusted virtually instantaneously and along with two other banks by the way. But Silicon Valley Bank was, as far as the news has presented, the second largest bank failure in American history, second only to Washington Mutual. This is a big deal for sure, and banks don't just go bust for no reason. A lot of people are asking why this happened, but it's really bad news when banks start going bust because that's where you keep your money. And when banks run out of money, people get nervous about whether they'll get it back.
A. J. Kierstead, Host (02:40):
And in this situation, there are an untold amount of people that work for the companies that invested their finances in this bank. I mean, like you mentioned, that's the big thing with Silicon Valley Bank. It's all these startups. I think one company of note, they had something like $500 million or some crazy amount of money is Roku, which is a technology company that does streaming. It's a streaming device and they sell their IP to other companies and such like [inaudible 00:03:07]-
Professor Seth Oranburg (03:06):
Yeah. Look, Roku CFO, Chief Financial Officer, if you're listening, feel free to post in the comments below. What were you thinking, man? You don't put your $500 million in one bank. Has anyone ever heard the expression, "Don't put all your eggs in one basket?" Don't put all of your companies assets in one bank either. But yeah, that's right. There's companies like Roku that had hundreds of millions of dollars in uninsured accounts earning, by the way, almost no interest. There's some real questions about whether or not they were paying enough attention to this side of their house, their financial house. And again, I never hear from the CFOs of any of these companies. This is an open invitation.
(03:51):
If you don't like what I'm saying, CFO of Roku, you can explain to me why you left all of your companies money in one barely interest bearing account. But that's right. The problem is that banks are only insured up to $255,000 per account. And that's important because lots of us depend on having that. That could be a life savings for an ordinary person. And we have the Federal Deposit Insurance Corporation that guarantees that money is going to be there when you need it, but that doesn't extend beyond that amount. And in fact, like 89% of SVB's deposits were uninsured because they were large accounts.
A. J. Kierstead, Host (04:26):
Is that unusual across the banking industry? I'm completely going off the rails. You sent me a bunch of awesome notes, but this is just super fascinating of a rabbit hole. I mean, is that generally speaking, is that terribly unusual? I know there should be diversification like we talked about a second ago with regards to Roku, but what does insurance look like for businesses that have these ... You can't operate a business on $250,000 in the bank. You're going to run out a payroll in one payroll cycle for even a tiny company.
Professor Seth Oranburg (04:54):
Sure, sure .Look, I mean, again, CFOs of the world contact me and opine, but here's how I see it. It costs nothing to get insurance in your bank account, you just have to maintain $250,000 or less in each account. Now of course, it is not plausible to do that for every account, for every company. And if you're fortunate enough to have $40 billion in cash, I'm looking at you Apple, maybe that is way too annoying to have X number of accounts, whatever 40 billion divided by 250,000 is. But I can only speak for myself. I mean, my family is not that wealthy, but thankfully my parents have more than $250,000. I'll admit that. And you know what they do? They keep that in separate accounts so their money's insured because the insurance is free. And why would you not take free insurance? My mom has, I guess three bank accounts, and she's 72 years old and it's her life savings and she can't afford to lose it. As a result, she keeps it protected.
(06:04):
The fact that Silicon Valley Bank was able to garner these large accounts and the fact that CFOs of major publicly traded companies, much less the private ones, were basically not ... They weren't taking the extra steps and doing the extra work to make sure their money was insured. And I think that's part of the Silicon Valley culture that I want to rail against a little bit in this podcast because I think it's actually the culture of Silicon Valley, the hubris, the boldness, the stupidity if I may, to just put all your eggs in one basket and to put it all in one bank and not protect yourself through all the available means. The short version again, is that if you have money in the bank and you have less than $250,000 in that account, you are fine. A hundred percent fine.
(06:56):
You're fine anyway, by the way, and I want to reassure our listeners of that, but the FDIC stepped in and did what it had to do now and it did what it had to do in 2008 and it's done what it has to have done in previous instances. And I mean, I am not one who is like, "Hey everyone, let's go trust the government." That's not my priors. But the FDIC has earned our trust over a number of these incidences. If you have less than 250 in your bank account, 250,000, you don't need to worry about anything and you probably don't need to worry much anyway. But that's giving away maybe the punchline. I do want to help us get there and understand why-
A. J. Kierstead, Host (07:34):
Yeah, let's dive into-
Professor Seth Oranburg (07:35):
... you should maybe worry a little bit.
A. J. Kierstead, Host (07:38):
We've picked on the people that weren't very, did some very sketchy things with regards to what they did with their money. But what about the bank itself? How did this failure happen?
Professor Seth Oranburg (07:47):
Well, I think that there are at least three theories as to why this failure happened out in the public space. And I don't agree with any of them, at least not whole cloth. And I've got my own theory, so I can run through the sort of three theories as to why it happened. But I guess there's cause and effect and cause and effect and cause and effect. It's turtles all the way down, A.J. The major cause of any bank failure occurs when people ask for their money and the bank doesn't have enough of it. Simply stated, that's called insolvency. And it happens when any institution can't pay its immediate obligations. The thing about a bank is that unlike other institutions, banks need to pay upon request. It's one of the reasons, by the way, you'll see a lot of advertisements for CDs, certificates of deposits, not those shiny things from the '90s with Nirvana on it, but like CDs, cash certificates of deposit where you don't have the right to request that money until a certain time occurs.
(08:51):
But in general, if you have money at the bank, you can go and ask for it any time and they need to be prepared to give it to you. What happened here was that people asked for $42 billion in two days and they didn't have it. The reason is pretty straightforward. I mean, no bank would keep that amount of cash on hand. That would be a real waste. Right now interest rates are 5%, maybe 6% depending on how you invest them in treasuries, maybe more if you're going out and using that money for commercial lending. Banks or businesses, they're for profit businesses. They make money as a business model. That's why they exist. And as a result, they don't just sit on all the money you give them, they invest it, they use it for various things and they may not have it, they may not have access to it at that moment in time. And $42 billion was about a quarter, a little less than a quarter of Silicon Valley Bank's total deposits. And I don't think anybody expected that demand to happen in that period of time.
A. J. Kierstead, Host (09:54):
What caused this run on the bank that ended up causing this mass attempt at withdrawal?
Professor Seth Oranburg (10:00):
Yeah, mass hysteria. This is panic. Panic at the bank. Well, there's three main theories that are floating around and one is what I'll call the blame crypto theory. And we're just going to just keep saying crypto's the problem. There's sort of a sociological theory that crypto made us all scared. And by the way, you could insert scary thing here. You could say, I don't know, Trump made us scared, Biden made us scared.
A. J. Kierstead, Host (10:28):
The war in Russia.
Professor Seth Oranburg (10:29):
Crypto made us scared. The war in Russia made us scared. COVID made us scared. Right, okay. Whatever it is that you are afraid of or you think people are afraid of, these do cause fear. And fear begets fear. Fear tends to multiply whatever it is you're afraid of. There's a lot of lack of confidence in the system according to this theory because there was a failure in the crypto markets predominantly with Sam Bankman-Fried, Sam Bankman-Fraud as many have come to call him, who had this entire schema of altruism that somehow resulted in him having $16 billion of other people's money and a bunch of shell games.
(11:08):
For another podcast if you'll have me, but we've seen that cryptocurrency has fallen apart in terms of a financial instrument. And some will say good riddance, but others have lost their savings on it. And many people were heavily invested. Theory number one is that people were heavily invested in crypto. Crypto turned out to be a bad idea aside from sort of #duh. Of course it was. Cryptocurrency is not based on anything real. It's based on these algorithms. There's so many competing ones. I wasn't surprised, but some people were. There's a theory that that caused people to freak out about everything.
A. J. Kierstead, Host (11:55):
A big thing that I've heard especially is with regards to the way that Silicon Valley Bank invested their money in bonds, in the treasury over extended amounts of time that they weren't able to pull their money in time. How likely do you think that ultimately was to being one of the main failure points?
Professor Seth Oranburg (12:14):
Well, this sounds like theory number two, I'm just going to take that as a way to jump to theory number two, which is the left wing of the Democratic party's theory, which is that Silicon Valley Bank was over-extended and under-regulated. And you might imagine Senator Warren, Senator Bernie Sanders are over there saying, "We need to regulate the banks, we need to stop them from risking other people's money. They were just overextended in these bonds and other things." Well, large banks like SVB are subject to a variety of capital requirements. They have to keep a certain amount of cash on hand. The minimum is without getting the details, minimum of six and a half percent of capital. SVB should have had $11 billion in cash, which is a ton of cash by most standards. Of course, we don't have to run the numbers to see that 11 billion in cash is less than 42 billion in withdrawals.
(13:19):
Hence the problem, but some were saying that SVB was over extended in long investments and had its money tied up, but it was in compliance with the law. Then the next allegation is that, well, then the law is broken. We should require banks to have higher capital requirements. We should require them to keep, I don't know, not six and a half percent. Let's make them keep 60% of their cash on hand. Well, okay, you can do that, but it comes at a cost. It comes at the opportunity cost of that capital. Because if they have to literally keep physical dollar bills in bank vaults, you need bank vaults and bank vaults cost money and don't generate any money on their own.
(14:00):
I mean, interest doesn't happen by accident. If you get a hundred dollars bill and try this at home, I encourage this actually, this is like a do-it-yourself science experiment. Go get a hundred dollar bill and put it in a mason jar with one of those lids you can seal and stash it in your basement and come back in two years and see if you have little baby a hundred dollars bills. It turns out that it's going to still be a hundred dollars bill and that a hundred dollar bill will be worth less, not worthless, but worth less than it was because of inflation. In order to just keep up with inflation, in order for you to have the same amount of money purchasing power as you did in the past, as you do in the future, you need to invest that money. You can't just keep it in a bank vault, which by the way are physical objects that cost money as well.
A. J. Kierstead, Host (14:49):
And also just the viability, I mean, banks are able to operate as a business because they're able to collect fees and interests and things like that from investments of this money. The reason why you're able to get a mortgage and things like that is because they're able to take that money and use it, which helps businesses be able to expand, people to be able to buy, to purchase a house with a mortgage and things like that. If it just sits there and it's such a vast amount of their resources, they're not going to have the funds, and I'd imagine there'd be far spread economic implications.
Professor Seth Oranburg (15:21):
Yeah, I mean, if a bank can't use its cash that it has in deposits to offer loans, how is it offering loans? And if you want to get a loan from a bank, you should ask yourself, "Well, where does that bank get the money they need to loan me?" They get that from those deposits. You need to give banks a certain amount of flexibility to use their deposits to earn profits because otherwise no one's going to go into that sector. Someone's going to do something else. If banks can't earn money, you're going to see more Sam Bankman-Fried cryptocurrency exchanges because apparently you can be a 31 year old 16 billionaire if you go that route. Look, these aren't charities and even charities have to break even. I mean, I work at a non-profit institution and we can't run in the red, meaning we can't lose money year after year after year and continue existing that money. Again, it comes from somewhere.
(16:16):
it comes from the taxpayers, it comes from somewhere. You need to give banks some amount of flexibility. And SVB was well within its margins in terms of how much cash it had on hand. The problem was that $42 billion was an unforeseeable amount and a capital requirement beyond what they had to keep on hand. You've got folks like Bernie Sanders and Senator Warren who are kind of anti this sort of thing. And unsurprisingly, they're saying we need tighter regulations. We did them follow the regulations more closely. Look, I think that there's merit to these arguments. I think that anytime you have a big institution like SVB, big institution, it's going to capture to some extent, have relationships with its regulators. But I don't think that's what caused this.
A. J. Kierstead, Host (17:03):
Let's move over to your third theory. I mean, what impact does the culture war maybe have had in the situation?
Professor Seth Oranburg (17:09):
Yeah, the culture war, it comes to ... I mean, the culture war is this idea that ... Well, in terms of the Republican Party or the right wing of the Republican Party is that we've got these "woke" banks, W-O-K-E, as in focused on diversity, inclusion, and equity and not on making money, sort of the counter-argument to the Democrats. You kind of get the interplay, the Democrats saying the bank cared too much about making money, and the Republicans are saying they cared too little. These things can't both be true at the same time.
(17:44):
The Republican theory trumpeted by Governor Ron DeSantis, Representative Marjorie Taylor Greene, and some of you have heard of Tucker Carlson, a pundit on the right, are blaming the failure on woke capitalism and arguing that SVB's failure was because they made contributions to sustainable finance, that they were investing in wind farms and investing in solar. These investments did not pay the kind of dividends you'd get from investing in, I don't know, coal or asphalt or tech. And as a result, they weren't profitable enough and that's why they lost their money. Theory number three is exactly opposite to theory number two, it's that the bank cared too little about profit. And this is almost certainly not the complete answer either.
A. J. Kierstead, Host (18:36):
It seems like a perfect storm. Everything that could have got messed up, got messed up. Add in the fact inflation's off the rails is another big thing I don't think we've touched on in this interview. I mean, what impact do you think inflation had on this?
Professor Seth Oranburg (18:50):
Well, inflation is up for sure, and it's up surprisingly. We're seeing mortgage rates around 6% and commercial loans are higher than that for commercial properties. And in general, the cost of everything is up because we have two things happening at once, which is inflation is going up and interest rates are going up. This is kind of unusual. In fact, what The Fed is trying to do is they're trying to increase interest rates in order to slow inflation, not really working, but most people are finding that there's a huge creep in how much they're spending on things. The same is true of companies. What happens when you're spending more than you expected to? You withdraw more from the bank than you typically do. One thing is that inflation, inflation itself, just the sheer cost of things has resulted in more withdrawals from the bank than typical.
(19:42):
But that's on the order of 10%, 12% because that's what we're looking at in terms of at most calculations of inflation. On the other hand, higher interest rates could also result in needing to take out more withdrawals to pay loans that have some type of ballooning or variable rate. But it's kind of messed up to say that The Fed did this because what The Fed is doing is slowing inflation. I'm not saying they're doing it perfectly or doing it fast enough. And this is now the fourth podcast I'm proposing myself to talk on, right? I mean, so many topics here, is The Fed doing its job? But to the extent The Fed is increasing interest rates, they are reducing inflation rates.
(20:25):
And both of those have pressure for people to withdraw their spending, to withdraw their accounts. The thing is, those withdrawals are like maybe up 10%, 12%, 15%, but what we're seeing here is four times the amount of withdrawals that the bank should have had liquidity to cover, 400%. None of these theories account for a 400% increase in withdrawals over a two day period. This is the fastest, largest bank run in American history. And as far as I know in human history. There's got to be something else going on here.
A. J. Kierstead, Host (21:03):
Closing thoughts. I mean, what's the future for the rest of the banking industry with regards to what happened to Silicon Valley Bank and is this a one off?
Professor Seth Oranburg (21:12):
Well, it was a three off at a minimum because we'd had three bank failures in March. We're going to see more bank failures and we're going to see more business failures as we move from the whatever you want to call the COVID economy into a recession. Anything you're involved in that is a high risk asset has become higher risk. We're going to see downgrading of certain corporate bonds that are going to be shown to be more and more risky. Companies are going to have to be offering higher and higher interest rates. Smaller banks are going to have to are offering higher percentage rates on certificates of deposit, and that's going to increase their exposure. And this is going to be a shakeout. Where as the economy gets tough, this is kind of the evolutionary theory of the economy, but we're going to see some companies fail when they were not properly set up to succeed in a more challenging environment.
(22:03):
That said, we're not looking at doomsday scenario, we're not looking at the Great Depression here. I don't see bank failures writ large happening across the board. I see what's happening is as companies that are over-extended in a couple ways and are vulnerable in ways that may be unpredicted are going to start failing. And A.J., I don't know if I have time for that last point here, but I just want to get to why I think SVB is vulnerable, why they were vulnerable. And it's because Silicon Valley itself, and here's where I want the listeners to pay attention and to look at Silicon Valley culture has a fundamental problem. It has an echo chamber. There is a dominant culture, and there are very, very few companies who are trumpeting ... First off, there's like 10 companies that have most of the money of Silicon Valley, which I did some back the numbers math, but effectively like the top 10 venture capital companies fund corporations that equate to 1% of the GDP of the world.
A. J. Kierstead, Host (23:10):
Wow.
Professor Seth Oranburg (23:12):
This is an incredible oligopoly. We have directors in these companies who are able to transform ... I mean, basically what happened was Accel Ventures, Andreessen Horowitz, Sequoia, and Lightspeed, top four VCs, get worried about their company's investments. They tell all their founders, "Get your money out of SVB," and that's enough to bankrupt the bank in a day. Four people can ruin SVB. That's how tight-knit this culture and this echo chamber, how powerful it is. Then once you hear that, "Hey, some company that is funded by Andreessen Horowitz, a major VC, they're pulling out, I'm going to pull out too." It's a me too kind of thing. And that's exactly what happened here. The dominoes fell real quickly. This is a really entangled market.
(24:06):
I don't think people realize the extent to which Silicon Valley has these interlocking directorships where a few people pull strings on a full-blown percentage of the world's productivity. A few human beings are basically calling the shots on whether or not a huge sector of the world liquidates its assets in a particular category. And that should worry all of us, because that's the kind of systemic risk that we didn't know was there and what turned out to be the problem with the toxic assets in the 2007-8 recession. We should be looking really carefully at the structure of Silicon Valley and the extent to which things that look independent are truly related because that's where the risk is going to be.
A. J. Kierstead, Host (24:59):
Professor Seth Oranburg, thanks so much for joining me.
Professor Seth Oranburg (25:01):
Thank you. Pleasure to be with you today.
A. J. Kierstead, Host (25:03):
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