 Hello and welcome to NewsClick. So the bank collapses in the United States over the last fortnight have generated a lot of news. What is the mechanics behind what has happened, especially with the Silicon Valley Bank? What is the politics behind it? We sat down with Bappa Sena, our resident tech expert. He's pulled up some data on this and we're going to take a look, a close look at what really happened. Welcome to the show Bappa. So Bappa, let's begin with the Silicon Valley Bank. Now that's the big one. Why do you think it's the big one here out of all these news that we're getting? In fact, it's spread even to Credit Suisse and it seems to be becoming bigger and bigger. But why is SVB the most significant one? Well, SVB is the most significant one in the US. Now Credit Suisse is really a really big bank, but that's in Europe. But all this came into focus with SVB, and I think that's where we should start talking about this. Only in that week, in the week of, let's say, March 10th, three banks collapsed in the US. The first one was Silvergate Bank, which was very closely tied with a lot of the crypto coins and the crypto exchanges. The Silicon Valley Bank was the second bank to collapse. And then following that, I think on Sunday, Silvergate, no, Signature. The third bank to collapse was Signature. Now Silicon Valley Bank is the second largest bank collapse in US history. So that's why it's big. And the Signature Bank, the third bank which collapsed, that's the third largest bank collapse in US history. So in a single week, there was second and the third largest bank collapses in the US history happened. And that's why it's making big news and shaking the financial markets, bank stocks are going down. There is a panic in the markets because of this. And so people have started equating it with the 2008 great financial crisis where the entire banking system and the US economy collapsed. So that's why it's a big deal. Now in order to compare, the total assets of the Silicon Valley Bank are roughly around $210 billion. And the assets of, I think, the third bank, which is the Signature Bank, that has assets of about $100 billion or $110 billion in that range. To put it in context, the largest bank failure ever in US history was in 2008 during the great financial crisis when Washington Mutual went down and its assets were around $310 billion. So we are really looking at fairly large scale bank collapses. And that's why the panic. Right. How does this affect the sector's biotech tech, where the Silicon Valley Bank was most active? What does it do to them? Right. So the Silicon Valley Bank, like the name suggests, was headquartered in Silicon Valley. And it catered to a lot of these VC funded startups. And the concentration of the VC funded startups were in tech and in biotech. And hence the direct effect on those customers of this bank. Interestingly, around 50%, more than 50% of US VC funded startups used to bank in the Silicon Valley Bank. So that's kind of the impact of this thing. The entire US emerging tech biotech scene, 50% of that was banking in Silicon Valley Bank. So this is a lot of rich people's money basically in one place. This is a lot of the VC money in one place. And actually, now it's turning out that the VCs, a lot of the VCs actually insisted when they would give money to a company, they would insist that the company bank with Silicon Valley Bank. Because the VCs had over time build up relations with the Silicon Valley Bank and would get preferential treatment from the bank. And there was a quid pro quo, as in the VC money would be parked there. And in return, this bank would give great terms, loan terms to the VCs and the founders of these companies. This bank has been around for 40 years. It did not go bad during the tech bust in 2000, but it went bad now. And we have to look at both why it went bust now, as well as how the US government has responded to this problem. They basically said, we'll give you back all your money. Don't worry. So tell us about both these things and whenever it's time to look at the data, we're ready. So let's first start with the specifics of this bank. So this bank is a peculiar bank. It's not like the regular bank where common people go and deposit their money. So this bank has a large amount of these customers, a big portion of the customers are, like we said, the VC funds, the venture backed startups, and the founders of those startups. And so one reason why it makes it peculiar is that in the US, the FDIC, which is a government agency which backs your deposits in banks. So that the insurance, your deposits are backed up to $250,000. So if you as a common person go to a bank and deposit up to $250,000, your deposits are safe even if the bank goes down. The federal government will take care of that. Now $250,000 covers most common people. Most common people will not have that much money in a single bank that covers most of the common people. But this bank, because it was not common people, it was VCs and their funded companies and their founders, the average deposit in this bank was in the order of $4 to $5 million. Now in fact, now statistics have come out that 93.9% of the deposits in this bank were above the $250,000 limit. So that causes a problem when the bank goes down because 93% of the customers are now not going to get all their money back. Now so what happened? Now we start looking at why this was the first bank to get impacted. What is peculiar about this bank? So we start with, yeah, so we start with what is called the Fed's fund rate. So the Federal Reserve in the US fixes the funds rate. So this is the base rate for the, this is kind of how they said monetary policy. So this is the rate at which the banks will lend, the Federal Reserve will lend to the banks. And this kind of forms the basis on which all other deposits and loans are made, right? Now if you look at this graph, this starts from around the financial crisis, 2008 at the right. So then before, just before the financial crisis, the Fed's fund rate was close to 5%. Yes. Financial crisis happens, the US banking sector monolith collapses and the Fed at that time to save the banking sector brings down that rate to 0%. Now even though the financial crisis gets over by let's say 2009, max 2010, it keeps the rates to 0% all the way to 2016. Okay. In 2016, they make this effort to kind of normal, because the 0% rate is not the normal rate, right? Absolutely. So they try to, they make an attempt to increase the rate, they go to about 2%, and then it starts falling, it impacts the economy. And even before the pandemic hits in 2020, which is this gray bar, they start decreasing the rates. The pandemic hits, they move it back to 0. And it stays 0 till 2022, right? Now in 2022, like from March of 2022 to now, which is in less than a year, they hike the rates from 0 to again close to 4.5%. Yeah, we are back to somewhere around 2007, 8. Right. But this kind of sharp price in rates is unprecedented in the U.S.S. Street. And this is kind of the reason why all these problems are happening. So see, when you have interest rates very low, you are effectively pumping money into the economy, right? You're trying to stimulate economic activity by pumping money into the economy. And that money goes into all kinds of investments, right? So that money in the U.S. fueled a lot of the tech bubble. It fueled the crypto bubble, right? So it fueled all these VC companies to make lots of investments into lots of these tech startups. And that money was like banked in the Silicon Valley Bank. So when the going was good in this time period, when the tech bubble was at its peak, tech valuations were shooting up, a lot of VC companies were getting funded, this Silicon Valley Bank got huge amount of inflows of deposits. Now, what did they do with those deposits? It's not unlike in the 2008 financial crisis when the banks were making all kinds of shady loans and they were doing these junk bonds and what are subprime mortgages. These guys were not doing any of that high-risk thing. They took that huge amount of deposits that were coming in from these VC-backed tech companies and put it into what they thought was the safest of all investments, which is in the treasury bonds and in the federal agency-backed, what are called mortgage-backed securities, which are backed by the federal government. So they put their money in what they thought was the safest, right? However, once this interest rates very sharply rose, it did a two-fold double-vammy to this bank. What it did was the money supply in the whole economy was contracting. So the tech bubble, first the crypto bubble burst, we saw a lot of these crypto companies going bust and even Bitcoin, the elite crypto coins, their market caps falling and then that followed with the tech bust. So the valuations of a lot of the big tech companies collapsed and the funding to the start-up market kind of froze. So the start-ups were not getting any new funding but the start-ups have these start-ups operate on this thing that they get some money and then they kind of use up the money very rapidly, right? And basically in the first few years, they're all loss-making. So they just use up the funding they get. So the start-ups were effectively not putting any more deposits while they were withdrawing the money over the last one year to run their activities, right? Normal business activities. From the bank's perspective, what was happening was their deposit intake had immediately gone to zero and had gone negative. So this bank was starting to lose deposits for the last one year. Right. Okay, so they're rapidly losing deposits. And that's because of this mismatch between the- Well, we'll come to that. That's because the Fed had increased the interest rates, the money supply in the whole economy was contracting and the VC funded companies. Got it. So these were the first to get affected. And so the VCs would not fund these highly speculative plays. And as a result, these companies which are now not getting any more funding, they're just withdrawing money to run their operations. So the bank is losing deposits. The double whammy comes that this investment they had done in what they thought was the safest of deposits, the treasury bonds and the federal government mortgage-backed securities there because the yield is going up. Now the yield and the price of a bond are inversely correlated. So if the yield goes up, the bond's price comes down. So all these bonds, their price was coming down. So they had $91 billion of these bonds they had bought. Now because of this rise in interest rates, the market value of these bonds had fallen by $15 billion, which would wipe out the equity of the bank. If you recognize that loss, the bank would become bankrupt instantaneously. Now there is a quirk in the US banking system where the banks can choose to categorize some assets as marked to market so that their prices changes every day with the market fluctuations and they can hold some assets as held to maturity where they will be valued at their coupon value, at the par value. Now, so the bank, SVV was holding these treasury bonds at held to maturity. So they were not recognizing the loss which was happening over the last one year. Okay, so is that sort of like presuming that whenever they mature we are going to get what we expect? Yeah, because they are backed by the federal government, that money is not going to go bankrupt. You will get that money back provided you hold to the maturity of that bond. Now those bonds have maturity, let's say whatever, 5, 10, they are long-term maturity bonds. But because the investors were taking out money, they needed to sell those bonds to be able to fund the investor withdrawals. And so when they started, and then I think at the beginning of March they announced that out of the $91 billion, they sold $21 billion of worth of bonds and recognized the loss of $1.8 billion. And then they basically said that in order to cover that loss they are going to issue new shares and get back $2.25 billion, that announcement they made. Now the moment they made this announcement like panic ensured in that entire VC industry, some of the leading VCs, the rumor is that Peter Thiel who is like this multi-billionaire who runs this founders fund and there are a huge number of companies, and this is kind of the most elite VCs, they effectively instructed their companies to withdraw money. And once this became like the street, this gossip went on the street that Peter Thiel is asking his companies to withdraw money, all the VC companies followed. And then on that single day of March 9th, $42 billion were withdrawn from the bank. And the bank instantly ran out of cash. And so at that point, the bank was not solvent. And so the Federal Reserve had to step in, on Friday they stepped in and they said that they're taking over the bank, which meant that the shareholders and the people who invested in the bonds of the company, they instantly were wiped out. And then the question was, will the depositors get all their money back? Because like I said, 93, 94% of the depositors were above the limit of $250,000. These are not ordinary people who deposited their money in this bank. But so then we come to the next part, which is like the bailouts. And so then this was causing a panic and this panic was spreading across the banking sector, like stocks across the banking sector were going down. Other banks like the First Republic Bank, they came under these bank runs. And so the Federal Government and the Federal Reserve at that point said that we are going to ensure everybody's deposit. See before this, the law is that up to $250,000 of deposits are going to be secured. But now the Federal Reserve comes in in order to stop this bank run and the spreading panic. They said that we're going to take over these two banks, Silicon Valley and Signature. But we are going to go one more step and we are going to basically ensure that everybody's deposits are secured. So all these VCs we see for him. Is this why people are making comparisons with the global financial crisis of 2008? Because sounds very similar to what the government did then. All the banks made a lot of money, the clock profits, the top bankers were sort of living it up and it was very upsetting. And that's also led to this whole outcry that there's so much inequality in the United States and why you're helping the rich and why aren't you helping those who actually couldn't pay their mortgages, for example. Right, so that is why the Biden administration has been very careful to say that this is not a bailout, right? Well, but is it? So, okay. So now there is one difference between the bailouts which happened in 2008 and now. Which is that in 2008, not only were the institutions bailed out, but the kind of the shareholders, the management, the people who bought the bonds for those institutions, they also were protected, right? So no management was ever removed or convicted for fraud or they weren't even. Even the shareholders and the investors did not take any cut. Now what has happened is they have removed the management. They have made sure they are saying that the shareholders will get zero. And the people who are investors in this bank, they will all get wiped out. So in that sense, it is not comparable to 2008. But to say that this is not a bailout is not correct, right? So basically what the Fed and the Treasury did following this was they announced really two things which require funds, right? One is that they made this announcement that for these two banks, Signature and Silicon Valley Bank, the shareholders will be made whole. And both these banks, more than 90% of their depositors are above the 250,000 limit. So the majority of the people who were normally not going to get covered are now going to get covered, right? And the FDIC, which is the agency responsible for making sure that the bank deposits goes to the people who have put their money, they have taken a loan of $142 billion in order to do this. Now, you can argue that once they dismantle the banks, they sell their assets, some of this will be recovered. But as of now, $142 billion has been taken by the FDIC to pay to the depositors, right? And that's only one part of it. And these are wealthy depositors. These are wealthy depositors. So people below $250,000 are automatically covered because they were covered under the previous regime, right? It is this new, this $142 billion is the new money which has been pumped in to help the people above $250,000, right? That's one part of the program. The second part of the program is they have made a blanket announcement that any bank can now, so the banks can, see there is already, so the reason for the Federal Reserve to exist is that the banks, in order to get their funds, they can go to the Federal Reserve. And the Federal Reserve lends to the banks at this Fed's fund rate, right? So any bank can go to the Federal Reserve, pledge its what are called high quality assets, specifically Treasury bonds, and get money in loan. And the rate that they pay is the Federal, the Fed's fund rate, right? But they said in addition to that, the banks can now go to the Federal Reserve, take a loan against Treasury bonds or like these top tier assets. But they are going to value the assets not at the market value, which was the previous regime, but at the par value, which is specifically to cover for this kind of activity by the Silicon Valley Bank. And just in the last one week, it is estimated that more than $160 billion have been loaned to the banks between this new program and the traditional discount window route. So in that one week, if you add these two figures, already $300 billion, $300 billion has been pumped in. Now, you may call it whatever term it is, but it is really a... Which is what you just said, it's the size of the bank, the biggest bank that collapsed in 2008 was about $300 billion. Yes, but the Federal Reserve has pumped in $300 billion just in the last one week in order to one, protect these two banks, but are the depositors of these two banks, but also to provide a pretty much open-ended window to all banks across the U.S. to withdraw money at a preferential... Because the collateral they are putting it is not going to be valued at its market value, but it's going to be valued at its par value, right? And the market value is lower than the par value, so it is a bailout for the banks yet again, even though they're trying very hard to project it not as a bailout. So, Bappa, does this explain why the other banks struggled? Does this explain what's happening in Europe with credit suites? Is there going to be a growing mistrust of the banking system? What's going to happen next? Right. So, see the thing is that while we said Silicon Valley Bank was... And the three banks which have failed, all of them, the other two were Crypto Bank, Silicon Valley was a tech primarily catering to this VC-funded tech companies. So, these are peculiar banks and they got hit primarily from their depositors who are not regular depositors, who are businesses and the businesses were withdrawing cash and not depositing new cash. However, there is an underlying problem which is going to affect the entire banking system. These are just the tip of the iceberg, so to speak. So, because they are peculiar in their clientele, they got exposed the first. But there is an underlying problem which is a problem that is there. Should we take a look at it? Yeah. So, let's take this. So, this is the total Federal Reserve assets starting from, let's say, just before the financial crisis to today. Now, how the Federal Reserve holds assets, that's a technical matter. But the difference is the interesting point is the relative difference between the assets, right? So, if you start off in 2007, before the crisis, you started off with one trillion, these numbers are in trillions of dollars. So, you started off with one trillion dollars of Federal Reserve assets. Now, when the assets increase, the Federal Reserve is essentially printing money and pumping it into the economy. So, what happens with the initial financial crisis is they print about a trillion dollars and that trillion dollars is used to bail out the banks, right? So, the crisis gets over, let's say by 2009, the crisis gets over. But you'll see that the assets continue to increase and the assets continue to increase way into 2014. So, what is effectively happening is the Federal Reserve is continuing to print money and pumping it into the economy. Now, this is because the economy is really shaky at that point in time and the Federal Reserve is trying to somehow stabilize the economy. But what is ending up happening is this is really free money, which is going to the banks and it is going to the rich, the one person to do all kinds of speculative investments. So, investments in tech companies, all kinds of speculative investments are happening. But the people as a whole, the unemployment rate pretty much remains steady, right? It does not decrease and there's a huge rise in income inequality. And that causes huge resentment against the banks, against the Federal Reserve, against the Federal Government in the US, where people are realizing that these policies are specifically targeted to help the rich while the poor continue to suffer, right? Also, underreaching inflation because you keep pumping in money. Yeah, no, so this goes on till about 2017-18, they make an attempt to cut it down, but even before the pandemic, they kind of reverse that. And in the pandemic, they just go crazy, right? So, they pumped in about $3.5 billion from $1 trillion, from $1 trillion to $4.5 trillion. So, about $3.5 trillion, they pump in about 10 years or 12 years from 2008 to 2020. Come to 2020, they pump in $5 trillion, sorry, how do we go back? They pump in $5 trillion, right? So, from $4 to $9 trillion, they pump in $5 trillion in a matter of like one year. So, it is this huge money printing that causes this raging inflation, right? So, US and the entire western world starts seeing inflation at about like depending on the country between 8-10% inflation, which they are not accustomed to. Initially, the inflation is in goods, but very soon the inflation moves to wages, right? As long as it was in goods, they kept on saying that this is transitory. That's the word they use. This is transitory because there is COVID, because the supply chains are disrupted in China and all of that. And so, they were saying they're transitory. When the inflation moves to wages, that's when they started panicking. And that's when they say, oh, this is not transitory, this is going to be entrenched. And then around the beginning of 2020, two, they started both increasing the interest rates very sharply. And then they started, this is the opposite of money printing. This is their withdrawing money from the, this is called quantitative tightening. They're effectively withdrawing, sucking money out of the economy. Now, once you do that, initially, the most speculative businesses, the most speculative entities, they suffer, right? Because they are most dependent on this easy money. But as we will see, this is very soon going to lead to a much more broader thing which affects everybody. What this sharp, what this like 5% increase in interest rates in the last one year and the quantitative tightening is doing is, is leading to something structural, which is affecting the entire economy and not just the most speculative aspects of the economy, right? Okay, so this is the most important part of actually what's happening. This is how it is transmitting to the economy, right? So this, these curves are called yield curves, right? Now, the curve in the blue, that is the yield curve at the beginning of 2022, right? So this is January, this is in the U.S. style dates. So this is January 3rd, 2022, the yield curve is the one in the blue. The yield curve today is the one in the red, okay? So what is the yield curve? So if you look at the X-axis, the yield curve is the federal funds rate, the rate of- At which the- At the which the U.S. lends out for different durations, right? So at the, the smallest duration is one month, the largest duration is 30 years, right? Now, now what you will notice is this is a normal looking yield curve, where the lower duration of a loan you take, the smaller the interest rates. As you increase the duration of your loan, the interest rates go up. Now, this is how actually all banking activity gets funded. So banks get deposits from common people. And you are typically doing a six month deposit, one year deposit, two year deposit, and then they lend it out on the long term, right? They lend out, they do a five year mortgage, a 10 year mortgage, a 20 year mortgage on a home. And the difference between, let's say, 10 year and one year, that is the profit of the bank. Right. So that's how banks make money. That is the standard, right? It's a basic thing. What has happened now, because the Fed increased the interest rates very dramatically, the yield curve has what is called inverted. So now what you see is that the short end, right, when you are doing short term loans, the short term interest rates are at four and a half percent. But in the long term, right, 10 years, it is like three and a half percent, right? So now what has happened is if a bank does the normal thing, which is it takes deposits in the short term and lends out in the long term, it's actually losing money. That's right. It's so clear. Yes. Negative one percent, and at the scale of your loaning out billions of dollars, that quickly turns into very big losses. And this tells us why SBB... Yeah, so obviously the bank is not going to make a loss on a loan it will give. So what does it do? What the banks were doing was they were artificially holding down, they were not passing the increase in the interest rates which the Fed has done, they were artificially holding down the deposit rates to near zero percent. So the banks were trying to hold the interest rates down at zero percent while loaning at let's say three and a half percent, which worked for a while till people figured out that why should I put my money in the bank when I put it in a safer instrument, the Treasury bonds are safer than any bank, and I can get four and a half percent when I'm getting zero percent in my banking account, right? If I do an FD in the bank, I will get zero percent. If I go to buy a bond from Treasury, four and a half percent. What will I normally do? I'll normally start withdrawing money. And so the banks are now facing across the board people who are moving out of bank FDs and moving to the Treasury bonds. And that is a systemic problem, right? Because if this persists for too long, then first of all, the banks are not going to make any new loans because of this mismatch. And you are facing with people taking their money out of the bank deposits. And this is ordinary people. It's not just now we're not just talking about wealthy people. So, see, the wealthy people, they are being financially more sophisticated. They are going to do it first. But eventually, everybody will figure this out. And that's where we come to the, already we are seeing, what we are seeing here is that, see, the banks have unrealized gains or losses, right? So because not everything, like we said, is marked to market, you can hold it to maturity, the banks have these gains or losses, unrealized gains or losses. So in the last one year, we are seeing the unrealized gains like going exponentially down, right? So now, what it estimated is currently the banks are, the FDIC has said, the banks are currently sitting at $620 billion of unrealized losses. Now, that is huge. Now, if everybody was to realize the unrealized losses, the US banking system will get wiped out, right? Now, obviously, everybody doesn't have to. The well-capitalized banks, they can afford to hold on and they can afford to meet their depositor request and not have to sell their assets. But if they were to sell their assets, it would be a big problem. So what you are now starting to see is not just SVB signature and Silvergate, which were kind of at the forefront lending to the most speculative businesses, but now banks which are more broadly diversified, right? Like Credit Suisse, now it is moving to those kinds of banks. So the weaker banks are going to get affected because they will be forced to sell their bonds and their bonds are now setting in huge losses. So if they sell, they go insolvent. So that's what you are seeing. That's what you are seeing a bank run, not just in the US, but it's now also moving to Europe. Seems definitely to be spreading. Yeah, so that's a global problem now you are seeing. And the root cause of the problem is the very high federal funds rate, right? Now the Fed is stuck, right? Because if it's in response to it, the way to fix it is you lower the Fed's fund rate. But you have raging inflation. So if you lower the Fed's fund rate, you are going to blow up the inflation thing even more. So in the context of the United States, this is what is their classical problem, right? They can't fix both the problems at the same time. Yeah, you can't, you can't, right? If you have inflation, then right. But this is not a technical thing also. This is effectively a class war, right? Now when you raise the interest rates, you are going to cool economic activity. People are going to lose jobs, right? So when Jay Powell, the chairman of the Fed, went to the Senate. He was asked, look, in the last one year, you raised Fed fund rate by 5%. And the unemployment rate moved from 3.5% to 4.5%. So 1% increase in unemployment rate, which roughly translates to a million people losing their jobs. And he shrugged and said, this is normal, right? This is how it works. In fact, the Fed has long insisted that the natural rate of unemployment in the US is 4.5%. What is natural? There's nothing natural about it. It's basically what you are saying. It's the rate of unemployment that is required so that the people don't start asking for bargaining for higher wages. All right. Right? And so that is the politics. But the moment a bank goes down, rich people get affected, you see the Fed completely throw away all those principles and pump in billions of dollars. It's literally overnight. So even though it is couched in all this technical language, actually what it is is class war, right? Where the 1% have to be preserved, protected, whether it was a 2008 financial crisis or pretty much for the last 12 years or even before that, that's the mandate of the Fed. But the moment people start asking for more wages and they start getting more wages because of the- In response to inflation. In response to inflation, in response to the demand of labor, right? You know, unemployment rate goes down, the demand of labor increases. So at that point, you see the Fed acting very decisively to not make that happen. Right, Pappa. Thanks a lot for joining us with that very illuminating conversation. Thanks again. Thanks.