Are Failing Banks About to Destroy the Economy?

This week, amid mounting worries about a looming recession that may have already begun, two banks in the United States collapsed. 

Both banks served the technology industry—already heavily hit by interest rate hikes and the general downturn as a result of the COVID-19 pandemic and the war in Ukraine—albeit in different ways. 

The first bank to implode was Silvergate, a Californian bank founded in 1988 that in recent years went all-in on banking the crypto industry. It began to run into trouble as the crypto economy collapsed last year, when depositors took their money out at a staggering pace—within months, its deposits dried up from over $12 billion to just under $4 billion at the end of 2022. The bank tried to sell securities that it had purchased to cover the losses, but rising interest rates had eroded their value. The bank got a $4.3 billion loan from the Federal Home Loan Bank (FHLB)—effectively a government bailout—but as its fortunes soured, FHLB demanded its money back right away. As problems mounted, the bank's stock tanked, and finally it announced voluntary liquidation on Thursday. 

The second bank to collapse was Silicon Valley Bank (SVB), which over decades has become the go-to banker for startups. SVB this week announced that it was fundraising to cover losses from the tech industry's downturn, which has seen the stock of even major firms like Meta and Tesla fall precipitously. Rumors about SVB's delicate financial position had already been spreading for months, with analysts warning that it—and other banks—were offering high interest rates to retain customers even as they had many low-interest loans (given during better times) still simmering. The fundraising announcement set off a bank run, with techies pulling their cash out in droves. On Friday, SVB shut down. 

With two banks now totally collapsed, many are now worried about contagion—that is, whether the collapse of these niche banks could spiral out into the wider economy. Shares of other banks in the U.S. (largely on the West Coast) fell precipitously on the news. European banks are also feeling the squeeze as share prices drop, and even larger banks like Bank of America and JPMorgan saw dips in their stock price. 

The right way to see this situation, however, might be that the contagion has already spread; Silvergate and SVB failing won't wreck the economy, rather, they are failing because the economy is already wrecked. 

It's tempting to write off Silvergate's failure as an isolated case due to its association with crypto, but as we've written at Motherboard before, crypto is actually tightly linked to movements in the wider economy. It is just more fragile, frivolous, and has fewer safeguards than the rest of the economy, meaning that shocks to the wider system tend to hit there first. Yes, FTX went bust because it was allegedly being run like a freewheeling slush fund for craven gamblers, but the money was lost because the crypto markets tanked in the first place. Similarly, Silvergate—even though it served its own niche industry—is part of the same trend affecting SVB, because tech's downturn is also tied to more general economic realities. And when these banks' core industries falter, when clients start pulling their money out in a panic, they run right up against the brick wall of the current financial landscape.

So, what does this all mean? Many analysts are now eyeing small- and mid-sized regional banks around the nation, which Silvergate and SVB both fall into the category of. As Bloomberg noted, these small banks are typically not looked at as closely by regulators as the big players, and they tend to have a less diversified stream of funding, making them more exposed to volatility. 

“Silicon Valley Bank is just the tip of the iceberg,” Christopher Whalen, chairman of financial consulting firm Whalen Global Advisors, told Bloomberg. “I’m not worried about the big guys but a lot of the small guys are going to take a terrible kicking."

To put it simply, these banks are middle dominoes, not the first ones. We see signs of more dominoes winding into the distance everywhere lately, including in plans at automaker GM to cut the "majority" of its white-collar workforce as it anticipates further economic downturn while also making capital-heavy investments in electric vehicle manufacturing. 

For now, it seems like most experts are not seeing the current situation as being an existential risk for the U.S. economy. Not every bank has a client base totally concentrated on cratered industries.

But the point is: Rather than being the cause of a meltdown, SVB and Silvergate's collapses are more likely symptoms of one that has already occurred, and may well get worse.