Why Finance Is a Business of Trust

After the market closed on Wednesday 8 March 2023, Silicon Valley Bank told investors that it had sold about $21 billion of securities at an after-tax loss of about $1.8 billion and planned to raise about $2.25 billion of new capital. The bank, founded in 1983 to serve venture-backed start-ups, had become the sixteenth-largest in the United States. Its deposits had tripled from about $62 billion at the end of 2019 to about $189 billion at the end of 2021 as venture money poured into its clients' accounts. The bank lent out only a fraction of that money. It put most of the rest into long-dated mortgage bonds and Treasuries yielding around 1.5–2%, and it labelled most of them "held to maturity", an accounting choice that kept their falling prices out of reported capital. By the end of 2022, after the Federal Reserve had raised its policy rate by more than four percentage points, those bonds were worth about $15 billion less than SVB had paid for them, roughly its entire shareholders' equity.

The announcement was meant to repair the balance sheet. Instead it told depositors that the losses were real. About 94% of SVB's deposits were above the $250,000 insurance limit (reported), and they belonged to a tight network of companies advised by the same venture firms. On Thursday 9 March the shares fell about 60% and clients withdrew about $42 billion, roughly a quarter of all deposits, in a single day; requests for about $100 billion more were queued for the next morning (Federal Reserve review). On Friday 10 March the California regulator closed the bank, then holding about $209 billion of assets, the second-largest bank failure in US history at the time. Two days later Signature Bank failed too, and the Treasury, the Fed and the FDIC agreed to protect every depositor of both banks and opened a new lending facility for the rest of the industry. Forty years of careful lending to start-ups were undone in about 36 hours.

SVB's loans were mostly sound. What failed was a promise: that money placed with the bank could be had back, in full, whenever its owners asked. This chapter explains why finance is built on promises of that kind, why it behaves so differently from other industries, and sets out the framework used in the rest of the book.