People Are Not Rational

Let me see if I can explain the Silicon Valley Bank fiasco.  As I have noted before, most people are not stupid–they have a modicum of intelligence.  Most people are ignorant, and increasingly so, especially young people–they don’t bother to educate themselves, to gather facts and to gain a solid understanding of situations.  And people are absolutely not rational–we are basically incapable of logical action based on facts.  Instead we do stupid emotional stuff.  That is what the SVB situation is about.

People put their money in banks.  The banks don’t and shouldn’t just hold that money.  If they did, they could never pay anyone any interest and money sitting in a bank is completely unproductive–it does nothing to help the economy.  Banks hold some of the money as mandated very liquid reserves.  But the rest is lent to borrowers or invested, and there are regulations about what banks can invest in.  Typically a bank has plenty of liquid assets on hand to meet the needs of customers who want access to a portion or all of the money they deposit at the bank.

Banks also raise capital–they have to have a certain equity base.  Most larger banks are publicly held; that is the cheapest way to get access to large amounts of capital.  The capital base both provides mandated reserves and serves as an additional source of funds for the bank to lend and invest.  So a healthy bank has lots of equity capital and lots of customer deposits, which it can invest and lend.  Hopefully the investments are solid and the loans get repaid.  Banks are heavily regulated in both regards.

A bank can get into financial trouble in a couple of ways.  One is it makes bad loans and doesn’t get paid interest or repaid principal.  If enough loans go bad, the bank can face a shortage of funds to match up with customers’ deposits.

What happened to SVB was that many of its customers are unprofitable startups that exist on rounds of investment from venture capital firms.  They deposit the invested money into SVB and gradually draw it down.  In the last year, many of these startups lost access to the capital markets–the VC funds realized they were basically bad investments and weren’t giving them additional capital.  This meant they had to draw down more and more of the money they had deposited in SVB.  SVB had lent or invested much of the funds, which is normal practice.  At some point, SVB had to start selling assets–investments–to meet the higher than expected demand for cash from its customers.  Since most of the investments are in bonds, whose prices have collapsed as Bidenflation sent interest rates soaring, SVB was getting back less when it sold the bonds than when it paid for them.  If the run by customers demanding cash doesn’t happen, you hold those bonds til maturity and get the full face value.  You can see the problem.

When word got out that SVB was having to take losses on investments to meet customers’ cash needs, the irrational happened.  Everyone decided they better get their money out of the bank, which only increased the demand, and the run was started.  A vicious downward cycle which would force the sale of more investments at a loss.  Supposedly smart VCs contributed to the collapse by telling the companies they invested in to get their money out.  They fed the panic.  If everyone stayed calm, SVB could likely have worked things out in a manner that allowed it to handle normal cash needs.  The government response of reassuring people that they won’t lose their money is the right one.  When people are behaving irrationally, someone has to be able to take steps to calm things down and interrupt the stupid behavior.

Quite suspiciously, executives at the bank sold stock shortly before the collapse and they handed out big bonuses.  Hard to imagine that they were not aware of the increasing mismatch between depositors’ needs for funds and their assets, which might be liquid but could only be sold at a loss.  Whatever else happens, the proceeds from the stock sales and the bonuses should be pulled back.  And the executives should be investigated and punished.

And let us not ignore the ideological aspects of the story.  Banks are supposed to have chief risk management officers who are tracking issues like the impact of a change in interest rates.  That person should have ensured that SVB was protected against the rapid rise in interest rates.  There are hedging instruments available specifically for that purpose and other techniques to limit exposure to the rate change.   For whatever bizarre reason, SVB hasn’t had a chief risk management officer for months.  But it has a second-in-command in this area who spends all her time pushing woke bullshit at the bank, and very proudly so.  In fact, the bank seemed a lot more interested in DEI than risk management.

What we see all across America is a committment to incompetence, been there forever in universities, spreading to public schools, in government, and now in business.  Woke ideology is more important that knowing something and being able to do your job.  This is happening in every profession.  My area of focus, health care, is not immune, and we will soon be experiencing completely incompetent medical care, but at least those inflicted this malpractice will have the right skin color, gender and sexual orientation.  So you can be comforted by that.

So this is a classic story of human irrationality, compounded by an even more irrational devotion to an insane ideology that prioritizes characteristics that have nothing to do with capability over actual knowledge, experience and good judgment.