“It does feel like Penn Square,” said CNBC’s Jim Cramer. Cramer was comparing the collapse of Silicon Valley Bank on Friday, March 10, to the failure in 1982 of the tiny Oklahoma City bank that brought down Seattle-First National Bank — Seafirst.
There are some parallels. Both failures occurred at banks that had a special role feeding a speculative boom. But there are some important differences, as I recall from covering the Penn Square saga for the P-I.
In Penn Square’s case, the boom was in natural gas. The “Energy Crisis” of the late 1970s had run up the cost of oil and gas. “Shallow” gas, close to the surface, was under federal price control, but “deep” gas was not. The result was a boom in drilling for deep gas. Penn Square Bank had made a business in loans to gas drillers, many of them newbies who weren’t too good at it. If a driller didn’t find gas, Penn Square would give him another loan, so that he could “drill his way out of debt.”
Penn Square became a perpetual motion machine of loans to gas drillers, lending out several times what the bank had in deposits. It did this by selling the loans to out-of-state banks like Seafirst, and turning around and lending the money again. Because so many of its loans turned bad, Penn Square spread financial sickness to “upstream” banks in New York, Chicago, and Seattle.
Silicon Valley Bank, based in Santa Clara, California, also made loans to a hot new industry, namely tech startups. The startup would get seed money from venture capitalists, then go to the bank for a loan. The bank would secure its loans with company stock, which at that point was illiquid because it was not publicly traded.
This is not a conservative way to run a bank, but if the trend is in your favor and you don’t make too many mistakes, it can work. And it did work, spectacularly. Founded in 1983 by venture capitalist Roger V. Smith, Silicon Valley Bank grew to more than $200 billion in assets. That’s still less than 10 percent the size of the giant Chase Bank, but it’s about four times the size of Portland-based Umpqua Bank, founded 30 years before Silicon Valley Bank.
A bank’s assets are the loans it makes and the investments it buys. And here is where Silicon Valley Bank was not like Penn Square. Silicon Valley wasn’t cranking out more loans than it had deposits. It was the opposite. It had more deposits than loans. Its problem was what to do with all the money.
It invested much of the money in bonds, especially U.S. Treasuries. Usually that’s a prudent thing. Treasuries are said to be the safest investments in the world, and held till maturity, they are. But Silicon Valley Bank bought “long” bonds, which may not mature for 30 years. Long bonds typically pay a higher interest rate than short bonds, and the bank liked that. But when depositors wanted their money, and the bank had to sell its long bonds, the value of those bonds in the market had gone down.
The prices of long bonds move the opposite of interest rates. When new bonds are offered at higher rates, old bonds trade at a discount. After the Great Recession of 2008, the Federal Reserve held interest rates unnaturally low. Indeed, never in American history have interest rates remained so low for so long. And that made bond prices high. Since inflation jumped up last year, the Fed has responded by raising interest rates back to more normal levels. The result was a discount on the old bonds. CNBC Business News reported January 7 that last year was “the worst-ever for U.S. bonds,” with the Total Bond Index down 13 percent.
At the Silicon Valley Bank, the depositors were mostly companies, not individuals. By press accounts, about 90 percent of the deposits were in amounts above the $250,000 guaranteed by the Federal Deposit Insurance Corporation. When the tech industry started announcing layoffs, companies started pulling out their money. There began a bank run, which if not stopped is a death sentence for a bank.
The federal government has stepped in and guaranteed all the deposits of Silicon Valley Bank and another troubled lender, Signature Bank of New York, which closed two days later. A third bank, Silvergate Bank, closed last week; it was involved in cryptocurrency. With the rash of “crisis” news, President Biden has assured everyone that the banking system is O.K. Biden risks sounding like Herbert Hoover, but he’s offering the banks the kind of protection that they didn’t have 90 years ago, so he’s probably right.
Still, there is one sense in which Silicon Valley Bank is another Penn Square. The failure of the little bank in Oklahoma City 40 years ago was an omen of a nasty recession. The failure of the Silicon Valley Bank, and of the other two lenders, likely signals another one coming.
Or already here.
Bruce Ramsey co-wrote a four-part series in 1983 in the Seattle Post-Intelligencer called “The Wrecking of Seafirst.”