The crisis of the collapse of Silicon Valley Bank (SVB) has had a serious impact on the global technology circle and financial markets, aggravating people's concerns about another round of financial tsunami. The U.S. Department of the Treasury and the Federal Reserve have also come out to support Silicon Valley Bank, which will fully guarantee the depositors of Silicon Valley Bank and enhance public confidence in the financial market. However, the market still cast a vote of no confidence in the bankruptcy of Silicon Valley Bank. A large number of small and medium-sized banks were run on, the signature bank (signature bank) collapsed, and the first republic bank was also in deep crisis. Union Loan injected nearly 100 billion U.S. dollars, but it still failed to reverse market confidence.
Seeing this, we have to talk about the root cause of this crisis: the Fed's continued violent interest rate hikes. After the latest 25 basis point interest rate hike in March, the US federal funds rate has reached 4.75%-5%, hitting the highest point since October 2007.
Then why the Federal Reserve’s interest rate hike is the culprit of this financial crisis, I believe that for many people who are not majors in finance, it is still a bit difficult to understand this logic. Combining my own knowledge and public information, the author presents how the Federal Reserve's interest rate hike affects Silicon Valley Bank as follows, hoping to help everyone better understand the whole incident.
After the outbreak began, in order to stimulate economic development, the US Federal Reserve adopted a series of policy measures such as quantitative easing to inject a large amount of money into the market to increase economic vitality. This part of the currency was realized by the Federal Reserve purchasing low-interest-rate US government bonds.
After there is a lot of money in the market, everyone has seen the resilience of technology companies in the epidemic and the stock market has performed strongly, so a large number of start-up companies have raised a lot of money. These start-up companies entrust a large amount of money to Silicon Valley Bank, and the deposits of Silicon Valley Bank have greatly increased. In fact, this situation also applies to many other banks. In order to maintain a more stable financial management, Silicon Valley Bank purchased a large amount of U.S. Treasury bonds as the core assets against risks, in addition to the usual loans and other businesses.
This situation continued until the second half of 2021, and the market quietly changed. In early 2022, the US inflation rate remains high and the market continues to overheat. In order to reduce the inflation rate, the Federal Reserve resorted to the big killer of raising interest rates, and the market began to panic. It is becoming more and more difficult for start-up companies to raise funds in the market, and everyone is lowering their debts, hoping to survive the capital winter. The stock market has also been falling, and a large number of assets are depreciating. At this time, investors hope that their money can be returned and transferred to the latest high-interest treasury bonds in the United States to better resist risks.
So much has been said here, there are a few issues we still need to clarify first, in order to truly understand the ins and outs of the whole thing. The first question is how U.S. treasury bonds work, and the second question is how the Federal Reserve’s interest rate hike led to the liquidity crisis of Silicon Valley Bank, which eventually collapsed.
Let's start by discussing the first question: how the US Treasury works.
The reason for national debt can be simply understood as that the government issues national debt and borrows money in order to meet various expenditure needs. The main issuer of U.S. treasury bonds is the Ministry of Finance. Under the bond issuance limit authorized by Congress, it will publicly issue bonds to the market. Various corporate institutions will bid to buy bonds, and at the same time, they will also propose their own desired interest rates. Of course, the funds of various institutions have costs. The most important factor affecting the cost is the US federal funds rate, which is the interest cost of US peer-to-peer lending. This is controlled and formulated by the Federal Reserve.
After various institutions bid to buy U.S. treasury bonds, the Ministry of Finance will grant the corresponding amount of treasury bonds according to the interest rate of the bidders from low to high until they are sold out. If there are unsold treasury bonds, the Federal Reserve will start the money printing machine and buy them all.
As mentioned above, U.S. treasury bonds are a kind of loan certificate. The value of each new bond issued is determined by the face value of the bond and the coupon rate of the bond. The face value can be understood as the initial principal, and the coupon rate can be understood as the fixed interest promised to be accepted. After a certain period of time, the corresponding interest will be accepted. After the deadline expires, the principal and current interest will be returned, and the coupon rate of each issued treasury bond is fixed.
For the bonds already in circulation in the market, its value is composed of the circulation value of the bond and the actual interest rate of the bond.
U.S. treasury bonds are fully circulated in the market, so no matter whether it is a newly issued treasury bond or an old treasury bond, as long as it is a treasury bond with the same maturity, if the interest rate is different, then capital will definitely pursue a higher rate of return.
As can be seen from the figure above, after the emergence of new bonds with higher interest rates in the market, the attractiveness of old bonds will decrease, and investors will sell the old bonds one after another, resulting in a decrease in the circulation value of the old bonds. The yield to maturity is fixed, so the actual interest rate corresponding to the old bond will increase due to the decrease in the circulation value of the old bond. From the following formula, it can be seen that the actual interest rate of the bond and the circulation price of the bond are negatively correlated.
After the above analysis, we can see that after the issuance of new bonds with higher interest rates, the market will sell a large number of old bonds, resulting in a decrease in the corresponding circulation price of the old bonds and an increase in the actual interest rate of the old bonds. The same newly issued bonds are purchased due to a large amount of funds entering the market, and the circulation price of the bond becomes higher, so the corresponding real interest rate falls. In this way, after full circulation, the interest rates of new and old bonds in the market will eventually converge.
Let's take a look at why the Fed's interest rate hike will lead to the bankruptcy of Silicon Valley Bank.
What the Federal Reserve controls is the US federal funds rate, which can be understood as the peer-to-peer lending rate of US financial institutions, that is, the bank's cost of funds interest rate. Finally, through layers of transmission, it also affects the cost of funds in the final market.
Simply put, when the Fed raises interest rates, the cost of funds in the market increases, and when the Fed lowers interest rates, the cost of funds in the market decreases.
As mentioned earlier in the issue of bonds in the United States, the majority of market participants must consider the cost of funds when purchasing treasury bonds. After the Fed raises interest rates, the cost of purchasing treasury bonds will rise. Institutions will increase bond interest rates when bidding, which will also result in new bond interest rates. higher case.
As mentioned earlier, before 2022, Silicon Valley Bank purchased a large number of U.S. low-interest bonds as the underlying safe asset in order to resist risks because of the large number of customers, especially technology startups, who deposited a large amount of deposits.
However, the direction of the wind has changed rapidly. After 2022, the Federal Reserve will continue to raise interest rates, leading to a continuous increase in the cost of market funds, and investment institutions are more inclined to reduce external liabilities. These factors have gradually made it difficult for technology start-up companies to raise funds. More deposits were withdrawn from Silicon Valley Bank to support the company's business development.
However, among the assets of Silicon Valley Bank, due to the large amount of low-interest bond assets, it is necessary to sell the funds. At this time, as the Federal Reserve continued to raise interest rates, the interest rates of new bonds were higher, and the old low-interest bonds were sold one after another, resulting in a decrease in the value of the old bonds. At this time, Silicon Valley Bank had to sell bonds to deal with customers' withdrawal runs, which led to Silicon Valley Bank posted an operating loss.
What is even more unfavorable is that this risk of Silicon Valley Bank was captured by the "Godfather of Venture Capital" Peter Thiel and other Silicon Valley bigwigs, who suggested that customers withdraw money, resulting in a run on the bank.
Due to customer runs, Silicon Valley Bank can only process more bonds. As a result, the more bonds sold, the more serious the loss, the higher the operating risk, the greater the panic, the more serious the run, and it fell into a death spiral. collapse.
What banks are most afraid of is a run on a large number of customers, because it is difficult to raise enough funds in a short period of time. But if it can't deal with customer runs, there will be a bigger run crisis, and eventually it will go bankrupt with the same fate as Silicon Valley Bank.
Silicon Valley Bank has always been a top student in the United States, and until the accident, it was still an example. However, the Fed's continuous violent interest rate hikes caused a high-quality bank to close down quickly, which is enough to show how huge the psychological impact of interest rate hikes on the market is. It is difficult for the financial market to avoid all risks, but what is more important is the confidence in the face of risks. If the Fed continues to raise interest rates, more financial disasters and panics are still waiting for us, let us wait and see.