Where did the global financial crisis begin?
Negotiations to save the investment bank Lehman Brothers collapsed on the afternoon of 14 September 2008, triggering a financial crisis that affected the whole world. A day later, the bank filed for protection from its creditors. Subsequently, part of the bank was bought by the British giant Barclays, and the financial sector took the biggest blow since the Great Depression in 1929.
The causes leading to this disaster can be traced back to 2004. At that time, Lehman Brothers bought BNC Mortgage, a major provider of mortgages to the least solvent customers, which gave it a steady stream of loans to put into securities. They thrived. Later, it added Aurora Loan Services, which provided mortgages without proof of income, to its portfolio, and suddenly the bank was posting the highest revenues and profits in its history. It became the fourth-largest investment bank and securities dealer in the US. The dream ended for the bank in 2007, when the number of clients unable to repay increased. Lehman Brothers, which had been on the market since 1850, began to fail. The crisis also gradually affected commercial warehouses worth 1.85 billion dollars, in which the bank invested as early as mid-2007, and it had almost 40 billion dollars in various projects. Another interesting fact was the payout of the CEO of the failed bank, which, according to the BBC, climbed to between $300 million and $500 million over eight years. Even such a generous reward could not help Richard Fuld to save the sinking ship.
The fall of the Silicon Valley bank
Silicon Valley Bank was founded in 1983 and from the beginning focused on smaller technology startups, as its name suggests. Headquartered in Santa Clara, California, USA and led by CEO Gregory Becker, it became an important part of the innovation economy and nothing in the entire California tech valley could have been done without its presence. The bank hosted events, networking events and dinners where its clients could get to know each other. It also helped start-up companies with recruitment. A week before the crash, CEO Becker received a phone call from the Moody's rating agency, which warned him that the bank's financial health was at risk. Its losses had ballooned to $1.8 billion, and a hastily drawn plan to raise $2.25 billion in new capital did not bode well. The news scared investors, causing the stock to plummet 60% and clients to withdraw some $40 billion from their accounts en masse.* The end was inevitable. On Friday, March 10, 2023, the Silicon Valley bank went bankrupt.
SVB Financial Group's share performance over 5 years. Source: tradingview.com
Triggering an avalanche of share declines in the banking sector
After SVB's collapse, an avalanche was triggered on Monday, March 13, and share values fell at dozens of small and medium-sized banks. Within a week, three banks bankrupted - Silvergate Bank, Signature Bank and Silicon Valley Bank. All of them were doing business with venture capital, and their downfall was also affected by the drop in the value of cryptocurrencies. The other banks' deposit base is more diversified, so they are partially protected from the "contagion". The problem of SVB was primarily risk management, or rather ignoring financial prudence. The bank waited until the last moment to see if it could reverse the adverse developments, but it failed to do so. The Federal Deposit Insurance Corporation (FDIC) was forcibly appointed receiver after the bank's failure.
Causes of the collapse
The causes of SVB's failure were rising interest rates, recession fears, and a slowdown in the market for initial public offerings that made it difficult for new companies to raise cash–leading to a reduction in the volume of corporate deposits in banks like SVB. First, Janet Yellen, the Treasury Secretary, declared that the government would not cover client accounts over the $250,000 limit, with up to 85% of accounts at SVB exceeding that amount. Eventually, she and the FDIC declared otherwise, and together they committed to backstop clients. They will pay them 100 percent of all uninsured deposits, with the funds coming from the Fed, not taxpayers.
The financial sector is shaken, but relatively safe for now
This government intervention should keep the situation under control and the 2008 scenario will not be repeated. Certainly not on such a significant scale. However, critics argue that this move was not very sensible on the part of the government, as banks may then behave more indifferently if they are confident that they will be supported in similar cases. On the other hand, it is important to remember that the Fed is trying to prevent other banks from failing. Normally, in a similar case where consumer and business confidence in the US financial system is threatened, it would ease monetary policy. It cannot afford to do that now because the inflation rate is still high and could shoot up significantly. In addition to the shares of the largest banks, the European banking index STOXX Europe 600[1] was also under pressure, falling by 3.8%.* On the other hand, we can see that some large US financial houses such as JPMorgan Chase, Bank of America and Citigroup are experiencing an influx of new clients.
In 2008, Lehman Brothers was a tough nut to crack.
Lehman Brothers stood out as a systemic institution, and its bankruptcy had a much greater impact than the collapse of SVB, which has so far been muted. Risk management was an issue at both institutions, but the degree of risk taken differed. Lehman Brothers focused on providing risky mortgage loans with complex derivatives, SVB provided loans to technology companies. Both banks registered warning signs; in the case of Lehman Brothers, it was the collapse of the real estate market and exposure to risky assets, while Silicon Valley Bank may have seen its bonds downgraded and was alerted to the need to raise capital. It was too late for both banks. Lehman Brothers was an important part of the financial industry, SVB a major player in technology.
Conclusion
It is fair to say that the world has learned from its mistakes and that we are able to withstand repeated mistakes. Every crash hurts, but in the case of the SVB bankrupt, it was much softer than the Lehman Brothers crash 14 years ago. However, it remains to be seen what the consequences will be. In Europe, Credit Suisse is the first to take a hit, having asked the Swiss National Bank for a loan of 50 billion Swiss francs. These events could hasten the coming of a recession, and we can hope that the next contagion that appears this decade will be successfully managed by the banking sector.
Lehman Brothers and Silicon Valley Bank in numbers
Lehman Brothers (1850-2008)
- 4th largest investment bank and securities trader in the US
- 61 branches worldwide
- Headquartered in New York
- Voted Forbes Magazine's Most Admired Investment Bank in 2007
Silicon Valley Bank (1983-2023)
- 16th largest bank in the U.S. by deposit volume
- 29 branches worldwide
- Headquartered in Santa Clara, California, USA
- A subsidiary of SVB Financial Group, a member of the S&P 500 index.
* Past performance is no guarantee of future results
