Behavioral Investing and Finance

The insolvency of Silicon Valley Bank (SVB) occurred very fast. One day they are doing fine and the next they are out of money. This is technically true but this does not mean they are insolvent or bankrupt at that time. Their bankruptcy was not due to a lack of assets but a lack of cash on hand or liquidity. Or to put it another way, they did not have enough cash for the number of people and companies that needed to withdraw money. This is called a bank run and is very much based on herd mentality.

Bank Run

What is a bank run? Bank runs are when a large number of depositors want to withdraw cash from a bank at the same time because they fear the bank is going to run out of money, even though the bank may have a huge amount of assets.

The classic movie bank run is in “It’s A Wonderful Life” when George Bailey’s company, the Bailey Brothers Building, and Loan are swarmed by investors who want their money because the town bank ran out of money and closed their doors. As George tells his investors,

“…you’re thinking of this place all wrong. As if I had the money back in a safe. The money’s
not here. Your money’s in Joe’s house right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others. Why you’re lending them the money to build, and then, they’re going to pay it back to you as best they can. Now, what are you going to do?
Foreclose on them?”

The problem is that most of a bank’s assets are not in cash. The bank doesn’t have all its money in a safe or in another bank but instead is invested in loans, government bonds, or other financial instruments that make the bank money. Remember the way banks make money is to loan money out to people and businesses. They don’t make money by storing money in a safe.

So, when a large number of depositors want to withdraw their money, the bank needs to use their cash on hand or sell investments, if they can. If they run out of cash for their withdrawal requests, they go bankrupt.

Herd Mentality

A bank run is the definition of herd mentality also known as “group think” or “mob behavior”. Herd mentality describes how people are psychologically influenced by the action of the majority, even though the majority may be incorrect.

In a bank run, fear is the emotion creating this herd mentality. People fear that they will lose all their money as the bank will go bankrupt but in fact, if they didn’t all request their money at the same time, the bank would be able to stay in business and still provide withdrawals. This herd mentality is what causes a bank run and bankruptcy.

Herd mentality can lead to bad outcomes if no thought is brought into the reasons why the majority is moving that way. For example, if you have less than $250K in an account at a bank, then the Federal Deposit Insurance Corporation (FDIC) will guarantee you will get your money, so you don’t need to withdraw your money from the bank immediately unless you need it for immediate reasons; i.e. payroll.

Silicon Valley Bank

So what happened with SVB? The simple explanation is exactly what we talked about above. There was a bank run and companies and people demanded their money at the same time from SVB. SVB did not have the cash, so they had to sell the government bonds they invested in at a loss to cover the cash withdrawals. Selling of these government bonds lead to more announced losses which lead to more fear from depositors who withdrew more cash and so on until they just could not pay out all the withdrawals and ended up with a negative cash balance of $1 billion dollars on March 9th, 2023. Although they had $124 billion total deposited in the prior 12 months.

There is debate and a major investigation on why they invested in so many low-interest government bonds at the height of the pandemic, didn’t change their investment strategy when the Federal Reserve was raising interest rates and didn’t look for another capital infusion earlier to stay solvent. All these questions hopefully are answered by the federal investigation, which will take months to years.

For our discussion on behavior bias, the insolvency of SVB may have been inevitable but it could have been delayed to allow them to find another source of cash if not for the herd mentality of a bank run on them.

Was it incorrect to withdraw money from SVB when they were losing so much on government bonds? I would say no. If I had money in SVB, I would have taken the money out too as their losses accumulated.

Contagion

The unfortunate effect of SVB is that bank runs will occur at other banks as they may be tied to SVB or have invested in similar ways. And fear is spreading to other banks as bank stocks are taking stock losses. Fear is a contagion in the banking industry right now.

As of Monday, March 13th, 2023, a regional bank, called Signature Bank also went bankrupt when depositors withdrew more than $10 billion in deposits, and there may be more bank runs.

What is my advice? If you need cash now, then by all means take money out for short-term needs (3 months or less), but if you have less than $250K in an account and don’t need the money now, you are guaranteed by the FDIC to not lose that money. If you have more than $250K in one account, then what happens is up in the air. U.S. regulators are now ensuring all depositors in SVB will get their money, above and beyond $250K, but what about the other banks? No one knows.