Silicon Valley Bank Failure; FDIC & SIPC Explained
Hey FAANG FIRE,
Next week is is going to be different. By now you have been inundated by news that Silicon Valley Bank has failed.
This is the largest bank failure since 2008. It started with SVB sharing that while their assets were larger than their liabilities, their assets were quickly losing value. The simplified reason being that they held most of their assets in the form of very long term bonds that were losing value as the Fed continued to raise interest rates. In order to maintain proper reserves, they were needing to sell those long term bonds at a loss (in the billions).
Then, in a panic, every VC in the valley started telling all their portfolio companies to move their money anywhere else. This caused a bank run and by Friday morning SVB was no more and the FDIC stepped in.
Companies large and small across the valley are scrambling. Even those who didn’t have a direct relationship with SVB will find out they are indirectly impacted. Garry Tan, CEO of Y-Combinator describes this as a possible startup extinction event.
Everyone is now waiting to see what happens next.
From the FDIC press release Friday (bolding added by me):
All insured depositors will have full access to their insured deposits no later than Monday morning, March 13, 2023. The FDIC will pay uninsured depositors an advance dividend within the next week. Uninsured depositors will receive a receivership certificate for the remaining amount of their uninsured funds. As the FDIC sells the assets of Silicon Valley Bank, future dividend payments may be made to uninsured depositors.
At minimum all account holders on Monday should have access to the FDIC limits of $250k. Unfortunately >90% of depositors (mainly companies) held more than the limit. As the FDIC sells assets they will use those to pay balances above $250k. Even as SVB collapsed, the bank held more in long term bonds than the total deposits. So it is very likely that the majority of balances will be recovered. It could take some time to unwind everything, and the main worry is that any delay could be a deathblow to many companies.
It is also possible that the FDIC quickly facilitates a buyer who is able to make all depositors whole instantly. They did so in 2008 when Washington Mutual collapsed. Chase bank was able to step in over the weekend. Things do start to get a little scary if we need to continue using 2008 examples.
Links to learn more:
https://www.fdic.gov/news/press-releases/2023/pr23016.html
https://www.bloomberg.com/opinion/articles/2023-03-10/startup-bank-had-a-startup-bank-run
https://www.npr.org/2023/03/11/1162805718/silicon-valley-bank-failure-startups
https://www.nytimes.com/2023/03/11/technology/silicon-valley-bank-crypto-investing.html
What to do?
The real uncertainty is for those who work for the companies impacted. Next week is payroll for most companies and depending on what happens it is possible your paycheck will be delayed.
This is a good reminder for everyone to have an emergency fund.
This is also a wake up call for everyone to brush up on how bank accounts and investment accounts are insured in the United States. You could be putting yourself at risk unnecessarily. The two key items to understand are FDIC and SIPC.
FDIC: Federal Deposit Insurance Corporation
“The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the Congress to maintain stability and public confidence in the nation’s financial system. The FDIC insures deposits; examines and supervises financial institutions for safety, soundness, and consumer protection; makes large and complex financial institutions resolvable; and manages receiverships.” - FDIC.gov
At a basic level, the FDIC provides insurance of up to $250,000 per person per bank.
The FDIC adds together all single accounts owned by the same person at the same bank and insures the total up to $250,000.
If the account is a joint account with 2 people, the amount increases to $500,000. Also, if the account is a trust with 3 beneficiaries it would insure $750,000. Again, this is all per account holder and bank. Read all the nuance direct from the FDIC.
Many banks also have programs that will automatically “sweep” balances across multiple accounts to extend your coverage (by increasing the number of accounts held which each would have their own FDIC coverage). Fidelity for example describes their program as follows:
If you have more than $245,000 in uninvested cash in your account, the Program maximizes your eligibility for FDIC insurance by systematically allocating this uninvested cash across multiple program banks. At a minimum, there are generally five banks available to accept customer deposits, making customers eligible for nearly $1,250,000 of FDIC insurance.
If you are holding significant amounts of cash it is worth going deeper here to make sure you are covered.
SIPC: Securities Investor Protection Corporation
The Securities Investor Protection Corporation is a federally mandated, non-profit, member-funded, United States corporation created under the Securities Investor Protection Act of 1970 that mandates membership of most US-registered broker-dealers. - SIPC.org
At a basic level SIPC protects against loss of cash and securities held at brokerages. Banks are members of FDIC, brokerages SIPC. SIPC covers $500k per account against the loss of cash and securities. Important to note that there is an explicit limit for cash held in brokerages of $250k.
Wait… this is FAANG FIRE. Many of us have more than $500k invested in our taxable brokerages, 401ks, Roth IRAs, and more. Is this at risk?
They shouldn’t be. There are several layers of protection in addition to SIPC that should provide additional confidence in your brokers ability to safely hold your assets beyond the SIPC limits.
For example, the U.S. Securities and Exchange Commission (SEC) has something called the Customer Protection Rule, which requires firms to segregate client assets from firm assets; accessing the money in client accounts would be committing fraud. Another SEC regulation, called the Net Capital Rule, says that firms must keep a minimum amount of liquid assets, depending on their size. -The Balance
One key item mentioned above is the “Customer Protection Rule”, also known as the 15c3-3 rule. “The rule requires brokerages to have physical possession of customers’ securities. Those paper stock certificates or other items need to be kept in a safe place.” This means that even if your broker fails, the underlying shares you hold are required to be held separate. Pretend physical stock certificates were still a thing. Brokers are required to hold those actual certificates.
If you wanted to go to the extreme, you could also directly register your shares. This has been popular among the Reddit GameStop crowd to prevent brokers from allowing their shares to be shorted.
Many brokerages also have specific “Excess of SIPC” insurance programs. Fidelity claims “Total aggregate excess of SIPC coverage available through Fidelity's excess of SIPC policy is $1 billion.” The key thing here is that this is a total policy and non per-account. Additionally there is a per-customer limit of $1.9M in if you hold cash awaiting investment. From a quick look Schwab and Morgan Stanley have similar policies.
Recap and Action Items
It is unclear what will happen over the next week. It is a good reminder to always have an Emergency Fund. You may be indirectly impacted without realizing… or certain Bloomberg articles could come to fruition. (Remember, when shit hits the fan, it can really hit the fan and go everywhere).
If you stay under FDIC limits, the FDIC is very fast to swoop in and make you whole. Amounts over FDIC limits could take more time and are not guaranteed.
FDIC limits can increase for joint accounts and trust accounts with multiple beneficiaries.
Thanks to the Customer Protection Rule, your broker should be automatically holding your underlying securities separately and they would be recoverable in the event your broker collapsed. Assuming they are members SIPC.
SIPC provides an additional $500k protection against assets held at brokers but cash is still limited to $250k.
Many large banks and brokers will offer cash sweeps across multiple accounts for you to easily increase your FDIC limits.
Not a good time to do “banking” anywhere without these basic protections.
Stay safe out there and always use protection (of the FDIC/SIPC variety).
3/13 Update: Joint Statement by the Treasury, Federal Reserve, and FDIC (excellent URL choice): https://home.treasury.gov/news/press-releases/jy1337
Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.
Crisis averted for now. I would still be much more mindful of FDIC and SIPC limits going forward.
How about financial institutions like Wealth front? They also sweep balances to partner banks
Fingers crossed! I hope there's no domino effect from this one.