Why Silicon Valley Bank Collapsed: A Simple Explainer

Almost everyone has heard by now that one of the biggest banks focused on serving startups and innovative tech companies collapsed in a matter of days, but a lot of things played into its eventual destruction. Here's a look at what ultimately led the U.S. government to step in over the weekend.

What Happened: The biggest banking collapse since the 2008 financial crisis was spearheaded by a bank run on SVB Financial Group SIVB last week, but the gears had been turning for quite some time.

Much of the problem stemmed from a combination of a short-lived surge in cash positions and a swift attack on inflation by the Federal Reserve.

The Set Up: SVB Financial, the parent company of Silicon Valley Bank, counts many startups and smaller tech companies as clients. Deposits from these clients soared during the pandemic, as many of them grew their cash positions exponentially amid record low rates.

As deposits climbed, SVB decided to buy U.S. treasuries and government-backed mortgage securities with the influx of cash. 

The Catalyst: As the U.S. emerged from the pandemic with a flourishing economy, inflation started to dig its teeth into hard-working Americans' pockets. With inflation rapidly rising across the board, the Fed raised its fists and began to jab at rising prices with a series of aggressive rate hikes. 

The effects of higher rates lagged behind in inflation readings, but several companies started to feel the pain as investors backed out of high-growth names and cash positions began to dwindle. 

The Tipping Point: Given the rising rates environment, inflows turned to outflows, and SVB was forced to sell some of its longer-term treasuries at a loss to cover increased withdrawal requests.

SVB sold out of its bond portfolio worth approximately $21 billion and recognized a loss of $1.8 billion, according to a release from last week. The portfolio was yielding just 1.79% while the 10-year was yielding closer to 4%, per Reuters.

SVB also went to the public markets to raise additional capital, announcing plans to offer $1.25 billion of its common stock and $500 million of depositary shares. As a result of the announcement, the stock tanked, which put more pressure on the bank.

The panic in the markets sparked a bank run as several customers rushed to withdraw capital, and ultimately, the bank's cash position ran dry. SVB then looked to find a buyer in order to source alternative funding, but the Federal Deposit Insurance Corporation (FDIC) shut it down and placed the bank under receivership, according to Reuters.

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The Government Steps In: Over the weekend, the Fed stepped in to inject liquidity into the situation in an effort to make depositors whole, however, the bank itself can be chalked up as a zero.

Depositors will be covered by the FDIC's deposit insurance fund. Furthermore, the Fed also announced plans to create a new Bank Term Funding Program centered around protecting institutions impacted by the crash of SVB Financial stock.

It's not a bailout, so shareholders will not recoup losses and taxpayers will not suffer. The move simply aims to build back confidence in the banking system, Fed Chair Jerome Powell, Treasury Secretary Janet Yellen and FDIC Chair Martin Gruenberg said in a joint statement. 

"The U.S. banking system remains resilient and on a solid foundation, in large part due to reforms that were made after the financial crisis that ensured better safeguards for the banking industry. Those reforms combined with today's actions demonstrate our commitment to take the necessary steps to ensure that depositors' savings remain safe."

See Also: EXCLUSIVE: Fed Steps In To Save Depositors Following SVB Failure; Is The Time To Buy Shares Of Regional Banks?

SPY Price Action: The SPDR S&P 500 SPY has faced significant selling pressure over the last few trading sessions, however it's bouncing back in the wake of the joint statement from the Fed, Treasury and FDIC.

The SPY was up 0.61% at $388.29 at the time of writing, according to Benzinga Pro.