Why_would_Silicon_Valley_Bank_by_10_year_bonds
00:00:00.000 | Hello, everybody, it's Sam from Financial Samurai.
00:00:02.860 | And in this episode, I want to go through a thought process on why Silicon Valley Bank
00:00:07.960 | would buy 10-year bonds yielding 1.69% back in 2021 and maybe in early 2022.
00:00:17.320 | Because here in 2023, I've been talking about buying Treasury bills, which are Treasury
00:00:22.920 | bonds with a one-year duration or earlier, three months, six months, nine months, or
00:00:27.640 | one year at about 5% to 5.15%.
00:00:32.040 | And it's probably going to go a little bit higher.
00:00:34.000 | I think T-bills at 5% plus is kind of a no-brainer.
00:00:39.720 | You just buy them risk-free, no state or local income taxes, and you just wait until the
00:00:45.520 | carnage finishes unfolding, right?
00:00:49.320 | T-billing and chilling is the new term.
00:00:52.460 | And I haven't talked much at all about buying 10-year Treasury bonds, let alone five years.
00:00:59.800 | I talked briefly about three-year, buying three-year Treasury bonds a couple of months
00:01:04.280 | ago when they were yielding 4%.
00:01:07.120 | But now, OK, 10-year Treasury bonds yield about 4%.
00:01:10.440 | Actually, they did yield about 4%.
00:01:12.560 | Now, after the Silicon Valley Bank collapse, they're yielding now about 3.65%, 3.7%.
00:01:20.640 | So if we are not that enthused about buying longer-dated Treasury bonds at 4%, 3.5%, 4%,
00:01:29.000 | 4.5% at one point, why on earth would Silicon Valley Bank buy 10-year Treasury bonds yielding
00:01:36.680 | only about 1.7%?
00:01:39.180 | We can all armchair quarterback and think, well, that was silly because that was near
00:01:43.920 | the top of the market.
00:01:45.640 | And obviously, when rates rise aggressively, bond values decline.
00:01:49.160 | And if you have to sell those Treasury bonds before maturity, you're going to lose money.
00:01:54.400 | I'm also looking at the archives, the Financial Samurai post archives and the episodes.
00:01:59.900 | And I don't see any posts or episodes talking about buying 10-year Treasury bonds when they're
00:02:05.560 | yielding 0.56%, 1%, 1.5%, 2%.
00:02:10.520 | Because at that time, I think we were all discussing, well, that's where bond yields
00:02:16.260 | really have nowhere to go but up.
00:02:19.800 | They could stay low.
00:02:21.360 | But at that point, OK, look, the risk-reward of buying bonds when they're yielding under
00:02:27.120 | 1% didn't seem that great.
00:02:29.800 | So instead, we did talk about buying stocks in real estate.
00:02:33.880 | You remember a post called "How to Predict the Stock Market Bottom Like Nostradamus."
00:02:39.640 | We talked about taking advantage of real estate opportunities during COVID-19.
00:02:45.600 | And you can see the archives of these posts and my thought process about taking advantage
00:02:50.760 | during a difficult time period.
00:02:53.280 | So back to Silicon Valley Bank.
00:02:55.460 | Why would they do so?
00:02:57.160 | They employ smart people.
00:02:58.400 | They get paid tons and tons of money.
00:03:00.760 | Well, it's essentially because they weren't buying these Treasury bonds with their money.
00:03:07.280 | It was other people's money.
00:03:08.400 | It was their depositors' money.
00:03:11.000 | And the depositors were getting paid from Silicon Valley Bank probably an interest rate
00:03:17.080 | of less than, let's say, 1%.
00:03:19.640 | We all remember when we were getting 0.1% to 0.5% on our money market accounts.
00:03:25.720 | So if you are a depositor at Silicon Valley Bank or any of these banks in 2020, 2021,
00:03:32.800 | you're probably getting less than a 1% interest rate.
00:03:35.400 | Heck, I even just moved money to a short-term CD at Chase Bank, which is where my small
00:03:42.600 | business has a relationship, because we were only getting 0.2%.
00:03:48.640 | So back then, I'm sure Silicon Valley Bank were paying depositors less than 1%.
00:03:54.720 | So if you then buy Treasury bonds yielding 1.69%, you have a positive net interest margin,
00:04:03.120 | a spread of at least 0.7%, maybe higher.
00:04:08.380 | And then the question is, why wouldn't Silicon Valley Bank better match duration?
00:04:13.940 | So these deposits are considered short-term deposits.
00:04:18.000 | They're very liquid, used for working capital needs, used to buy a house, buy a boat, pay
00:04:23.680 | employees and so forth.
00:04:25.460 | So why would Silicon Valley Bank buy 10-year Treasuries?
00:04:29.240 | That's a mismatch in duration.
00:04:32.040 | And the simple answer is that 10-year Treasury bond yields were higher than 5-year, 3-year,
00:04:38.680 | 1-year.
00:04:39.760 | So the bank thought, well, let's invest in this duration to make more money.
00:04:45.140 | It's always about money, folks.
00:04:47.020 | But it's also about making risk-adjusted investments, risk-appropriate investments.
00:04:53.140 | And so as the Fed started raising rates, the Fed funds rate is the shortest duration.
00:04:58.520 | It's like an overnight banking rate.
00:05:01.640 | Deposit rates started to go up.
00:05:03.980 | So the cost of funding started going up for Silicon Valley Bank.
00:05:09.080 | And so if you lock in a 1.69% rate for 10 years, and your cost of deposits now balloons
00:05:15.900 | to, let's say, 4%, 4.2%, 4.5% now, that's what we see at many of the competing banks,
00:05:23.840 | then you're upside down.
00:05:24.840 | You have a negative net interest margin.
00:05:27.320 | You're losing money.
00:05:28.860 | And then if you don't get as many deposits, there becomes this shortfall.
00:05:34.880 | And the shortfall will result in-- it's almost like a Ponzi scheme, right?
00:05:38.700 | Because no bank has all of its deposits money available to its depositors, right?
00:05:45.280 | The bank will have a tier 1 capital ratio of between 12% to 14%.
00:05:50.240 | There'll be some tier 2 capital.
00:05:52.680 | And then the rest is lent out to make a profit.
00:05:56.120 | That's banking 101.
00:05:57.800 | So in retrospect, if you have a time machine, you would have told the investment committee
00:06:02.260 | at Silicon Valley Bank not to invest half their deposits in 10-year treasury bonds.
00:06:08.280 | You better match liability duration, let's say, three months, six months, one year.
00:06:14.680 | So what would happen is your profits would be smaller.
00:06:17.820 | Your stock price would probably not be as high.
00:06:21.320 | And nobody likes that, right?
00:06:22.960 | Everybody wants to make more money.
00:06:24.880 | So if you're going to take this excess risk, and you're going to see the rewards of a higher
00:06:29.000 | stock price, you would then rationally sell as the stock would go to the moon.
00:06:35.800 | And then you would try to distance yourself as it collapses because the Fed raised rates
00:06:42.780 | more aggressively and more quickly than anticipated, collapsing your hold to maturity bonds.
00:06:49.120 | Silicon Valley planned to hold these 10-year bonds to maturity for 10 years and just earn
00:06:53.600 | 1.69%.
00:06:55.300 | But then they had to sell to raise liquidity because it was facing a liquidity crunch,
00:07:01.040 | especially after it announced it had tried to raise $3 billion from the public market
00:07:07.240 | and couldn't.
00:07:08.280 | And therefore, the bank run accelerated.
00:07:11.560 | In conclusion, let's talk about some key takeaways.
00:07:15.700 | Takeaway number one, if you are investing other people's money, you're going to be willing
00:07:20.840 | to take more risk.
00:07:22.480 | It's just the way it is.
00:07:24.040 | It's human nature.
00:07:25.400 | But if you're investing your own money, which is what I do to help keep my family afloat
00:07:30.800 | so my wife and I don't have to go back to work, it is much different, more conservative,
00:07:38.280 | more thoughtful, less risky.
00:07:41.100 | So please be careful listening to other people's investment advice, especially if they're talking
00:07:47.360 | about investing other people's money.
00:07:50.160 | If you look at Wall Street strategists, they strategize about target prices and everything.
00:07:56.920 | But it's not their money, so they can talk about anything and there's really no repercussions
00:08:01.060 | except for maybe their reputation and their salary and bonus.
00:08:04.940 | So if you go down the chain and you start listening to pontificators on social media,
00:08:10.440 | well, there's really no repercussions, especially if they are-- it's the funny thing where people
00:08:16.060 | talk about making money investing.
00:08:18.160 | Well, if you're so good at making money investing, why are you trying to pump people up with
00:08:23.600 | your investing course and all that stuff?
00:08:26.820 | It just doesn't make sense.
00:08:28.160 | But it does make sense because it's more profitable to sell the dream about how to be a great
00:08:33.200 | investor than to just invest your own money.
00:08:36.760 | The second takeaway is that very smart and connected people still get things wrong.
00:08:43.360 | The CEO of Silicon Valley Bank was a director at the San Francisco Fed.
00:08:49.280 | So presumably, he had conversations with other Fed officials and was more plugged in than
00:08:54.480 | the rest of us.
00:08:55.920 | But if he was more plugged in than the rest of us, why would he green light the decision
00:09:00.940 | to buy 10-year bonds yielding 1.69% in 2021?
00:09:07.800 | I really think most of us back then-- this is not revisionist history because I'm looking
00:09:11.800 | at the history.
00:09:13.280 | Most of us did not want to buy bonds because they were yielding so low.
00:09:17.400 | The risk reward was not there.
00:09:19.400 | So I think it's really important that before we invest a single dollar, to talk to someone
00:09:25.780 | else with an opposing point of view, to look at the other side.
00:09:30.340 | If we were always right on our investments, we'd all be multimillionaires or billionaires
00:09:35.040 | by now.
00:09:36.040 | Obviously, we're not because something unexpected or something we didn't believe always tends
00:09:43.260 | to happen.
00:09:44.260 | This is the nature of the beast when we put money into risk assets.
00:09:48.720 | And we have to accept that.
00:09:50.080 | A third takeaway is to look at the yield curve.
00:09:53.640 | The yield curve right now is inverted.
00:09:55.760 | It's the most inverted since the 1980s.
00:09:59.360 | And this is an indicator of another recession within the next 12 to 18 months.
00:10:04.920 | And if you lost your job already, it's already a recession.
00:10:07.440 | It might be a depression.
00:10:08.680 | Hopefully not.
00:10:10.120 | But this is the thing.
00:10:11.120 | If the yield curve is inverted, you don't want to borrow short and lend long.
00:10:16.460 | This is what Silicon Valley Bank did.
00:10:18.560 | They borrowed short by paying, paying their depositors a high interest rate.
00:10:24.720 | It's inverted, right?
00:10:25.800 | The short end is more expensive than the long end.
00:10:28.580 | And then they're lending money.
00:10:29.660 | They're trying to make money on the long end, which is paying a lower interest rate or a
00:10:35.320 | lower return.
00:10:36.800 | So therefore, they're upside down, negative net interest margin.
00:10:40.900 | On the flip side, for all of us who wisely refinanced our mortgages in 2021 and 2022,
00:10:49.520 | we were on the other side of the Silicon Valley Bank trade of spending $90 to $100 billion
00:10:55.080 | buying 10-year bond yields, yielding 1.7%.
00:10:59.300 | We were able to borrow long and then sell short.
00:11:04.700 | And since we're not a bank, we're not really selling short.
00:11:06.860 | We're just enjoying our home now.
00:11:10.200 | So that's the short.
00:11:11.920 | A fourth takeaway from the Silicon Valley Bank collapse is the risk of working at a
00:11:17.480 | startup.
00:11:18.480 | I never thought about this risk before, how the working capital can just get frozen up
00:11:23.240 | in a bank that's been around for 40 years.
00:11:25.840 | And it's been a great partner to many, many thousands of startups in the ecosystem.
00:11:31.900 | But working at a startup, you face a much higher risk profile than working at an established
00:11:37.440 | firm with very strong profitability and cash flow.
00:11:41.160 | I do question the narrative that if Silicon Valley Bank funds are not released ASAP, that
00:11:48.160 | the entire startup ecosystem will fail because companies won't be able to meet payroll and
00:11:53.720 | will have to lay off or furlough workers.
00:11:56.400 | The thing is, if you're a worker, is missing one paycheck really going to devastate your
00:12:01.560 | finances?
00:12:02.560 | I hope not, especially if you're a financial samurai listener and reader.
00:12:06.520 | I am hopeful that there's going to be resolution and there's going to be a large acquire of
00:12:11.040 | Silicon Valley Bank.
00:12:12.400 | And we'll find out pretty soon who will make depositors who have over $250,000 at the bank
00:12:18.560 | hole.
00:12:19.560 | In such a scenario, you volunteering two weeks more of your time to work and then ultimately
00:12:26.480 | getting paid will come out making you look pretty good.
00:12:29.720 | You're going to look pretty loyal.
00:12:31.080 | You're going to look like you're part of the team, brothers and sisters in arms.
00:12:36.480 | And if you don't end up getting paid, which is the lower probability scenario, then you
00:12:41.600 | will have ended up wasting time, the ability to make some side hustle money.
00:12:47.320 | But your reputation as a strong team player will live on.
00:12:51.560 | People don't forget this, especially during times of crisis.
00:12:55.600 | And that will be helpful for your next job, your next career, your next opportunity.
00:12:59.940 | The final takeaway from this whole Silicon Valley Bank collapse is that we shouldn't
00:13:05.320 | depend on the government to save us.
00:13:08.240 | Even though the FDIC has stepped in to receive Silicon Valley Bank and guarantee those depositors
00:13:15.080 | with up to $250,000, we should not rely on anybody to achieve financial independence
00:13:22.440 | and to bail us out if we are in trouble.
00:13:25.080 | I remember Monday, September 15, 2008, very clearly.
00:13:30.340 | Just like now.
00:13:31.340 | It's very interesting.
00:13:32.340 | Just like now, there was a lot of smoke and fire about whether Lehman would survive the
00:13:36.640 | weekend.
00:13:37.920 | And I bet my neighbor, my colleague, Will, $100, saying that, of course, the government
00:13:44.280 | was going to bail out Lehman.
00:13:45.940 | How could they let contagion continue?
00:13:49.600 | And then, of course, on Monday, the government let Lehman fail.
00:13:53.480 | And then Lehman failed, and then the contagion spread, and what resulted in a terrible collapse
00:13:59.260 | in the financial markets and the real estate market.
00:14:02.600 | It was a clear wake-up call back then to never rely on the government to save you.
00:14:09.640 | Financial Samurai was born in July 2009 at the bottom of the global financial crisis.
00:14:16.020 | If there was not a global financial crisis, the site would never have been born.
00:14:20.920 | This podcast would never have been started.
00:14:23.960 | So that's a bright side for you as listeners and readers if you enjoy this work.
00:14:28.640 | And for me as someone who sought financial freedom, this pain that I felt during the
00:14:33.720 | global financial crisis motivated me to change.
00:14:37.600 | Before the financial crisis, I just sucked up dealing with all the stress and pain and
00:14:42.440 | long hours because I wanted to climb the corporate ladder and make more money.
00:14:46.640 | And then when the financial crisis hit and I realized the government wouldn't save me
00:14:51.340 | or my colleagues or the industry, I realized I needed to find and develop contingency plans.
00:14:58.000 | I couldn't just rely on my job, one income source to survive and to gain financial independence
00:15:04.600 | eventually.
00:15:05.600 | I needed to develop alternative income streams, more passive income investments, a side hustle,
00:15:12.400 | a side business, whatever it is.
00:15:14.200 | I needed to do whatever it took so that I would be secure and my future family would
00:15:20.200 | be secure as well.
00:15:21.640 | So if you're feeling some pain from the Silicon Valley bank collapse, embrace it, accept it,
00:15:29.640 | and use it as motivation to change for the better.
00:15:32.040 | All right, everybody.
00:15:33.400 | It's Saturday morning, March 11th, 2023.
00:15:36.560 | I got to get out of bed to feed the kids and take the kids to a birthday play date.
00:15:42.260 | Let's hope for the best.
00:15:43.960 | Let's hope there is a positive resolution in the coming week where all depositors, innocent
00:15:49.880 | depositors get made whole.
00:15:52.600 | If you enjoyed this podcast, please share with a friend and leave a positive review.
00:15:57.400 | Don't forget to sign up for my weekly newsletter at FinancialSamurai.com/news and please support
00:16:04.640 | Buy This, Not That at FinancialSamurai.com/btnt.
00:16:09.880 | I'd love a positive review on Amazon as well.
00:16:12.600 | Thanks so much and we will be in touch shortly.