Hello, everybody, it's Sam from Financial Samurai. And in this episode, I want to go through a thought process on why Silicon Valley Bank would buy 10-year bonds yielding 1.69% back in 2021 and maybe in early 2022. Because here in 2023, I've been talking about buying Treasury bills, which are Treasury bonds with a one-year duration or earlier, three months, six months, nine months, or one year at about 5% to 5.15%.

And it's probably going to go a little bit higher. I think T-bills at 5% plus is kind of a no-brainer. You just buy them risk-free, no state or local income taxes, and you just wait until the carnage finishes unfolding, right? T-billing and chilling is the new term. And I haven't talked much at all about buying 10-year Treasury bonds, let alone five years.

I talked briefly about three-year, buying three-year Treasury bonds a couple of months ago when they were yielding 4%. But now, OK, 10-year Treasury bonds yield about 4%. Actually, they did yield about 4%. Now, after the Silicon Valley Bank collapse, they're yielding now about 3.65%, 3.7%. So if we are not that enthused about buying longer-dated Treasury bonds at 4%, 3.5%, 4%, 4.5% at one point, why on earth would Silicon Valley Bank buy 10-year Treasury bonds yielding only about 1.7%?

We can all armchair quarterback and think, well, that was silly because that was near the top of the market. And obviously, when rates rise aggressively, bond values decline. And if you have to sell those Treasury bonds before maturity, you're going to lose money. I'm also looking at the archives, the Financial Samurai post archives and the episodes.

And I don't see any posts or episodes talking about buying 10-year Treasury bonds when they're yielding 0.56%, 1%, 1.5%, 2%. Because at that time, I think we were all discussing, well, that's where bond yields really have nowhere to go but up. They could stay low. But at that point, OK, look, the risk-reward of buying bonds when they're yielding under 1% didn't seem that great.

So instead, we did talk about buying stocks in real estate. You remember a post called "How to Predict the Stock Market Bottom Like Nostradamus." We talked about taking advantage of real estate opportunities during COVID-19. And you can see the archives of these posts and my thought process about taking advantage during a difficult time period.

So back to Silicon Valley Bank. Why would they do so? They employ smart people. They get paid tons and tons of money. Well, it's essentially because they weren't buying these Treasury bonds with their money. It was other people's money. It was their depositors' money. And the depositors were getting paid from Silicon Valley Bank probably an interest rate of less than, let's say, 1%.

We all remember when we were getting 0.1% to 0.5% on our money market accounts. So if you are a depositor at Silicon Valley Bank or any of these banks in 2020, 2021, you're probably getting less than a 1% interest rate. Heck, I even just moved money to a short-term CD at Chase Bank, which is where my small business has a relationship, because we were only getting 0.2%.

So back then, I'm sure Silicon Valley Bank were paying depositors less than 1%. So if you then buy Treasury bonds yielding 1.69%, you have a positive net interest margin, a spread of at least 0.7%, maybe higher. And then the question is, why wouldn't Silicon Valley Bank better match duration?

So these deposits are considered short-term deposits. They're very liquid, used for working capital needs, used to buy a house, buy a boat, pay employees and so forth. So why would Silicon Valley Bank buy 10-year Treasuries? That's a mismatch in duration. And the simple answer is that 10-year Treasury bond yields were higher than 5-year, 3-year, 1-year.

So the bank thought, well, let's invest in this duration to make more money. It's always about money, folks. But it's also about making risk-adjusted investments, risk-appropriate investments. And so as the Fed started raising rates, the Fed funds rate is the shortest duration. It's like an overnight banking rate. Deposit rates started to go up.

So the cost of funding started going up for Silicon Valley Bank. And so if you lock in a 1.69% rate for 10 years, and your cost of deposits now balloons to, let's say, 4%, 4.2%, 4.5% now, that's what we see at many of the competing banks, then you're upside down.

You have a negative net interest margin. You're losing money. And then if you don't get as many deposits, there becomes this shortfall. And the shortfall will result in-- it's almost like a Ponzi scheme, right? Because no bank has all of its deposits money available to its depositors, right? The bank will have a tier 1 capital ratio of between 12% to 14%.

There'll be some tier 2 capital. And then the rest is lent out to make a profit. That's banking 101. So in retrospect, if you have a time machine, you would have told the investment committee at Silicon Valley Bank not to invest half their deposits in 10-year treasury bonds. You better match liability duration, let's say, three months, six months, one year.

So what would happen is your profits would be smaller. Your stock price would probably not be as high. And nobody likes that, right? Everybody wants to make more money. So if you're going to take this excess risk, and you're going to see the rewards of a higher stock price, you would then rationally sell as the stock would go to the moon.

And then you would try to distance yourself as it collapses because the Fed raised rates more aggressively and more quickly than anticipated, collapsing your hold to maturity bonds. Silicon Valley planned to hold these 10-year bonds to maturity for 10 years and just earn 1.69%. But then they had to sell to raise liquidity because it was facing a liquidity crunch, especially after it announced it had tried to raise $3 billion from the public market and couldn't.

And therefore, the bank run accelerated. In conclusion, let's talk about some key takeaways. Takeaway number one, if you are investing other people's money, you're going to be willing to take more risk. It's just the way it is. It's human nature. But if you're investing your own money, which is what I do to help keep my family afloat so my wife and I don't have to go back to work, it is much different, more conservative, more thoughtful, less risky.

So please be careful listening to other people's investment advice, especially if they're talking about investing other people's money. If you look at Wall Street strategists, they strategize about target prices and everything. But it's not their money, so they can talk about anything and there's really no repercussions except for maybe their reputation and their salary and bonus.

So if you go down the chain and you start listening to pontificators on social media, well, there's really no repercussions, especially if they are-- it's the funny thing where people talk about making money investing. Well, if you're so good at making money investing, why are you trying to pump people up with your investing course and all that stuff?

It just doesn't make sense. But it does make sense because it's more profitable to sell the dream about how to be a great investor than to just invest your own money. The second takeaway is that very smart and connected people still get things wrong. The CEO of Silicon Valley Bank was a director at the San Francisco Fed.

So presumably, he had conversations with other Fed officials and was more plugged in than the rest of us. But if he was more plugged in than the rest of us, why would he green light the decision to buy 10-year bonds yielding 1.69% in 2021? I really think most of us back then-- this is not revisionist history because I'm looking at the history.

Most of us did not want to buy bonds because they were yielding so low. The risk reward was not there. So I think it's really important that before we invest a single dollar, to talk to someone else with an opposing point of view, to look at the other side.

If we were always right on our investments, we'd all be multimillionaires or billionaires by now. Obviously, we're not because something unexpected or something we didn't believe always tends to happen. This is the nature of the beast when we put money into risk assets. And we have to accept that.

A third takeaway is to look at the yield curve. The yield curve right now is inverted. It's the most inverted since the 1980s. And this is an indicator of another recession within the next 12 to 18 months. And if you lost your job already, it's already a recession. It might be a depression.

Hopefully not. But this is the thing. If the yield curve is inverted, you don't want to borrow short and lend long. This is what Silicon Valley Bank did. They borrowed short by paying, paying their depositors a high interest rate. It's inverted, right? The short end is more expensive than the long end.

And then they're lending money. They're trying to make money on the long end, which is paying a lower interest rate or a lower return. So therefore, they're upside down, negative net interest margin. On the flip side, for all of us who wisely refinanced our mortgages in 2021 and 2022, we were on the other side of the Silicon Valley Bank trade of spending $90 to $100 billion buying 10-year bond yields, yielding 1.7%.

We were able to borrow long and then sell short. And since we're not a bank, we're not really selling short. We're just enjoying our home now. So that's the short. A fourth takeaway from the Silicon Valley Bank collapse is the risk of working at a startup. I never thought about this risk before, how the working capital can just get frozen up in a bank that's been around for 40 years.

And it's been a great partner to many, many thousands of startups in the ecosystem. But working at a startup, you face a much higher risk profile than working at an established firm with very strong profitability and cash flow. I do question the narrative that if Silicon Valley Bank funds are not released ASAP, that the entire startup ecosystem will fail because companies won't be able to meet payroll and will have to lay off or furlough workers.

The thing is, if you're a worker, is missing one paycheck really going to devastate your finances? I hope not, especially if you're a financial samurai listener and reader. I am hopeful that there's going to be resolution and there's going to be a large acquire of Silicon Valley Bank. And we'll find out pretty soon who will make depositors who have over $250,000 at the bank hole.

In such a scenario, you volunteering two weeks more of your time to work and then ultimately getting paid will come out making you look pretty good. You're going to look pretty loyal. You're going to look like you're part of the team, brothers and sisters in arms. And if you don't end up getting paid, which is the lower probability scenario, then you will have ended up wasting time, the ability to make some side hustle money.

But your reputation as a strong team player will live on. People don't forget this, especially during times of crisis. And that will be helpful for your next job, your next career, your next opportunity. The final takeaway from this whole Silicon Valley Bank collapse is that we shouldn't depend on the government to save us.

Even though the FDIC has stepped in to receive Silicon Valley Bank and guarantee those depositors with up to $250,000, we should not rely on anybody to achieve financial independence and to bail us out if we are in trouble. I remember Monday, September 15, 2008, very clearly. Just like now.

It's very interesting. Just like now, there was a lot of smoke and fire about whether Lehman would survive the weekend. And I bet my neighbor, my colleague, Will, $100, saying that, of course, the government was going to bail out Lehman. How could they let contagion continue? And then, of course, on Monday, the government let Lehman fail.

And then Lehman failed, and then the contagion spread, and what resulted in a terrible collapse in the financial markets and the real estate market. It was a clear wake-up call back then to never rely on the government to save you. Financial Samurai was born in July 2009 at the bottom of the global financial crisis.

If there was not a global financial crisis, the site would never have been born. This podcast would never have been started. So that's a bright side for you as listeners and readers if you enjoy this work. And for me as someone who sought financial freedom, this pain that I felt during the global financial crisis motivated me to change.

Before the financial crisis, I just sucked up dealing with all the stress and pain and long hours because I wanted to climb the corporate ladder and make more money. And then when the financial crisis hit and I realized the government wouldn't save me or my colleagues or the industry, I realized I needed to find and develop contingency plans.

I couldn't just rely on my job, one income source to survive and to gain financial independence eventually. I needed to develop alternative income streams, more passive income investments, a side hustle, a side business, whatever it is. I needed to do whatever it took so that I would be secure and my future family would be secure as well.

So if you're feeling some pain from the Silicon Valley bank collapse, embrace it, accept it, and use it as motivation to change for the better. All right, everybody. It's Saturday morning, March 11th, 2023. I got to get out of bed to feed the kids and take the kids to a birthday play date.

Let's hope for the best. Let's hope there is a positive resolution in the coming week where all depositors, innocent depositors get made whole. If you enjoyed this podcast, please share with a friend and leave a positive review. Don't forget to sign up for my weekly newsletter at FinancialSamurai.com/news and please support Buy This, Not That at FinancialSamurai.com/btnt.

I'd love a positive review on Amazon as well. Thanks so much and we will be in touch shortly.