The U.S. federal government only insures bank deposits up to the amount of $250,000—under normal circumstances. But the failure of Silicon Valley Bank (SVB) last week triggered an extraordinary intervention, with Washington guaranteeing all deposits in full. It was an acknowledgment of the possibility that SVB’s failure might have produced a cascade of bank runs across the financial system—and also a reflection of the special status of the bank’s community of depositors, centered on California’s tech economy.

What role did the tech economy play in SVB’s failure? How could the bailouts affect the fight against inflation? And does the U.S. government simply make up the rules of financial bailouts as it goes along? Those are a few of the questions that came up in my recent conversation with FP economics columnist Adam Tooze on the podcast we co-host, Ones and Tooze. What follows is an excerpt, edited for length and clarity.

For the full conversation, look for Ones and Tooze wherever you get your podcasts.

LISTEN HERE: For the entire conversation, and episodes in the weeks ahead on this subject and others, follow Ones and Tooze wherever you get your podcasts. 

Cameron Abadi: To what extent exactly was Silicon Valley Bank’s failure about the bank’s own mismanagement versus the Federal Reserve’s interest rate hikes of recent months? Or is there another factor entirely that I’m overlooking here?

Adam Tooze: Both those factors—Silicon Valley Bank’s mismanagement and the Fed’s interest rate hikes—do play a key role. But there’s a third factor here, because this was a bank run, and that’s the depositors. So the question here really is what is the behavior of the people who put their money in the bank, and what motivated them to do this?

Or you could view this from the bank’s side: How on earth did they imagine they could run a bank with the sort of quality of deposits that they had? If you take well over $100 billion in deposits from businesses that were basically just choosing to put the big checks they’re getting from venture capital or, indeed, loans from your own bank into the bank account, then that money is much more unstable than regular deposits. And what makes this even more terrifying is that these big lumpy deposits that you had that were super flighty were themselves under the influence of an even smaller group of venture capital rainmaker influencers in Silicon Valley. So it’s almost as though you’re running a bank with the deposits from a flighty, skittish high school playground. And one moment, the top five or six kids, the most fashionable, the most popular kids are saying, “We put our money in the bank.” And the next moment they’re saying, “No, it all has to be yanked. It’s got to go somewhere else.”

So it’s a totally toxic depositor side, which the bank, then, astonishingly, decided to invest in U.S. treasuries, which by itself is not a crazy plan, because treasuries are safe. If you’re going to match your deposits with American government assets, you’d just think they’d go into short-term government assets, which are particularly liquid. But instead, they took long-term government assets. And that really matters, because they’re particularly vulnerable to interest rate changes. And as interest rates go up, the value of the bonds goes down, because the bond is a promise of the government to pay a certain rate of interest on $100 or $1,000 or whatever. And as the general level of interest rates goes up, of course, any given promise of that type goes down in value relative to what the new level of interest rates is. And so they suffered losses on these, which were predictable. If you think that this huge surge happened in 2021, the only way interest rates were going to go from the level that they were at was up, which meant that you were exposed to risk. And you would expect the bank to hedge, and they didn’t hedge it.

So this was absolutely an accident waiting to happen. And it’s a combination of quite strange behavior by the depositors, very bad management on the part of the bank and the, I think, culpable negligence on the part of the regulators.

CA: What exactly is the relevance of the Silicon Valley part of this? What is distinctive about this cluster of businesses that comprises the U.S. tech scene, and how did that contribute to the bank failure?

AT: I think what it reveals is that it’s an astonishingly incestuous network of relationships, which at one level are quite unbusiness-like in their approach to money, because ultimately I think they think money’s cheap. And really the thing to do is just get the money together and then throw it at what really matters, which is the technological innovation. And so the less time you spend worrying about boring, mundane things like cash management and the stability of your bank and so on, that’s very, very, very old economy. And, you know, the hot news is really the latest tech innovation, where you get your best engineers from and so on, how you grow your market. And I think it reflects all of that.

I mean, sociologically speaking, I think you might say that what the bank and the other players in the system were all prioritizing is networking. What they’re above all prioritizing is the fact that their venture backers, the bank itself, their competitors, rivals—and, just in general, the ecosystem that they’re in—all use this facility. And that’s why you use it. And it would be strange to say, “Oh, no, I’m going to take my pot of money from some fancy venture capital firm and put it in a regular old bank like Bank of America” or something like that. That would just be sort of odd. It would be countercultural in a way.

CA: The government’s response here has been to assure all the depositors that they’re going to be made whole, which is contrary to its own standard rules about bank insurance. So what explains the government’s actions here—does the government just make up the rules as it goes along in a crisis like this?

AT: I mean, it can look like that, except that almost all of the rules governing the FDIC, the Fed, and the Treasury have an exception clause built in. They literally have a rule saying that in exceptional situations, you can suspend the ordinary rules. So the FDIC, in the event of systemic risk to the entire financial system, can provide insurance for more than just the $250,000. That’s how that exception is framed. It has to be exceptional circumstances, and then the levy is on the entire banking system. The Fed, under the famous 13.3 clause of the Federal Reserve Act, can also declare a systemic exception a crisis. But the facilities that it offers now have to be offered to all banks in the system. So it can’t any longer simply do a special purpose deal for a particular bank.

CA: Don’t bailouts of this kind contradict the entire policy of fighting inflation? I mean, how else is the Federal Reserve’s rise in interest rates supposed to have an effect on inflation other than through negative events like bank failures?

AT: Yes, this is an absolutely fundamental question. You put it very well. There is indeed a contradiction here. I mean, a lot of us have been asking the question for a while. The phrase was, what will bend and what will break? And the question was, you know, how far can the Fed and all the other central banks navigate a soft or reasonably hard landing, which is bending the economy, bending societal resistance to austerity and fiscal financial pressure. And at what point do they endanger institutions in doing so? And something rather important has broken at the heart of the very important tech sector in the United States economy.

We’ve seen others—you know, the funding of Sri Lanka. Pakistan’s in terrible trouble right now. The world is full of crises. This is just the one that’s hogging the headlines. And the really stark thing that’s exposed here is the disparity, the huge contrast in the way in which, as you say, this deflationary exercise is discussed, because we were OK, to put it crudely, with a certain sort of unemployment. We were OK with a certain sort of job loss. And after all, there were job losses ripping through the tech sector. But that conversation was all very well. Right? The institutions remain intact. The banks, the businesses all remain intact. They just laid workers off. And the question is exactly how much unemployment do we need? But when it comes to this moment where what’s on the line are both jobs and the viability of businesses, what was feared, after all, was that businesses would basically have to shut because they couldn’t access their accounts. Then all of a sudden it’s an exception, and we have to do something about it.

And so this reveals a kind of double standard, if you like. A bank in the Silicon Valley Bank case, which has 97 percent business customers, why are they getting this kind of special treatment when the entire aim of policy was, in fact, to ensure the right level of unemployment to bring inflation down? What we’re really discovering at this moment is that the interest rate necessitated by the anti-inflationary push might be more than the banking system can stand. In a sense, another way of formulating all of this is that the risk of a hard landing has gone up.

CA: Are there any other financial institutions in the United States or elsewhere in the world that we should be thinking of as especially vulnerable to the rise in interest rates?

AT: There’s a lot of pain out there, because there is $23 trillion of U.S. government debt out there, broadly speaking. And all of that has been devalued. Last year was the worst year ever in the history of the bond market. Huge losses. The key word here is unrealized losses, because if you don’t have to sell the bonds, and you hold them to maturity, there’s even an accounting clause you can invoke to park these assets on your balance sheet as what’s called non-marketable. In other words, you promise basically not to sell them until they reach maturity. And these are bonds, so they’ll pay off in due course and then you’ll get the full value of the bond back. So you will never actually make the loss.

But allowing for these accounting fiddles, there is a lot of loss out there. I mean, at one point the losses in the American banking system were estimated to be $620 billion. The question is whether you have to sell. You only have to sell if you need liquidity, if you need cash quick, and you only need that as a bank if you’re facing some sort of liquidity run. And that’s what happened to Silicon Valley Bank. But if you look across the other American banks, Bank of America is the one that stands out as having particularly large losses. Barron’s had a report saying they had losses up to about $120 billion—unrealized, important—and Bank of America is not facing a bank run. In fact, Silicon Valley depositors ran into Bank of America, put money into the bank. But were it to come under pressure, it would be in real trouble.

And there is an example of that precise problem in the global financial system right now. Credit Suisse has now gone into crisis. Now, Credit Suisse is the no. 2 big global bank in Switzerland next to UBS. It was once in the top 10 easily of global banks, and it has suffered a series of scandals—Bulgarian mafia, various other types of accounting irregularities. It’s really been a can of worms. And it has very high-end clients, because these two Swiss banks pride themselves as being a little bit like Silicon Valley Bank, you know, banks where very rich people put their money. And they have paid the price. Over the course of the last six to 12 months, they saw a very substantial withdrawal of very large deposits.

And at some point, then you face the question of where you’re going to get liquidity, where you’re going to get cash. And then they found themselves sitting on the large portfolio of bonds. And the Swiss National Bank, literally overnight from Wednesday to Thursday of this week, declared that it would provide liquidity to Credit Suisse. And what that means is exactly what the Treasury and the Fed are doing for the American banking system, which is to buy debt off their books, buy bonds off their books, and give them cash in exchange to the tune of like $50 billion for this one bank, Credit Suisse.

So the combination of the loss with the necessity of actually facing that loss, which is produced by a sudden liquidity squeeze, that’s the really toxic element here. And the confidence shock is operating now across the entire financial system.