The Treasury Department is right to ensure that investors at Silicon Valley Bank have access to their deposits.

Financial contagion had to be avoided. The data are clear. The share prices of regional banks have dropped by 25% over the past month. Equity investors are terrified of a national run on banks . This matters because SVB was an important part of the venture capital ecosystem. The bank enjoyed rapid growth. Before its collapse, it was the country’s 16th-largest bank. In December 2021, before the equity market correction in emerging technology stocks, the share price of SVB approached $800. To investors, SVB was a high-technology stock. Over 98% of SVB’s stock was owned by very large institutions. The shares owned by those institutions, and all other equity investors, are now worth zero. The principle of moral hazard is being upheld.

What went wrong?

SVB failed because of poor risk management. The COVID-19 pandemic caused the U.S. economy to contract sharply in early 2020. Massive stimulus, monetary and fiscal, was injected into the economy. The financial system was awash in cash. Money flowed into the venture capital system. SVB reaped the benefits of those flows. Deposits soared. Humans are a herd species, and venture capitalists, VCs, are no different. As a herd, VCs chose SVB as their bank. Importantly, almost 90% of the deposits at SVB were above the $250,000 Federal Deposit Insurance Corporation insurance limit. Out of SVB’s $173 billion of customer deposits at the end of 2022, $152 billion were reportedly uninsured, and only $4.8 billion were fully insured. Fully insured deposits are sticky.

For a typical regional bank, uninsured deposits only make up 40% of liabilities. It bears noting here that bank deposits are liabilities. Loans and other financial securities are assets. The major failure of SVB management was to invest nonsticky, institutional deposits into long-dated U.S. treasuries and mortgage-backed securities.

In March 2022, the Federal Reserve raised interest rates by 0.25%. In June 2022, the Federal Reserve started to raise interest rates aggressively, a 0.75% increase. At that time, the management of SVB should have hedged its asset portfolio against a sharp rise in interest rates. The bank did not. The bank was left with a mismatch between its liabilities, nonsticky institutional deposits, and its assets, long-duration assets, which lost value as the Federal Reserve embarked on its aggressive fight against inflation.

As the Federal Reserve withdrew liquidity from the financial system, capital flows into the VC space slowed. VC firms with assets "parked" at SVB began to withdraw their deposits. SVB had a problem. At the beginning of last week, market rumors circulated that SVB had a severe duration mismatch between liabilities and assets. SVB sold assets at a loss. SVB tried to raise capital. It was too late. The VC herd began a run on the bank. The federal government closed the bank.

Still, the Treasury Department was right to move quickly. It had to avoid the risk of a national financial meltdown.

James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes  a daily note  on finance and the economy, politics, sociology, and criminal justice.