The factors behind Silicon Valley Bank's collapse

GEOFF BENNETT: This was the first of two days of hearings about the failure of Silicon Valley Bank, and the role of federal regulators in all of this.

We will hear more in a moment about how lawmakers from both parties criticized top officials today, but, first, let's break down some of the basics behind the second largest bank failure in U.S. history.

Economics correspondent Paul Solman is our guide.

PAUL SOLMAN: The collapse of Silicon Valley Bank.

First, what happened?

DANA PETERSON, The Conference Board: SVB is a large bank that essentially failed.

And why, I asked economist Dana Peterson.

DANA PETERSON: First of all, it was highly concentrated in an industry, the tech sector, that's really not doing that well right now.

PAUL SOLMAN: And the depositors were?

DANA PETERSON: Many of the folks who were invested in SVB were very high net worth individuals, meaning they had tons of money.

And you also had a number of start-up companies in the tech sector.

So you had companies that need money for payroll and cash.

PAUL SOLMAN: Of course, banks usually love such depositors.

But SVB didn't have enough corporate or individual borrowers to loan the money to.

What does a bank do then?

SIMON JOHNSON, MIT Sloan School of Management: You can lend to the government.

Uncle Sam and Auntie Sammy are very happy to borrow from the public.

And they paid decent rates of interest.

PAUL SOLMAN: Interest on Sam and Sammy's IOUs, that is, their government bonds.

But that was a few years back.

Then the tech sector turned sour, and the depositors had to start withdrawing their money.

To come up with the cash, SVB had to sell some of those bonds.

Guaranteed safe by the government, but, says Johnson: SIMON JOHNSON: Problem is, Paul, there is interest rate risk, which means, as interest rates go up, the value of the bonds go down.

PAUL SOLMAN: This is often confusing.

So, I asked, why, when interest rates go up, does the value of bonds go down?

SIMON JOHNSON: It is the value of the old bonds, the bonds that were issued at a previous interest rate, Paul, because now the government is borrowing, paying a higher interest rate.

PAUL SOLMAN: Now, I thought this might benefit from a bit of show and tell at the Treasury itself, simple when you stop to think about it.

The bank had bought billions of dollars of U.S. Treasury bonds at a low rate of interest.

Suddenly, it had to sell some to come up with the cash to pay off fleeing depositors.

Meanwhile, interest rates had gone up.

Today's bonds are paying a much higher rate of interest than these.

So which would you rather have?

Obviously, this one, which means this one's worth less.

The price goes down, the bank loses money and, says Simon Johnson: SIMON JOHNSON: Depositors thought about that, noticed it in some fashion, and decided to pull out even more money.

PAUL SOLMAN: And that's what happened?

SIMON JOHNSON: And then the run was on.

JIMMY STEWART, Actor: All right now, what happened?

How did it start?

THOMAS MITCHELL, Actor: How does anything like this ever start?

All I know is the bank called our loan.

JIMMY STEWART: When?

THOMAS MITCHELL: About an hour ago.

I had to hand over all our cash.

JIMMY STEWART: All of it?

THOMAS MITCHELL: Every cent of it.

JIMMY STEWART: Now, just remember that this thing isn't as black as it appeared.

SHEILA BAIR, Former Chair, Federal Deposit Insurance Corporation: It's a classic Jimmy Stewart story in "It's A Wonderful Life."

PAUL SOLMAN: As former FDIC Chair Sheila Bair told Geoff last week: SHEILA BAIR: We have all seen that, right, when the depositors went in and ran the bank and the money had been invested in mortgages.

They didn't have all the cash.

No bank does.

Every bank lends out some of their deposits or makes investments with some of their deposits.

ACTOR: I will take mine now.

JIMMY STEWART: No, but you're thinking of this place all wrong, as if I had the money back in a safe.

The money's not here.

SIMON JOHNSON: The bank has made loans.

If the depositors are withdrawing their money, either you call in the loan or, if you can't do that, you can't pay the depositors.

Either way, the bank is in serious trouble and may not survive.

PAUL SOLMAN: So, then who done it?

Well, several suspects, SVB taking more deposits than they could profitably put to work and putting them all in one basket, long-term bonds, quick-trigger depositors, inflation that hiked interest rates, killing the value of long-term bonds and say, the likes of Senator Elizabeth Warren, loosening regulation starting back in 2018.

SEN. ELIZABETH WARREN (D-MA): We need to learn from what has just happened with these banks and go forward by tightening the regulations.

It's just that simple.

PAUL SOLMAN: Simon Johnson agrees.

SIMON JOHNSON: I think loose regulation was very important, in part because -- and this is what was said by the top Fed officials at the time -- it changed the tone of supervision.

And Silicon Valley Bank was clearly very poorly supervised.

PAUL SOLMAN: So what's the fix?

David Wessel from the Brookings Institution.

DAVID WESSEL, Brookings Institution: The fix was that the Federal Deposit Insurance Corporation, with the permission of the Treasury secretary, invoked a special provision of law and said that they would stand behind the deposits of every depositor at Signature Bank and Silicon Valley Bank, even if they had a lot more than $250,000 in the bank.

JEROME POWELL, Federal Reserve Chairman: Good afternoon.

PAUL SOLMAN: And the Federal Reserve also rode to the rescue.

JEROME POWELL: You have seen that we have the tools to protect depositors when there's a threat of serious harm to the economy or to -- or to the financial system.

And we're prepared to use those tools.

And I think depositors should assume that their deposits are safe.

PAUL SOLMAN: So we're at the Federal Reserve.

What's the Fed's role in all this?

DAVID WESSEL: The Federal Reserve is a lender of last resort.

So when the banks got in trouble, they lent hundreds of billions of dollars to the banks.

PAUL SOLMAN: OK, the key question, what's the future hold?

DAVID WESSEL: The economy was already slowing down, partly because the Federal Reserve has raised interest rates a lot.

But now the banking crisis is probably going to slow it further.

Banks are going to be more reluctant to lend.

That means less borrowing and less spending in the economy.

PAUL SOLMAN: But that's what the Fed wanted to begin with, slow down the economy.

DAVID WESSEL: Absolutely.

As Jay Powell, the Fed chair, said in his press conference the other day, the credit crunch that's caused by the banking crisis is some way going to substitute for interest rate increases.

PAUL SOLMAN: And thus, concludes Wessel: DAVID WESSEL: The Fed won't have to raise interest rates so much.

PAUL SOLMAN: Because the banking crunch may or may not squash inflation its own.

For the "PBS NewsHour," Paul Solman in Washington.