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IN THE WEEK SINCE Silicon Valley Bank (SVB) failed, a debate has raged: Did the government do the right thing when it decided to guarantee all of SVB’s depositors, including those that exceeded FDIC limits?
On one side of this debate are those who view the government’s action as an inappropriate and undeserved bailout. In an article titled “You Should Be Outraged About Silicon Valley Bank,” The Atlantic argued that the bank’s failure was the predictable result of incompetent risk management. Critics further cite a reality of human nature: If bank executives are confident the government will step in to pick up the pieces every time something goes wrong, they won’t be as careful in managing risk. Economists call this “moral hazard.”
On the other side are those who think the government did the right thing. They point to the fact that the crisis was quickly contained, and at a cost that will likely be insignificant. Not surprisingly, the loudest voices in this camp came from Silicon Valley. Before the government stepped in, one venture capitalist warned of a “startup extinction event” if SVB were to fail. He urged the Federal Reserve to, as he put it, “bearhug the situation,” but also argued that this should not be characterized as a bailout and would not create moral hazard.
For better or worse, the crisis was contained, and everyone is now breathing a little easier. But it’s worth asking what we can learn from this incident. I see five lessons:
Rule No. 1 of investing. In a letter to my clients last weekend, I commented that, when it comes to our finances, there’s always something to worry about. Beyond the stock market, which everyone understands to be volatile, investors have lost sleep over investments which are usually perceived to be far safer.
For instance, three years ago, at the start of the pandemic, there was widespread worry about municipal bonds. Earlier this year, with another government shutdown on the radar, investors began discussing the unlikely possibility of a default on Treasury bonds. And despite their infrequency, the failure of SVB, along with that of Signature Bank, serves as a reminder that even the safest instrument available—a bank account—can carry risk.
Fortunately, there is a solution, and it’s an easy one: diversification. It’s not only the simplest tool in an investor’s toolbox, but I believe it’s also the most effective. Back in 2018, I suggested several ways to diversify so as to protect against so-called unknown unknowns. As an example, I cited the 2003 blackout that hit New York City. Among the effects, ATM and credit card networks went offline. For those without cash to purchase groceries, it was a difficult situation. While it was temporary, these are the sorts of black swan events that can occur. That’s why I recommend diversifying along as many dimensions as possible to guard against whatever the next financial curveball turns out to be.
Rule No. 2 of investing. When it comes to managing our finances, many things are outside our control. That’s why it’s even more important to control what we can. SVB customers whose balances exceeded FDIC limits are lucky the government came to their rescue, but they wouldn’t have needed that support if they’d taken even the simplest of steps.
Have more than $250,000 in an individual account or $500,000 in a joint account? The easiest thing is to open an account at another bank to double your coverage. I know folks who maintain three or four separate accounts. It’s not hard, and yet there are solutions that are even easier. You could open an account with a bank that participates in the IntraFi Network. If you need to maintain large cash balances, an IntraFi bank will automatically split your cash up among multiple banks, with none exceeding FDIC limits. From the customer’s perspective, it’s as easy as opening a single account, but it provides virtually unlimited coverage. A service called Max provides a similar solution, but with an added feature: As banks raise and lower their interest rates, Max will automatically shift balances around to maximize customers’ income.
Those are two simple bank-based solutions. If you don’t mind a tiny amount of inconvenience, you could move excess cash into a brokerage account, where you could invest in a money market account that holds only Treasury bills. That would provide both more interest and essentially unlimited government backing.
Not so smart. In finance, there’s the concept of the “smart money.” I’ve never liked this term, and the Silicon Valley mess illustrates why. Even people who are knowledgeable and experienced—like SVB’s clientele in the venture capital community—can make mistakes.
In the aftermath of SVB’s failure, some have pointed out that the bank’s risks were hiding in plain sight. One observer, for example, was making the case on Twitter as far back as January. The average banking customer might not have followed his arguments, but certainly venture capitalists should have been paying attention. The implication: The notion of smart money is a myth.
Recency bias. Why did so many of SVB’s customers ignore the risk when their accounts exceeded FDIC limits? If you asked them, my guess is they’d say that the risk of a bank failure seemed remote—like the sort of thing that might have happened back in the 1930s, but not today. That complacency is understandable. Outside of recessions, bank failures are rare. But this episode reminds us to be careful of what psychologists call recency bias. Just because something hasn’t happened recently doesn’t mean it won’t.
Reputation. For decades, Silicon Valley Bank was “the” bank for Bay Area elites. Similarly, First Republic Bank, which is teetering, has cultivated an image as the banking destination for the well-heeled. Its ads feature photos of sophisticated-looking customers, including tech founders, heirs, artists and the like. But outward appearances were deceiving, as we’ve all now learned. Silicon Valley and First Republic, it turns out, were much better at marketing than at banking.
With the benefit of hindsight, we know this. The problem, though, is that P.T. Barnum-like characters inhabit every industry, and they’re difficult to identify in advance. Last year, I described “the storyteller’s toolbox,” with some recommendations on how to spot—and hopefully avoid—financial hucksters. Ultimately, though, I’ve only found one solution to this problem: to keep one’s financial life as simple as possible.
That’s why, whether an investor has $30,000 or $30 million, my advice is the same—to maintain a simple portfolio of low-cost index funds and Treasury bonds, and to assiduously avoid anything more complicated than that. That, I believe, is the best formula for virtually every investor.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.
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Nice article! The debate over bail-out vs bail-in seems moot to me. What’s the fungible difference between deposits evenly distributed in $250k/$500k chunks throughout the banking system and the government declaring all deposits covered? And now banks have the BTFP facility
My recurring bills are automated thru a brick & mortar FDIC account.
Daily expenses such as food, fuel and fun are handled by an IntraFi account at a completely different type of TradFi institution that also has brick & mortar locations. The risk of a payment card outage is mediated by cash in a fire safe. Some might think keeping cash on hand is crazy and , of course, that’s true right up until it isn’t☺
Adam, this was a most excellent article. Thank you!
Kudo to Adam on this insightful article. In the end, it’s all about risk management.
Timely article. The Fed, along with other central banks, acted a few hours ago to shore up the banking system.
https://www.reuters.com/business/finance/fed-other-central-banks-set-joint-liquidity-operation-2023-03-19/
Adam, I echo below sentiments from Wm Perry, and send thanks too. Marjorie
Thanks for this Humble Dollar article. I signed up for your Daily Ideas emails about two months ago and enjoy reading them. For those who are not signed up for your emails those emails often include links to the source documents which mirror your Humble Dollar articles.
Thanks, Bill
How much of the SVB failure was directly related to an ESG philosophy and/or only having one director with any banking experience…probably more than the readers here will dare admit.
Mik, I’d appreciate it if you avoided politicizing financial issues in the comment section. There are plenty of sites where you can express your political opinions. Please don’t include HumbleDollar on that list.
Jonathan…In what way are my comments perceived to be political?
Adam’s article is about personal finance. Is your comment about personal finance? No. You’re trying to score political points.
Well that was predictable…and wrong.
“directly related to an ESG philosophy”???
You’ve told me where you get your “news” without telling me where you get your “news.”
Why is asking questions offensive to you?
Because you didn’t even ask a question. Nice try.
The words “How much” imply a question, whether you like the question or not.
If you are a company with more than 100 employees, you have little choice but to have a large bank account. Every day, you pay out and take in millions of dollars in the course of ordinary business.
I worked at Chase in the 80s – I handled the IT systems for the Met Life account. They kept $10 billion in their accounts, and every day they paid out hundreds of millions in claims. I would imagine that they thought Chase was a pretty secure place to keep their money.
‘The notion of smart money is a myth.’ You got that right. I learned this the hard way with my daughters’ college funds which were mostly in Dodge & Cox mutual funds. The non-smart money guys there lost more than 68% in the GFC (2007-2008). I’ve been totally self directed since then and couldn’t be happier with the results.
I don’t suppose billionaire Peter Theil reads the Humble Dollar, perhaps he should and if he did, he wouldn’t have to call in his favors that protected his lost $50 million dollar investment in SVB.
Chump change for Peter Theil.
https://www.propublica.org/article/lord-of-the-roths-how-tech-mogul-peter-thiel-turned-a-retirement-account-for-the-middle-class-into-a-5-billion-dollar-tax-free-piggy-bank
Numerous banking organizations are in crisis mode. I’d suspect all are myself in the current international mini banking crisis.
It also suggests a risk laden international banking condensation.
Just a few as you suggest in the USA Adam SVB, First National Republic(Chap.11), Signature, & others same sized as well as internationally Credit Suisse, & the ever stable Swiss franc became part of the bail-in. In New Englands area alone I suspect many have been contacted about several area banks mergers & acquisitions, akin to the 80s.
A local financial institution I’m in bought or merged (its lawyers statements questionable) with a competitor, making it stronger.
Financial Times, Forbes, CNN, World Economic Forum, all have enlightening opinions and facts as well as this sites contemporaneous input I’d equate to the named above’s input.
Concentration has enormous risk, everything has risk, when all risk is gone, thats all thats left.
Adam, thank for your back-to-the basics article. It did strike a cord.
I am reminded of the phrase “know yourself first…” This desire for more that is so deeply rooted has lead me astray. Whereas I started with all index funds, over time I pepper my allocations with other types of investments only to discover reasons for regret later.
My childhood hero Bruce Lee is credited by saying he wasn’t afraid of someone who practiced a thousand techniques, but someone who practiced one technique a thousand times. I should know by now the index fund is the one.
Message to me: Observe yourself ….stop mucking around and stay the course ! Smart money be damned!
On the topic of treasuries, I feel I did something right, but only in retrospect. Years ago when iBonds first came out we were able to buy $30K per year. I purchased them for several years for downside protection. I just started a family and what if I got laid-off and the market also tanked? For years though I held self-doubt. Did purchase too much? Shouldn’t I have purchased more equities at that age per the text books?
So now almost two decades later, my iBond holdings have grown and become the bedrock of my portfolio. They’ve allowed me to hold more equities and stand firm in the face of today’s challenges.
Lesson lived for the meek (me): Build that solid foundation first then invest more into equities.
Anything could happen. War in Europe, a global plague, death of a loved one and banks imploding yet again.
Through your article I am reminded that by being prepared with things I can control, I’ll be in a better position to live out each day with less stress and distraction whatever happens.
Kind of scary to have iBonds becoming the bedrock of ANY portfolio, trying to match inflation is a peculiar goal at the individual level.
Great article, Adam. I liked “to guard against whatever the next financial curve ball turns out to be.” Your suggestion for one account will help me help my mother, she likes her cash. This could be viewed as an after-the-fact I told you so piece—except that you, and Jonathan, have been “telling it” long before it happened.
Edmund…Vanguard has a U.S. Treasury money market fund paying 4.58%as of 3/17. If your mother likes cash. Has checkwriting privileges.
VUSXX. Free of state taxes too.