3 Mistakes to Avoid When You’re Swamped with Good Fortune

"Silicon Valley Bank - Tempe, Arizona" by Tony Webster is licensed under CC BY 2.0.

Too much of a good thing can become a bad thing.

Just ask Silicon Valley Bank (SVB).

Not gonna school you on FDIC insurance, why big-shot Silicon Valley Venture Capitalists act like lemmings, or god forbid, the disastrous consequences of an asset/liability mismatch.

Nope. I’m gonna talk about how not to get mugged by good fortune.

The tsunami of liquidity created in 2020 by the Fed in reaction to the pandemic meant cheap money floated a lot of speculative boats. VCs and start-ups made hay, and SVB, their bank of choice, saw its deposits TRIPLE from 2019 to 2022.

That would be a good thing that became a bad thing.

Banks make money by taking your deposit and investing the money in something that yields more than they have to pay you in interest. (a.k.a. “The spread” or Net Interest Margin (NIM)). It’s normal that what they invest in, e.g., loans or treasuries, have a longer time horizon than your deposit, which you can take out at will.

The assumption is that not everyone will take their money out at the same time, and so as long as there’s enough ready cash (or equivalent) at hand to meet those routine withdrawals, no problem.

Back to SVB – here’s how it all began.

SVB had a flood of deposits, nowhere compelling to invest them, and Wall Street overlords who expected them to make a spread.

Something had to give.

The very conditions that brought SVB abundant deposits (easy money, a.k.a. low interest rates) were the conditions that made earning a healthy return on those deposits difficult. To generate a return investors would applaud, SVB had to take on more risk. As a general rule, the higher the return earned, the greater the risk taken.

Banks have a menu of risks they can choose from: leverage (debt), credit, or investment risk (e.g., for bonds, a longer time horizon). Take my word for it. (But if you’re a nerd who wants more info, hit reply, and I’ll fill you in.)

SVB chose “safe” from a credit risk perspective but “unsafe” from an investment risk perspective, long-dated U.S. Treasuries (government debt). Because fixed-income prices go DOWN when rates go UP, the value of SVB’s investment portfolio was going down at the worst time possible, when the flow of deposits turned negative.

They had a liquidity problem that morphed into an insolvency problem.

You may think that a bank’s woes contain no useful insights for your finances or your business, but that’s not so. Here’s what you can learn.

Three mistakes that Silicon Valley Bank made:

Mistake number 1: Assume that current conditions, especially when extreme, will last forever. 

When times are bad, you look forward to when they get better.

But when they are good, you get seduced into believing they’ll last forever and become less vigilant.

You focus on harvesting good fortune to the exclusion of everything else. You optimize your behavior/systems/processes for the good fortune you believe will be permanent.

This makes you or your business less resilient. Because it’s been so optimized for the good times, it can’t handle the bad ones gracefully.

It makes you complacent about the risks growing in the shadows.

Mistake number 2: Don’t stop trying to keep the overlords happy.

Sometimes you can’t keep everyone happy. When rates are low, and deposits are pouring in, banks will struggle with their net interest margin. That’s just financial physics.

The Street can be insatiable about growth, and sometimes the only way to deliver that growth is to try to pretend the financial equivalent of gravity doesn’t exist. 

You can’t. Gravity always wins. 

SVB’s mistake was in trying to meet unrealistic expectations, by piling on risk and buying way too much long-dated treasuries, just to eke out a bit more in earnings.

Mistake number 3: Don’t forget to check ALL the risk boxes. 

The risk you forget to manage is the risk that will bite you in the ass.

Risk is alive and dynamic. It’s always present and always changing. Risk ebbs and flow like clouds in the sky. It changes based on the constantly changing environment in which it exists.

Your risk checklist is never one and done.

This isn’t a bad thing. Dance with risk. Play with risk. Risk is what escorts good fortune into your house. 

Managing risk entails questions like “Am I getting the proper return for this risk?” “Are the probabilities of these risks coming to pass changing – are they more or less likely to happen?” “What magnified or reduces the impact of the risks taken?”

In the end, it’s all about seeing things as they are, knowing they will change, and staying true to your course.