At time of writing, two of the three largest bank failures in US history have taken place over the span of a long weekend. A collapse of Silvergate bank earlier in the week, predicted by experts and regulators based on its investment in cryptocurrency and following the collapse of cryptocurrency hedge fund FTX, led to bank runs in major cities. On Friday, Silicon Valley Bank, popular with startups and venture capitalists, was forced to close and taken over by the federal government. Over the weekend, Signature Bank, which has marketed heavily to students, apparently suffered the same fate.

How Do Banks Fail?

Bank runs are often thought of as rare in the modern age. They indicate a breakdown in confidence and an asset-liability mismatch. In layman’s terms, this means that a bank owes people attempting to withdraw money that it cannot produce at a given moment. Banks usually keep very little cash on hand, because aside from being dangerous for robberies, money kept on hand means money not loaned out to make a profit. Thus, if everyone decides to collect at once, the bank cannot pay, and the bank fails.

Pre-great depression, this was catastrophic, because anyone who left their money in the bank during a run would be wiped out. This creates a problem, because under those circumstances the best thing you can do when you suspect a bank might fail is to withdraw your money as soon as possible, which encourages others to do so as well, which becomes a self fulfilling prophecy.

Worse still, since banks hold money for businesses and other banks, their collapse means that frequently local businesses are unable to pay employees, and customers are unable to pay bills. At its worst, this turns a single bank run into a broader financial panic and can precipitate a full on recession. This happened during the Great Depression, and a smaller scale version played out in the late 2000s, before the government stepped in.

Thus, after 1933, the Roosevelt Administration created the Federal Deposit Insurance Corporation. Banks pay insurance premiums and in exchange, the government guarantees deposits, that is, savings and checking accounts, up to a maximum amount of $250,000 per person. In addition to preventing individuals from losing everything in a sudden panic, the program was intended to prevent bank runs from happening in the first place, the idea being that since individuals are assured of the safety of their savings, there is no need to join the mob at the first sign of a run.

Of course, there are still problems. While $250,000 may seem like a fortune at first glance, there are many ways individuals can lose money. Large savings for things like retirement, home purchases, or education can easily exceed this sum. Meanwhile payroll for businesses, even small businesses, can go far beyond the $250,000 limit. And while it may be hard to pity anyone getting a quarter million dollar payout, the point is that this is money that is no longer circulating in the economy. It means homes no longer being bought, families working longer into their lives, and potentially employees not being paid on time, or being let go.

Here it is worth noting again that Silicon Valley Bank was popular with small businesses, startups, and investors; that is, those least likely to be covered by deposit insurance and most likely to have impacts on the wider economy. This is why the federal government has been quick to issue statements hours before the opening of stock markets that all deposits will be covered. The federal reserve has made funds available to banks facing liquidity issues as part of its Exchange Stabilization Fund and has hinted that it may reduce interest rates.

So Now What?

On Monday morning as markets opened and financial stock prices plunged, President Biden made a speech from the Roosevelt Room, reassuring the public that thanks to swift and decisive actions taken by regulators, all Americans can expect to have full access to their money, and no further disruption should be expected. Biden underscored that this is not a bailout, stating “No losses will be borne by the taxpayers. Instead, the money will come from the fees that banks pay into the Deposit Insurance Fund.”

The President also alluded to the previous administration’s rollbacks of regulations instituted after the 2008 recession as partly responsible for the bank failure. Notably, the sizes of Silicon Valley and Signature banks place them between tiers, not subject to the oversight of small banks, nor the catastrophic “stress testing” of large banks, a requirement which was rolled back to only large national banks under the Trump administration.

Details are still being investigated by federal regulators, which Biden affirmed would lead to accountability of upper management if regulations were violated. Information already provided by the FDIC and previous filings suggests that although assets held by the bank were well above the amount of deposits as of the beginning of the year, making a failure due to a bank run unusual. Analysts have speculated that the assets in question were likely composed of long term treasury bonds, which cannot be easily converted to cash, and though safe against losing money, are not adjusted for inflation or interest rate hikes, as have been seen the past several years.

The Federal Reserve Board of Governors convened a closed door emergency meeting on Monday. At time of writing, stock and commodity markets continue to fluctuate in response to the atmosphere of uncertainty, with volatility indices spiking. The wider and lasting impact of the bank failures, and the conditions that have apparently brought back the bank run, remain to be seen, with investors and consumers seemingly waiting for signals. The February report on the Consumer Price Index, which measures inflation on consumer goods, is due to be released before markets open Tuesday, March 14, 2023, while the Federal Reserve Board of Governors is next due for a scheduled meeting on March 21, 2023.