Bank Runs, Now & Then

Silicon Valley Bank, the 16th biggest bank in the country, was closed on Friday. It was the second-biggest bank failure in U.S. history.

As recently as November 2021, the market cap of the company was more than $44 billion. That equity is now essentially worthless.

There is a lot to this story but it really boils down to an old-fashioned bank run. A flood of withdrawals from depositors destroyed the bank.

If everyone with a Planet Fitness membership showed up at the gym at the exact same time there would be chaos at the squat racks. It would be impossible for anyone to work out and the gym model wouldn’t work.

The same thing applies to banks. If everyone goes to get their money out on the same day, it’s going to be hard for a bank to survive.

There could be plenty of different ways this plays out but I find myself captivated by the process of a bank run.

The SVB ordeal caused me to revisit my old copy of The Panic of 1907 by Robert Bruner and Sean Carr.

It’s a wonderful account of one of the biggest and most influential financial crises in history.

The Panic of 1907 would probably be more famous if it wasn’t overshadowed by the Great Depression just a couple of decades later.

It lasted 15 months and saw GDP decline an estimated 30% (even more than the Great Depression).

Commodity prices crashed. Bankruptcies exploded. The stock market fell 50%. Industrial production dropped by more than at any time in history up to that point. The unemployment rate went from 2.8% to 8%.

Trust in the financial system went out the window as banks failed left and right. In October and November of 1907 alone, 25 banks and 17 trust companies went under.

John Pierpont Morgan more or less single-handedly saved the U.S. banking system by being a one-man central bank when none existed at the time.

He not only bullied the other banks into putting money in the system to save many of the failing banks but helped slow the pace of bank runs by instructing bank tellers to count out money as slowly as possible to stem the tide of withdrawals (it actually worked).

The banking system is more electronic today so that strategy wouldn’t work anymore. There was a financial institution in 1907 that experienced a “silent” bank run that took place over the course of 4 months.

Silicon Valley Bank basically went under in 24-48 hours once word spread that they might be in trouble.

The free flow of information today is one of the biggest differences between now and the Panic of 1907. There was also no Federal Reserve of FDIC insurance back then.

I’m not banking on a system-wide calamity the likes of 1907 this time around (fingers crossed) but there are some psychological similarities between the bank runs of the early 20th century and what we saw this week.

Bruner and Carr laid out 7 reasons the Panic of 1907 was a perfect storm for bank runs and a massive financial crisis:

1. Complexity. Complexity makes it difficult to know what is going on and establishes linkages that enable contagion of the crisis to spread.

2. Buoyant growth. Economic expansion creates rising demands for capital and liquidity and the excessive mistakes that eventually must be corrected.

3. Inadequate safety buffers. In the late stages of an economic expansion, borrowers and creditors overreach in their use of debt, lowering the margin of safety in the financial system.

4. Adverse leadership. Prominent people in the public and private spheres wittingly and unwittingly may implement policies that raise uncertainty, thereby impairing confidence and elevating risk.

5. Real economic shock. An unexpected event (or events) hit the economy and financial system, causing sudden reversal in the outlook of investors and depositors.

6. Undue fear, greed, and other aberrations. Beyond a change in the rational economic outlook is a shift from optimism to pessimism that creates a self-reinforcing downward spiral. The more bad news, the more behavior that generates bad news.

7. Failure of collective action. The most well-intended responses by people on the scene prove inadequate to the challenge of the worst crises.

Again, not exactly like 1907 but this run on the bank seems to check all of the boxes in its own way.

The bizarre thing about the banking sector is it’s a faith-based system. Sure there are assets and liabilities, checks and balances, rules and regulations but trust plays a larger role than most people think.

Bank runs themselves are about a loss of faith and trust but they’re difficult to explain because of the psychological component involved.

Two economists took a stab at explaining why bank runs happen and concluded they’re kind of random. Depositors are worried a financial shock will cause a lengthy liquidation so they pull their money en masse.

But what sets them off?

People being people, I guess?

There was an infamous story of a bank run in Hong Kong that was caused by a long line in front of a pastry shop that just so happened to be right next to a bank. People assumed the line was for depositors taking their money out of the bank, word spread and soon the bank run was on for no other reason than the herd mentality.

George Charles Selden published a book in 1912 called The Psychology of the Stock Market that feels like it could have been published yesterday. He tackled the psychology behind booms and busts and how the Panic of 1907 fits in:

Both the panic and the boom are eminently psychological phenomena. This is not saying that fundamental conditions do not at times warrant sharp declines in prices and at other times equally sharp advances. But the panic, properly so called, represents a decline greater than is warranted by conditions, usually because of an excited state of the public mind, accompanied by exhaustion of resources; while the term “boom” is used to mean an excessive and largely speculative advance. There are some special features connected with the panic and the boom which are worthy of separate consideration. It is really astonishing what a hold the fear of a possible panic has upon the minds of many investors. The memory of the events of 1907 has undoubtedly operated greatly to lessen the volume of speculative trade from that time to the present.

Panic was a word that was used more frequently in the 1800s and early-1900s. Today we just have recessions. Back then things got so bad that they were either called depressions or panics.

Never say never, but it’s hard to believe the bank run we saw this week will lead to a 1907-like panic.

But it’s worth noting how the one constant across all economic environments is human nature.

Booms, busts and bank runs will always occur because people are people.

Further Reading:
In the Markets Nothing is as Dependable as Cycles