“More Silly-Con Valley” is the title of an interesting article about the Silicon Valley Bank. This should be seen as the types of activities that occur in a regime of perpetual inflation and the use of taxpayer money to bail out bankrupt business.
‘Privatizing Profits and Socializing Losses, Tech Bubble Style
The Wall Street Journal had an article this past week entitled “Tech’s Hometown Bank.” This has convinced me that Silicon Valley has replaced Wall Street as the new epicentre of financial malfeasance and conflict of interest.
The article is about the Silicon Valley Bank (“SVB”). The business model of SVB is to make loans to tech start-up companies which very often have negative cash flow, limited (if any) tangible assets and are financially dependent on successive rounds of fickle venture capital funding. In other words, these are entities that have absolutely no debt capacity and which should be entirely equity financed.
SVB funds these loans overwhelmingly with borrowed money, almost all deposits benefiting from FDIC insurance. The bank reported a ratio of tangible equity to assets of 6.4% at the end of 2014 (see page 51 of these financial statements).
What could explain this seeming madness? The answer is simple: in addition to charging interest on the loans, SVB takes warrants  in its high-tech borrowers. At last count, the holding company of the bank had warrants in 1,625 of these companies.
This means that SVB has perfected the business model of “heads we win, tails the taxpayer loses.” If things go well, the shareholders of SVB cash in on the warrants; if things go badly, the FDIC picks up almost all of the loss.
By playing this game with high volatility tech start-ups, SVB has gone way beyond anything that Wall Street was able to manufacture with the relatively prosaic sub-prime mortgage loans of the financial crisis.
By keeping the warrants in the holding company of the bank, they have even created the theoretical possibility of the bank going under, leaving large losses for the FDIC and the taxpayer, while the shareholders continue to benefit from the warrants. Bravo!
But it doesn’t end there. It turns out that SVB has an active business with the venture capital funds, and very often the personnel of these funds, that provide equity financing to these companies.
The article points out that SVB is often willing to work with its borrowers when they go “off plan” and are unable to comply with their loan agreements – one venture capitalist even praised SVB as “the kindest bank in the business.”
This leniency is hardly surprising, however, when you consider that SVB would be foreclosing on itself, as a warrant holder, and some of its most important clients. And if their tender-hearted banking leads to a greater ultimate loss, well once again, this would be primarily the problem of the FDIC. That is, of you and me.‘
The entire article can be read here.