On Friday, the Federal Deposit Insurance Corporation (FDIC), shut down Silicon Valley Bank, which caused an uproar in the financial markets and made investors and bank customers nervous. This event is reminiscent of another crisis that occurred in the 1980s, when similar shutdowns took place.

Have you ever played "Liar's Poker"? It’s a classic betting game that was played by bond traders on Wall Street in the 1980s that involves betting on the serial numbers of dollar bills. You start with 2 or more players, each with an equal stack of dollar bills. The bills are put into one stack, shuffled, and dealt back to the players equally. The first player begins the game by making a bid on the number of bills with a certain digit or combination of digits in the serial number. For example, they might bid "two bills with the number '3' in the serial number."

The next player can either make a higher bid or challenge the previous player's bid. If they make a higher bid, the next player must make an even higher bid or challenge. If they challenge, the bills are revealed. To reveal the bills, each player flips over their top bill and reveals the serial number. The player with the highest number of bills that match the digit or combination of digits in the bid wins the round. The winner of the round collects one bill from each of the other players. The game continues with players taking turns making bids and challenging until one player has collected all the bills.

The game has become a cultural symbol of the high-stakes world of finance and has been featured in various books, movies, and TV shows. Michael Lewis's book "Liar's Poker" helped popularize the game and brought it to a wider audience.

Lewis’s book provides an insider's look at the culture and practices of the financial industry during a time of tremendous change and innovation. He describes his time working at Salomon Brothers, a prominent investment bank at the time, where he was trained in the art of "liar's poker”. He also provides an overview of the bond market, explaining how it works and how it was impacted by new financial instruments and technologies.

Overall, "Liar's Poker" is an entertaining look at the world of finance that also gave a unique insight into the causes of the Savings & Loan crisis that impacted the entire country. Lewis detailed how the S&L’s attracted depositors at a higher pace than they found borrowers to make loans to. The young whippersnappers from Salomon Brothers, where Lewis worked, convinced many of those institutions to put that cash into bonds that they sold without explaining the risk of buying those bonds. When interest rates went up, the losses the S&Ls experienced caused many to become insolvent.

Before I dive in to what a 30 year old book has to do with a bank in California, it may be worth taking a step back to explain how bonds work. A bond is simply a loan. You loan the government or a company money by buying a bond. The bond has a stated coupon, or interest rate, as well as a stated maturity date. Most bonds trade in $1000 increments, so if you want to loan the US government $10,000 today, you could buy ten 10-year US Treasury bonds that are currently paying around 3.7%.

If you hold the bonds until maturity, you are guaranteed by the US Treasury to receive your $10,000 back along with $370 of interest every year you own it. If you need your money back before maturity, you can sell the bonds to someone else at the current market price. The market price is primarily decided by where interest rates are since the bond was bought. If interest rates are higher on bonds of similar maturity, you will have to discount the price of your bond that pays a lower interest rate. Conversely, if interest rates are lower, you likely can sell it for more than you bought it for.

The financial term for how sensitive a bond is to interest rate movement is “duration”. I won’t go into the calculation but let’s look at a 10-year US Treasury bought in early August 2020. The coupon would have been around 0.60%, or it paid about $6 for every $1000 invested. The duration of that bond was 9.7 years, which can give a rough estimate for how much the bond price will change with every 1% move in interest rates. A bond with a 9.7-year duration will move inversely around 9.7% for every 1% move in interest rates. Had you bought that bond in 2020, the current price would likely be about 25-30% lower than when you bought it due to the fact that your bond paying $6 is less valuable than new ones paying $37.

All of that is to supply insight as to what caused the Silicon Valley Bank to be closed by regulators last Friday. SVB, as the bank is known, had been very successful at attracting deposits from startups, venture capitalists, and private equity funds. They attracted so much money that they couldn’t loan it all out. Instead, they bought long term US Treasuries and other bonds that earned a little interest while paying less or no interest to their depositors.

Sound familiar?

The FDIC is a U.S. government agency that provides insurance protection to bank depositors in case their bank fails up to $250,000 per depositor, per bank. They require banks to maintain a certain amount of capital versus the loans they make. When some large depositors realized that SVB had made some bad bond bets, they started making large withdrawals because of the losses. The FDIC stepped in to protect the insured borrowers by shutting down further withdrawals.

The problem is that 95% of SVB’s deposits were uninsured.

I think that could be what card sharks call “Sucker Bets”.

Here are 3 smarter approaches:

Keep your deposits < $250,000 at any bank. You can spread around your cash, limiting the balances to no more than $250,000 at any one institution. If you don’t like the idea of keeping track of a several accounts, services like MaxMyInterest.com will do that for you.
Use a money market mutual fund. Money market mutual funds are investment funds that invest in short-term, low-risk securities such as Treasury bills, certificates of deposit, and commercial paper. They are designed to provide investors with a low-risk investment option that can offer higher returns than a savings account or a checking account.
When you invest in a money market mutual fund, you are pooling your money with other investors to create a larger fund that is managed by an investment company. The investment company then uses the pooled funds to purchase a variety of short-term, low-risk securities.
Money market mutual funds typically strive to maintain a stable net asset value (NAV) of $1 per share. This means that the value of each share in the fund will remain relatively constant over time, and investors can buy and sell shares at any time.
While money market mutual funds are not insured by the FDIC, if you use one that sticks to US Treasuries, such as the Schwab U.S. Treasury Money Fund (SNSXX), you are investing in direct obligations with no limits on protection.
Invest directly in US Treasuries. Investing in US Treasuries is considered the most secure way to earn interest. At TreasuryDirect.gov, you can purchase Treasury bills (mature < 1-year), Bonds, and Savings Bonds directly from the US Government. Current rates for 1-2 year maturities are around 5%.
For those looking for more customized solutions, ATX Portfolio Advisors offers cash management services that can exclusively use US Treasuries (or other types of bonds, if appropriate). This could help you better align your portfolio with your cash flow needs while optimizing your return.

If you would like to discuss your cash management, get in touch. It beats playing FDIC poker.