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.
Tech start-up valuations keep climbing into the stratosphere, thanks to the Fed’s EZ money. So there is money in them thar hills! Very tempting, so how van we get at it using other people’s money? Silicon Valley has the answer.
SVB funds these loans overwhelmingly with borrowed money, almost all deposits benefiting from FDIC insurance[1]. 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 [2] 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!
This post was published at Acting-Man on December 16, 2015.
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