From Too Big to Fail to Too Small to Survive: The Changing Nature of Bank Contagion

Image by Alice Herrick

The specter of the 2008 global financial crisis was hard to ignore when federal regulators closed down Silicon Valley Bank on March 10th. Indeed, the 2023 bank crisis had many elements of the 2008 crisis, from when the shutters of fear rippled through financial markets to when the fat cats were bailed out, and the dust settled. In 2008, however, that sequence of events took several years to play out, while this time around, it was all over in a matter of days, except for the political retribution.


Silicon Valley Bank was unlike any other commercial bank in the country. Founded forty years ago to meet the needs of startup companies, a major player in the closed, incestuous Silicon Valley world, where venture capital rules and billionaires help other billionaires create new billionaires.


Why a handful of leading venture capitalists turned on Silicon Valley Bank remains unclear. For years, venture capitalists had directed their portfolio companies to use SVB as the depository for their funds. One would have to expect that those venture capitalists – touted far and wide as among the most visionary financiers on the planet – were aware of the issues SVB was facing in a rising interest rate environment. After all, the challenges facing commercial banks as rising rates were translating into losses on their bond holdings had been written about months earlier in the Wall Street Journal, and last November, JPMorgan raised specific concerns about the impact on Silicon Valley Bank.


It is hard to imagine that there weren’t solutions to the issues facing Silicon Valley Bank. As one SVB insider suggested, one would imagine that any number of sovereign wealth funds would’ve been happy to take a piece of Silicon Valley Bank and, in doing so, secure its place as a player in the most dynamic economic region on earth. Yet somehow, it all came tumbling down when rather than fix the problem, leading venture capitalists in Silicon Valley chose to cut and run.


As the run on Silicon Valley Bank began to gain steam that Thursday, those same venture capitalists and hedge fund gurus took to social media to demand that the federal government step in and fix the situation. The irony was lost on no one, as a cabal of erstwhile libertarians, who had long lectured the nation on the evils of government regulation, thought of every excuse under the sun why the federal government must immediately step into the breach.


They were not just asking for a bailout; they were demanding one. Not for Silicon Valley Bank, mind you, but for themselves. It turns out they had little interest in whether Silicon Valley Bank survived – or they would have fixed the problem themselves – but they had a huge financial stake in protecting the billions of dollars of deposits their portfolio companies had tied up in those uninsured accounts. As one observer put it, every libertarian becomes a socialist the moment the free market screws them.


In the heat of the crisis, hedge fund billionaire Bill Ackman threw down the gauntlet: Jerome Powell and Janet Yellen had 48 hours to guarantee all of the deposits in Silicon Valley Bank, or there would be a run on the entire banking system, leaving no banks in the country standing save the four largest banks, which have been deemed “too-big-to-fail” since 2008, and where the government effectively guarantees all deposits.


In the early moments of the crisis, many observers presumed that SVB had the perfect profile of a bank that could be allowed to fail without significant risk of contagion, given its narrow regional and industry focus. But that turned out not to be the case. Unlike 2008, when the contagion that came close to cratering the global financial system was a product of the very real linkages among mortgage-linked financial products, contagion this time around was as much a behavioral phenomenon as a financial one.


As rumors of the run on SVB rocketed across the Internet, individuals thousands of miles away watched the crisis unfold in real time and wondered how they could be sure their own bank was safe. And many of them decided not to wait to find out. At that moment, we learned that the nature of contagion had changed, and the impact of the collapse of Silicon Valley Bank was both immediate and severe. In the blink of an eye, hundreds of billions of dollars were drained from regional banks nationwide.


Then, as suddenly as the 2023 bank crisis burst onto center stage, by Sunday, March 12th, it was over. Using their authority to waive the limits on FDIC deposit insurance in the face of what they deemed to be a systemic threat to the financial system, Jerome Powell and Janet Yellen did what Ackman and others had demanded and guaranteed that all depositors at Silicon Valley Bank would be made whole.


Call it what you will sound judgment or capitulation, but Powell and Yellen waved their magic wand, the sense of crisis dissipated, and people began to move on. Was it a bailout? Of course, it was. SVB shareholders may have lost out, but depositors who had no legal right to be protected from financial loss got their billions back – including those who instigated the run in the first place.


In the wake of the collapse of Silicon Valley Bank, Bernie Sanders returned to the themes of the 2008 crisis and the outrage at once again seeing those who had done so much to instigate a crisis to reap a financial windfall from its resolution. For Sanders, that meant doubling down on his insistence that commercial banks should be broken up to put an end to ‘too-big-to-fail.’


Looking back at events in March, however, it’s hard not to reach the opposite conclusion. As deposits flowed out of regional banks when the bank run was at its peak, much of the money withdrawn from regional banks flowed into JPMorgan Chase and Citibank. Many of those who had followed the collapse of Silicon Valley Bank on their laptops and smartphones, and feared that their bank might be next, chose to transfer their money to banks that the federal government had officially confirmed would not be allowed to fail.


In today’s world, where people can move their money instantaneously from apps on their phones, it should come as no surprise that as soon as news broke of the collapse of a little-known bank, hundreds of billions of dollars were moved nearly instantaneously to those banks people knew would never be allowed to fail. The confluence of social media, smartphones, and financial technology have become the new catalysts for contagion, and a central question arising from the 2023 bank crisis is not whether we need to get rid of banks that are too big to fail but whether the small-enough-to-fail banks of Bernie Sanders’ imagination have ceased to exist.


David Alexander Paul

David is the President of Fiscal Strategies Group and was previously Managing Director of Public Financial Management, a public and project finance subsidiary of Hongkong and Shanghai Bank. He also served as the Vice Provost of Drexel University. He founded and served as CEO of, a mathematics and math education Internet company and virtual community.

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