The collapse of Silicon Valley Bank last week sent the financial world into turmoil, and has started to bleed into politics.
But much about what actually happened in the years, months and days before the bank’s implosion remains poorly understood. The chaos has revealed, however, big questions that could shape accountability for the bank’s collapse, and the federal response.
TPM spoke with several experts to suss out a non-exhaustive list of questions that frame up the crisis.
Where were the supervisors?
The Wall Street Journal reported in November 2022 that the Fed’s interest-rate hikes were inflicting losses at SVB — the balance sheet problem which ended up sparking the bank run last week.
Rating agencies and various short sellers also released reports documenting the same issue.
“The media knew it, shorts knew it, the rating agencies knew it, and then clearly the Fed was grossly deficient here,” Dennis Kelleher, CEO of the banking reform group Better Markets, told TPM.
That left many wondering how supervisors might have missed the same warning signs that so many others saw.
“It’s not as if supervisory authorities are toothless — there was definitely room to extract valuable info here,” Skanda Amarnath, executive director of the economic research and advocacy group Employ America, told TPM.
One recently retired Federal Reserve bank examiner, who spoke on condition of anonymity, told TPM that it was unclear whether bank examiners with the San Francisco Federal Reserve, the main federal regulator for SVB, had taken steps to push the bank to resolve its balance sheet issues.
“The supervisors got to see the same risk management problems as everyone else, and apparently not much happened,” the person said.
What role did the 2018 bank deregulation play?
A lot of talk has focused on a push for deregulation that saw Congress, in 2018, loosen regulatory requirements on mid-size regional banks that had originally been put in place through the Dodd-Frank Act in the wake of the 2008 financial crisis. These 2018 changes slackened regular stress testing, and lightened internal liquidity ratios that mid-sized banks had to maintain.
Congress also changed the threshold at which banks were deemed “systemically important” from $50 billion in assets to $250 billion. Banks in that category receive extra supervision and regulatory requirements, including more stringent capital and liquidity requirements, annual stress tests, and the requirement to have a so-called “living will” — a plan for how the bank will be resolved should it fail.
Lawmakers gave the Federal Reserve some leeway in how it interpreted the new law and how it policed individual banks. The Fed took that leeway and implemented the law in a manner that was less aggressive than it could have.
Under Fed policy, it chose not to treat SVB — then a bank with assets fewer than $250 billion — with the scrutiny that it would give to systemically important lenders. The Fed did that by choosing to exempt banks holding between $100 billion and $250 billion in assets from having to perform company-run stress testing, and to maintain a certain liquidity coverage ratio — a measure designed to ensure that a bank has enough liquid assets to withstand a bank run.
Because SVB saw roughly $42 billion in deposit withdrawals take place across a single day last week, many who followed the saga of the 2018 deregulation have been left wondering: would heightened liquidity ratios of the sort in place before 2018 have protected the bank against a run of that size?
Amarnath argued that the pre-2018 regulations would at the very least have forced management to consider what deposit outflow they’d have to cushion for. The makeup of SVB’s depositors raises another question, he said: “Why are you so vulnerable to a concentrated deposit outflow that you’re sunk in two days?”
“In the case of SVB, there were key reasons to believe that there would be more outflows in a stressed period if all of your depositors are chunky businesses controlled by a set of VCs,” he said.
Kelleher, the Better Markets CEO, said that looking at the specific liquidity requirements, while important, missed the aggregate effect that other, now-weakened aspects of Dodd-Frank would have imposed on SVB.
He added that other elements of the law, like the removal of internal, regular stress tests and the imposition of quarterly, instead of monthly, liquidity tests likely created more room to operate the bank in a “reckless and unsafe” manner.
“They all interrelate and build on each other and create a matrix that is greater than the sum of the parts,” he said.
How did the risks at SVB accumulate?
Much commentary has presented the cause of the run on SVB as fairly straightforward: the bank bet on interest rates staying low and didn’t hedge, creating a fatal vulnerability which exploded last week.
But it’s far less clear why its leadership made the decisions that led to that reality.
SVB grew astronomically in the years after the 2018 deregulation. Fortune reported that SVB doubled its deposits from March 2020 to March 2021, while the bank’s assets also grew by roughly two-thirds from 2019 to the end of 2020.
The Wall Street Journal reported that SVB dropped hedges on $14 billion in its securities by the end of 2022. It’s not clear why bank management did that, or what overall picture the bank’s investors were looking at.
“Everyone is pointing to and discussing the astonishing level and amount of uninsured deposits, and that’s an important factor,” Kelleher said, while also referencing the maturity mismatch, unrealized losses, and other apparent problems at the bank.
But he added that SVB had other “red flags” that bank management should have been accounting for, including highly correlated deposit holders that, in a crisis situation, could move as a pack.
“One is that they had extreme geographic concentration of customers, and a concentration of a particular type of customer within a specific geographic area, which is high tech firms, biotech firms,” he said, describing it as a “particular type of client that was extremely interest-rate sensitive.”
Saule Omarova, a professor at Cornell Law School and former Biden nominee for the position of Comptroller of the Currency, a financial regulatory role that would not have overseen SVB, said that the complexity which led to SVB’s rapid increase in uninsured deposits and a fragile balance sheet was a one-way bet on interest rates staying low.
“It’s a simple story on the surface in terms of what directly caused this particular bank run or created the possibility of the bank run,” she said. “And then there is a much more complex story underneath that has to do with structural factors.”
How bad was the risk of contagion?
Omarova framed up a broader question to TPM.
“Why is it that an institution that only five years ago was explicitly, legally deemed to be systemically insignificant was deemed this weekend to be systemically significant?” Omarova asked.
She was referencing the 2018 deregulation law — which exempted banks smaller than $250 million from regulatory safeguards — and the Fed’s subsequent interpretation of that law, holding that SVB did not pose a systemic risk to the country’s financial system, and was therefore worthy of a lighter regulatory and supervisory touch.
On Sunday, the FDIC, the Fed and the Tresury issued a joint statement saying that would take a set of action suggesting that SVB did pose a systemically significant risk to the rest of the financial sector.
“The Fed, the Treasury, the people who actually made that call, I want to think that they did what they thought was the only right way to handle it, and they must have had information that really drove it,” Omarova said. “Otherwise, if thats not the case, then we are in a very interesting kind of political economy situation.”
Just how much damage did the DFP inflict on this country? It’s going to take years to clear us from the stench of T****. (I don’t type out his full name because he probably reads every sentence in which it appears.)
What drives me nuts is the constant Republican friendly frame that the media takes on all subjects that involve regulation. Train wreck with actual trains, due to Republicans and Trump. Train wreck that involves a bank, due to Republicans and Trump. Somehow though the train had woke wheels and the overpaid idiots that collateralized the bank with highly interest rate sensitive mortgage backed securities, well I guess they were just too woke.
I get a kick out of the San Francisco Federal Reserve homepage. Ground Zero in a financial incident that rocks world markets and not a mention when thousands are focusing on poor supervision. Indeed, Greg Becker had been sitting on that board since 2019, and now just a “vacant” on the organization chart. I would think Omarova would not have to speculate on the deeper problems as she could point to a task force looking into one of the global crucibles of creation and destruction of capital.
https://www.thestreet.com/technology/svb-ceo-quietly-and-swiftly-removed-from-powerful-board
Had half a Wall Street been placed in jail in the Bush years maybe this would not have happened.
"The lesson I would take from S.V.B. is that banks need to be strongly regulated whether or not their deposits are insured. The bailout won’t change that fact, and following that wisdom should prevent more bailouts.
And you know who would have agreed? Adam Smith, who in “The Wealth of Nations” called for bank regulation, which he compared to the requirement that urban buildings have walls that limit the spread of fire. Wouldn’t we all, even the ultrarich and large companies, be happier if we didn’t have to worry about our banks going down in flames?" Paul Krugman.
So the feds stepped in to protect all deposits at Silicon Valley Bank, even though the law says that deposits only up to $250,000 are insured and even though there was a pretty good case that allowing big depositors to take a haircut wouldn’t have created a systemic crisis. S.V.B. was pretty sui generis, far more exposed both to interest risk and to potential runs than any other significant bank, so even some losses for larger depositors may not have caused much contagion.
Still, I understand the logic: If I were a policymaker, I’d be reluctant to let S.V.B. fail, merely because while it probably wouldn’t have caused a wider crisis, one can’t be completely certain and the risks of erring in doing too much were far smaller than the risks of doing too little.
That said, there are good reasons to feel uncomfortable about this bailout. And yes, it was a bailout. The fact that the funds will come from the Federal Deposit Insurance Corporation — which will make up any losses with increased fees on banks — rather than directly from the Treasury doesn’t change the reality that the government came in to rescue depositors who had no legal right to demand such a rescue.
Furthermore, having to rescue this particular bank and this particular group of depositors is infuriating: Just a few years ago, S.V.B. was one of the midsize banks that lobbied successfully for the removal of regulations that might have prevented this disaster, and the tech sector is famously full of libertarians who like to denounce big government right up to the minute they themselves needed government aid.
But both the money and the unfairness are really secondary concerns. The bigger question is whether, by saving big depositors from their own fecklessness, policymakers have encouraged future bad behavior. In particular, businesses that placed large sums with S.V.B. without asking whether the bank was sound are paying no price (aside from a few days of anxiety). Will this lead to more irresponsible behavior? That is, has the S.V.B. bailout created moral hazard?
Moral hazard is a familiar concept in the economics of insurance: When people are guaranteed compensation for losses, they have no incentive to act prudently and in some cases may engage in deliberate acts of destruction. During the 1970s, when New York, in general, was at a low point and property values were depressed, the Bronx was wracked by fires, at least some of which may have been deliberately set by landlords who expected to receive more from insurers than their buildings were worth.
In banking, insuring deposits means that depositors have no reason to concern themselves with how the banks are using their money. This in turn creates an incentive for banks to engage in bad behavior, such as making highly risky but high-yielding loans. If the loans pay off, the bank makes a lot of money; if they don’t, the owners just walk away. Heads, they win; tails, the taxpayers lose.
This isn’t a hypothetical case; it’s pretty much what happened during the S.&L. crisis of the 1980s, when savings and loan associations, especially but not only in Texas, effectively gambled on a huge scale with other people’s money. When the bets went bad, taxpayers had to compensate depositors, with the total cost amounting to as much as $124 billion — which, as an equivalent share of gross domestic product, would be something like $500 billion today.
The thing is, it’s not news that guaranteeing depositors creates moral hazard. That moral hazard is one of the reasons banks are regulated — required to keep a fair bit of cash on hand, limited in the kind of risks they can take, required to have assets that exceed their deposits by a significant amount (a.k.a. capital requirements). This last requirement is intended not just to provide a cushion against possible losses but also to give bank owners skin in the game, an incentive to avoid risking depositors’ funds, since they will have to bear many of the losses, via their capital, if they lose money.
The savings and loan crisis had a lot to do with the very bad decision by Congress to relax regulations on those associations, which were in financial trouble as a result of high interest rates. There are obvious parallels to the crisis at Silicon Valley Bank, which also hit a wall because of rising interest rates and was able to take such big risks in part because the Trump administration and Congress had relaxed regulations on midsize banks.
But here’s the thing: The vast bulk of deposits at S.V.B. weren’t insured, because deposit insurance is capped at $250,000. Depositors who had given the bank more than that didn’t fail to do due diligence on the bank’s risky strategy because they thought that the government would bail them out; everyone knows about the F.D.I.C. insurance limit, after all.
They failed to do due diligence because, well, it never occurred to them that bankers who seemed so solid, so sympatico with the whole venture capital ethos, actually had no idea what to do with the money placed in their care.
Now, you could argue that S.V.B.’s depositors felt safe because they somewhat cynically believed that they would be bailed out if things went bad even if they weren’t entitled to any help — which is exactly what just happened. And if you believe that argument, the feds, by making all depositors whole, have confirmed that belief, creating more moral hazard.
The logic of this view is impeccable. And I don’t believe it for a minute, because it gives depositors too much credit.
I don’t believe that S.V.B.’s depositors were making careful, rational calculations about risks and likely policy responses, because I don’t believe that they understood how banking works in the first place. For heaven’s sake, some of S.V.B.’s biggest clients were in crypto. Need we say more?
And just in general, asking investors — not just small investors, who are formally insured, but even businesses with millions or hundreds of millions in the bank — to evaluate the soundness of the banks where they park their funds is expecting too much from people who are, after all, trying to run their own businesses.
The lesson I would take from S.V.B. is that banks need to be strongly regulated whether or not their deposits are insured. The bailout won’t change that fact, and following that wisdom should prevent more bailouts.
And you know who would have agreed? Adam Smith, who in “The Wealth of Nations” called for bank regulation, which he compared to the requirement that urban buildings have walls that limit the spread of fire. Wouldn’t we all, even the ultrarich and large companies, be happier if we didn’t have to worry about our banks going down in flames?