Bank failures should not have been a surprise

The failure of Silicon Valley Bank should not have been a surprise to financial executives and bank regulators. They should have seen it coming, and the fact that they didn’t raises significant concerns about the post-2008 regulatory apparatus that was supposed to prevent this kind of thing.

SVB’s failure was not due to fraud or deception, or at least no evidence we have so far suggests as much. The bank wasn’t trying to pull a fast one on depositors or lie to inspectors. It made poor decisions that culminated in a bank run.

In a time when corporate monikers are frequently mystifying, Silicon Valley Bank did roughly what you’d expect it to do: It was the bank for many tech start-ups. Those tech start-ups had lots of cash from venture capitalists that they needed to deposit somewhere. SVB was not only their go-to, but often where their financiers expected them to bank.

Banks typically make money by lending out deposits at interest, but tech start-ups don’t borrow a lot of money from commercial banks, which was one reason why SVB had done well out of that market niche. But it was a niche on which it had become unhealthily dependent.

When money poured into start-ups during a venture-capital boom that owed not a little to the Fed’s interest-rate policy, that left the bank with a lot of money on deposit. So it bought tons of long-term Treasuries and mortgage-backed securities — extremely safe, government-backed assets. It relied on these assets far more than other banks did. But as interest rates increase, the market value of those long-term assets declines. This meant that while in theory it was adequately capitalized, it was, in reality, highly vulnerable to rising rates. That meant that even though the face value of SVB’s assets was roughly enough to pay back depositors, the market value was insufficient if it had to do so all at once.

When depositors started figuring out the danger SVB was in, too many of them decided they wanted their money back, and the bank couldn’t pay them all. So the FDIC took over the now-failed bank.

Some want to blame the Fed’s interest-rate increases for this episode. They are certainly part of the story, as the rate increases caused SVB’s long-term assets to lose value. But every bank faces the same Fed raising the same federal-funds rate, and not every bank had SVB’s problem.

Some also want to blame SVB’s ESG and diversity initiatives. We oppose such initiatives and hold to the old-fashioned idea that banks should be in the business of making money, not serving the flavor of the day in progressive politics. But SVB is hardly the only bank doing ESG and diversity initiatives, and other banks that do them did not get taken over by the FDIC over the weekend.

No, this particular bank made particularly poor decisions in how it managed its business. Agree or disagree with the Fed’s rate increases, they were not a surprise. Other banks planned around them. SVB failed to do so adequately, and its executives are justly paying the price for that failure.

But where were the bank regulators? Elizabeth Warren and other progressives are trying to blame rule changes made during the Trump presidency for the lack of regulatory oversight, but that is a red herring. The fundamental information about SVB’s potential problems didn’t need a more powerful government to uncover. SVB’s business model made it an obvious outlier compared with other banks, based on public data that anyone could have looked at months ago, and its rapid growth in the past year should have attracted attention from regulators.

The financial sector in this country does not lack for regulators. This, not interest rates, is where the Fed deserves more blame. The monetary-policy decisions get the headlines, but most of the day-to-day work at the Fed, especially the regional Feds, is in bank regulation. Why wasn’t the San Francisco Fed, in whose jurisdiction SVB resided, on the case?

Nearly every news story you read will mention somewhere in the first few paragraphs that SVB was the 16th-largest bank in the country. That’s true, but misleading as to the impact SVB has on the economy in general. The list of the largest banks is highly uneven, with the top four (JPMorgan Chase, Bank of America, Citibank, and Wells Fargo) holding consolidated assets in excess of $9 trillion. SVB held $209 billion. By no definition of the term was SVB “too big to fail.” If the 16th-largest bank is too big, why not the 17th, or 18th, or 19th?

Yet the losses of its depositors are being socialized nonetheless. Executives, shareholders, and unsecured bondholders are being wiped out, but depositors will get back 100 percent of their money, in excess of the FDIC’s $250,000 cap. The purpose of that cap is to protect individuals with normal checking and savings accounts without guaranteeing every massive firm’s deposits with the full faith and credit of the federal government. But in SVB’s case, most of its customers were firms with millions deposited, not individuals. These companies had the option of purchasing deposit insurance above the limit but chose not to, and yet the government is eschewing the limit and pledging to make them whole anyway. Will it do so in the future if other banks make poor decisions? It’ll be hard to argue it shouldn’t, especially if the potential victims are politically sympathetic.

The Fed is now under pressure to stop interest-rate increases, out of fears that continuing them could cause more bank failures. That’s troubling because real interest rates are still negative, and nominal GDP growth is still well in excess of its pre-pandemic trend. That means that, despite the increases that have already taken place, monetary policy isn’t contractionary yet, and inflation remains more than triple what it should be.

Because of the actions of one medium-sized bank doing business almost exclusively in one sector of the economy in one region of the country, and the failure of regulators to better police those actions, it’s possible that the U.S. now has de facto unlimited deposit insurance, a weaker monetary policy, and a slew of politicians itching to make hay out of the whole debacle. It is also another instance in which the federal government is making sweeping decisions, with significant long-term implications, without going through Congress.

We were promised post-2008 that such instability was a thing of the past, due to Dodd-Frank, better Fed regulation, and the government’s learning from its mistakes. But the government apparently can’t spot ordinary problematic banking practices. What other obvious problems, which everyone expects regulators to fix, are lurking out there only to be found out once it’s too late? There’s systemic risk for you.

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