Silicon Valley Bank had more red flags than a CCP meeting but regulators cared about climate not bank risks
Despite skeins of bank regulations supposed to prevent another financial meltdown, Silicon Valley Bank, the country’s 17th-biggest bank, went down in flames last week. It was the second-biggest bank failure in U.S. history and has prompted a lot of finger-pointing.
Management messed up by not addressing a serious cash shortage until it was too late. Some blame Peter Thiel, saying the venture capital investor’s call for small tech firms to withdraw deposits from SVB accelerated its demise. Others are critical of Goldman Sachs, SVB’s adviser who signed off on their ill-advised decision to try to sell equity, thus alerting investors to their capital shortfall.
There’s plenty of blame to go around, but when a financial institution goes under, you have to wonder: where were the regulators? After all, there were more red flags than you see at a CCP convention.
Last year was a year for the record books, and not in a good way. In response to the worst inflation in 40 years, the Federal Reserve undertook one of the most aggressive rate hiking programs in history. In response, U.S. investors sold down stocks, and especially high-multiple tech shares. The S&P 500 was off 18% in 2022; the NASDAQ dropped 33%.
In addition, last year was the worst year ever recorded for U.S. bonds. The Total Bond Index, which tracks high-quality U.S. corporate and government debt, lost more than 13% in 2022.
Thanks to trillions of dollars in government spending during and after the pandemic and to massive money printing by the Federal Reserve, banks nationwide enjoyed a massive influx of deposits beginning in 2020. Most, including Silicon Valley Bank, put much of that money into investments like Treasury bonds and other fixed-income securities that nosedived when rates went up. Federal Depository Insurance Company (FDIC) filings show that US banks took over $600 billion worth of unrealized losses last year…a major red flag.
Meanwhile, banks, including SVB, were slow to respond to rising rates, and started losing deposits last year as customers took money out of checking and savings accounts to invest in higher-yielding Treasuries or money market funds. Bloomberg reports that “commercial bank deposits fell last year for the first time since 1948 as net withdrawals hit $278 billion…”
Those issues – portfolio losses and declining deposits – caused SVB to fail, but the problems were not unique to that bank. Indeed, Signature Bank also collapsed, for similar reasons, just hours ago. Authorities should have been on high alert.
They were not. Consider the Financial Stability Oversight Council, the body created in 2010 after the financial crisis, which was meant to avert just this sort of collapse. The council is chaired today by Treasury Secretary Janet Yellen and includes 9 other voting members including Fed Chair Jay Powell, the heads of the FDIC and the Bureau of Consumer Financial Protection (CFPB), Gary Gensler, head of the SEC.
The council’s website defines its task as “identifying risks to the financial stability of the United States…”
The council last met on February 10 via videoconference. The readout of that meeting shows the group previewed its 2023 priorities, which included “climate-related financial risks, nonbank financial intermediation, Treasury market resilience, and risks related to digital assets.”
Climate change, which it describes as “an emerging threat to U.S. financial stability,” is identified in the 2022 annual report as a “key priority” and has been one of the council’s principal preoccupations for the past two years.
To be fair, the council was also concerned about crypto currency-related risks, nonbank financial intermediation and the resilience of Treasury markets. Those were the issues on which the council was focused, not mounting portfolio losses and declining deposits.
This is shocking. As economist Ed Hyman has pointed out, there has never been a rate tightening cycle without some sort of financial shock, like the failure of Long Term Capital Management in 1998 or the bursting of the dot-com bubble in 2001. That’s because Fed rate hikes are intended to drain excess liquidity out of the system and also to deflate overpriced assets, like housing in 2008 or tech stocks in 2001. Because investors tend to move in herds, the process is rarely smooth.
When people started asking for their funds last week, SVB faced a liquidity crisis. Their holdings had shrunk in value, so they tried to raise new capital by selling stock and preferred shares to tide them over. Going to public markets instead of private lenders was a mistake. Depositors were spooked and rushed to claim their funds, causing a bank run and the shuttering of SVB.
Was anyone paying attention? As Peter Earle wrote in the American Institute for Economic Research, “as of late December, SVB held 57 percent of its total assets in investments while the average among 74 similar competitors was about 42 percent. Of those investments, $108 billion were in US Treasury and agency securities — an asset class which had its worst year on record in 2022.”
Earlier this year Earle also reported increased activity at the Fed’s discount window; it is not clear whether that pick-up in bank short-term borrowing signaled industry-wide distress or whether SVB was a participant, but surely it was another red flag.
What does all this mean for the average American? Regulators have in recent hours arranged to cover depositors at SVB and for Signature Bank, which has also closed. They are also putting together a borrowing facility to stabilize other financial institutions caught in the downdraft. If the authorities can limit the contagion with these moves, and if no other banks are stricken, it will most likely calm markets and prevent a full-on panic.
However, there will be damage. The Fed will be more cautious about raising rates going forward. While that means that car payments or mortgage rates won’t go up as fast as recently predicted, it means inflation – the worst tax of all – will stay higher for longer.
None of this bodes well for stock prices, economic growth or wealth creation. Will President Biden still claim his economic plan is working?
Published on Fox News
