Mariam Zuhaib/AP Photo
Sen. Mike Crapo (R-ID) is seen at a Senate Finance Committee hearing on March 7, 2023. Crapo was a principal sponsor of a bank deregulation bill in 2018.
The brightest minds in and around San Francisco Bay had an unadulterated meltdown over the weekend over the failure of Silicon Valley Bank. This was a failure that they themselves caused, mind you, engineering a digital flash bank run that forced SVB to realize heavy losses, mostly from interest rate hikes and the bank’s unbelievable failure to even attempt to manage interest rate risk.
The venture capitalist–led mob quickly moved on to another dire warning: Because over 90 percent of SVB’s depositors exceeded $250,000 in guaranteed FDIC insurance, the government must make them 100 percent whole, immediately, or every regional bank in America will see the same failure. Hedge fund titan Bill Ackman, venture capitalist David Sacks, and angel investor Jason Calacanis led the charge, saying that thousands of startup firms will have trouble making payroll, and other regionals won’t be able to stop a torrent of withdrawals. They essentially took out a match next to a gas pump and demanded that federal regulators not force them to light it.
It worked. Federal officials announced a backstop to “fully protect all depositors” at both Silicon Valley Bank and Signature Bank, which was also closed on Sunday. “Depositors will have access to all of their money starting Monday, March 13,” the joint announcement by Treasury, the Federal Reserve, and the FDIC read. A special bank assessment will offset losses, they say; all shareholders and bondholders “will not be protected,” with senior management fired. A $25 billion fund has been initiated to protect deposits, even though the theory is that no taxpayer funds will be implicated.
I predicted that calls for a bailout, which this is no matter who wants to claim otherwise, would be intense. Retroactive changing of the deposit insurance system from a quarter-million dollars to infinite for two banks, one of which happened to be staffed by either incompetents or corrupt actors, seems like an enormous step, especially as it’s a contestable question whether or not contagion would spread to other banks.
But the real problem is that this gift to a handful of extremely wealthy people will blind everyone as to how we got here. The first premise of this action—that small businesses with over $250,000 in the bank shouldn’t bear the cost of a bank failure—is rendered irrelevant with just the simplest understanding of risk management. The second premise, that regulators must invoke a systemic risk exception to preserve depositors, is also laughable, considering that SVB expressly lobbied to have the systemic risk label taken off of their bank, and is now facing the consequences. Members of Congress—from both parties—agreed to do so, and bank officials used that deregulatory freedom to abuse the trust of their customers.
That’s what really went on here, and as the anger from this unforced error builds, policymakers can take this opportunity to restore public trust. One member of Congress is already poised to do so.
THE FIRST WORDS OUT OF THE MOUTH of Rep. Katie Porter (D-CA) when I talked to her on Sunday were: “Can you believe we have to talk about this shit again?” She was referring to a conversation we had in 2018, when she was still just a financial expert and a candidate for Congress, about S.2155, which I call the Crapo bill, a reference to its co-author (Idaho Republican Sen. Mike Crapo) and its underlying contents.
Silicon Valley Bank’s CEO lobbied explicitly for banks under $250 billion to be exempted from additional stress tests and heightened capital and liquidity requirements.
The Crapo bill, designed in conjunction with four conservative Democrats on the Senate Banking Committee who went around their ranking member, Sen. Sherrod Brown (D-OH), to do it, was supposed to be simple regulatory relief for tiny community banks overburdened by the onerous rules of the Dodd-Frank Act. In reality, it was deregulation for “stadium banks,” which as I explained in my exhaustive piece at the Intercept in 2018, refers to banks that are smaller than the real giants like JPMorgan Chase and Wells Fargo, but big enough to spend money granting naming rights to a stadium.
The most important part of the Crapo bill was Section 401, which increased by fivefold the threshold for enhanced regulatory standards, from $50 billion in assets to $250 billion. Silicon Valley Bank’s CEO, Greg Becker, lobbied explicitly for this change. It meant that banks under $250 billion would not be subject to additional stress tests and heightened capital and liquidity requirements. SVB topped out around $200 billion, after growing rapidly in the past few years.
The final rule for enhanced regulatory standards said that all banks eligible for them would have to “hold a buffer of highly liquid assets based on projected funding needs during a 30-day stress event.” The rules in the Federal Register say: “In general, the more a company relies on short-term funding, the larger the required buffer will be.” As Daniel Davies explains, this was the part of Dodd-Frank designed to prevent bank runs, ensuring that banks have both the structural funding necessary to carry out operations and the emergency funding to handle sudden withdrawals.
Silicon Valley Bank had an unusually high amount of its assets placed in long-term government and mortgage securities, creating a mismatch and, yes, a reliance on short-term funding, namely those deposits that could be withdrawn at any time.
Its rapid growth was also a function of the Crapo bill, since it removed the regulatory hurdles banks would encounter by growing larger. Indeed, banks immediately started scooping up rivals, and the consolidation led to risk-taking affecting a wider class of customers.
Section 401 of the Crapo bill also, by changing one word in the federal code from “may” to “shall,” enabled the Federal Reserve to weaken rules further for the stadium banks. In 2019, using this tailoring provision like Republican supporters of the law urged, they removed the “modified Liquidity Coverage Ratio” from banks under $250 billion (like SVB), a similar kind of emergency measure as in the enhanced regulatory standards. Then-Fed governor Lael Brainard condemned this “reduction in core resilience.”
When I asked Porter about the Crapo bill five years ago, she said its optimal vote tally should be zero. “This vote to reduce capital holding, to lessen much-needed guardrails, was under the guise of being pro-business,” Porter added yesterday. “There is nothing pro-business about a banking failure, as the situation illustrates. Representatives who really care about a strong economy for all, not just their corporate donors, would have voted against it.”
She is readying legislation to reverse Section 401, and place the standards back on SVB and banks of similar size. (The Crapo bill was terrible for other reasons, but she’s just focusing on that one.) The cries that innocent depositors just trying to make payroll shouldn’t be punished for the sins of their banks, Porter said, gives all the more reason to make sure the regulations protect them.
Amazingly, Sen. Mark Warner (D-VA), who got mad at people like Saule Omarova for pointing out that the Crapo bill he helped design unnecessarily increased bank risk, went on television Sunday and doubled down on his leadership. “I do think these midsized banks needed some regulatory relief,” he told ABC. Shame is obviously in short supply in that Senate office.
By contrast, Sen. Elizabeth Warren (D-MA) called the bill the “Bank Lobbyist Act,” and called out Democratic supporters of the Crapo bill by name, correctly stating that “this bill wouldn’t be on the path to becoming law without the support of these Democrats” and that “the Senate just voted to increase the chances your money will be used to bail out big banks again.” She has been proven utterly correct.
THE IDEA THAT BANK CUSTOMERS that are small businesses drove the bank run at SVB, because their accounts inevitably have more than the FDIC deposit insurance limit in them and are therefore exposed to losses, is an amazing oversimplification.
Contrary to their belief, Silicon Valley big brains are not the first ones to figure out that deposit insurance doesn’t protect their payroll accounts. Companies manage this small risk of bank failure through recognized insurance strategies. There are private-sector solutions like Intrafi’s Insured Cash Sweep, which essentially cuts up large accounts into $250,000 pieces and splits them across the banks participating in its network. CDARS, another Intrafi product, is a less liquid option that segments cash into CDs. Some prior FDIC officials have expressed anger at these schemes, but there also are cash management accounts with a “sweep” feature, or additional insurance to take out (this Forbes story has several examples).
Any risk manager worth their salt at a company knows of a panoply of ways to avoid the threat of bank failure on deposits. “The pain of having to explain this,” Porter said to me.
Importantly, SVB was part of the network of cash sweep banks; it had an offer on its website about it. But according to Adam Levitin, there were only $469 million in reciprocal deposits, which is where cash sweep would show up. In other words, almost nobody banking at SVB used them.
The banking system has been utterly transformed overnight to prevent a threat that should have been easily avoided with basic risk management among SVB and its customers.
Why not? There are a couple of options. One, Silicon Valley startups are so bad with money that they never thought of this. (It’s incredible that Roku, which has been around for a while, had nearly half a billion dollars on hand at SVB, without hedging that risk at all.) The fact that VC big brains were toying with new types of deposit insurance this weekend that already exist (it’s like Uber reinventing the bus) raises that possibility.
The other possibility is that SVB wanted that money kept with them. There are very strange stories coming out about how SVB required companies to hold their money with them in exchange for venture debt agreements, and then gave cheap “white glove” service to founders: low-interest mortgages, lines of credit, and the like. SVB might have had a reason to want their hands on that money exclusively.
So you have depositors that either didn’t know the first thing about risk management, or were bribed by the bank into neglecting it. And you have a bank that didn’t have a chief risk officer for close to a year, that put their entire risk management on autopilot and got blindsided by interest rate–fueled losses. “Interest rates do two things, they go up and down. SVB did not foresee and manage properly that inevitable thing,” Porter said.
Let’s not forget the terrible supervisory job of the Federal Reserve, SVB’s primary regulator, in all of this. Not only did their interest rate spikes cause this problem, they failed to recognize obvious threats from SVB’s balance sheet. The enhanced regulations were put in place to remove regulatory discretion; instead, SVB lobbied for and got those regulations removed, and the Fed went back to laissez-faire supervision.
SVB’s losses aren’t really that major in the grand scheme; the haircut that depositors would take under normal rules would be minimal. It might take a minute, which with payroll being due was a risk startups didn’t want to take. But they have well-heeled benefactors—the VCs shouting about the end of the world—who could have supplied whatever bridge support was needed for companies they still profess to believe in.
Instead, we now have this extraordinary scenario of bailing out the entire deposit base of the United States in one shot. The banking system has been utterly transformed overnight to prevent a threat that should have been easily avoided with basic risk management among SVB and its customers. In effect, depositors at SVB got all the upside of banking there, paying nothing extra to lighten the risk of failure, and none of the downside. Privatized profits, socialized risks.
“The most interesting thing, we have analog banking reg in a digital world,” Porter said. “How do you cope with that, how do you build regulations to reflect that? If these failures are going to occur more quickly, then the tools of defense and protection to guard against that need to be stronger, not weaker.”
