Tom Williams/CQ Roll Call via AP Images
Federal Reserve Chairman Jerome Powell arrives to testify before the Senate Banking Committee, March 7, 2023, on Capitol Hill.
AUSTIN, TEXAS – I’m at South by Southwest, a music festival that for some reason has been expanded to include a massive bullshit factory, complete with self-congratulatory panels (every one entitled “The Future Of” something or other), an exhibit hall hawking things like “phantom snack experiences” that simulate eating food without the calories (the CIA also has a large booth), and a “conscious conversations” lounge. Reality had the bad manners to intrude when the Silicon Valley Bank collapse sent a large contingent of tech executives here into a tizzy; I too have heard about crying in the streets and people furiously attempting to conduct wire transfers during panel discussions.
But fear not! The nation’s strategic bullshit reserve is inexhaustible, a fact being eminently reinforced in the wake of the collapse of SVB, and federal regulators’ backdoor bailout of the rest of the system. The gaslighting has reached mission-critical levels, in fact.
Everyone involved in this bank crisis did something wrong, a useful state of affairs because it allows them all to deflect blame. You have the brightest minds in Silicon Valley whining their way to a bailout while unwittingly admitting that they run billion-dollar businesses without understanding the first thing about cash management. You have a bank exposed to huge flight risk from uninsured depositors from the same industry leaders who text one another constantly, yet willfully ignoring the unrealized losses on its balance sheet. You have Silicon Valley Bank’s auditor (who was also Signature Bank’s auditor) saying everything’s fine two weeks before the collapse. You have stock analysts and credit rating agencies saying everything’s fine days before the collapse. You have politicians with ties to the deregulation, like Mark Warner and Jon Tester. You have politicians with ties to the bank, like Gavin Newsom. You have ex-politicians who sat on the board of one of the dead banks, like Barney Frank. And so on.
Without absolving anyone else of responsibility, I want to focus on the Federal Reserve, and its conduct before, during, and after the crisis event. The ongoing failures at the Fed are risking economic stability and paradoxically threatening a return of inflation.
Last Friday, I covered how the Fed’s interest rate hike exposed SVB and other banks to risk of collapse. But the Fed also happens to be SVB’s primary regulator. While the bipartisan deregulation bill weakened the requirements that large regional banks had on liquidity and capital, this doesn’t mean that they were completely unsupervised.
Anyone spending five minutes with SVB’s balance sheet could decipher that the bank was a time bomb. Not everybody is spending five minutes with regional bank balance sheets; in reality, you just have the people whose job it is to do so, and maybe investors looking for a payday. One short seller had warned people on Twitter for two months that SVB was going under. He saw that SVB bought long-dated securities at the top of the market, and took massive losses. He also saw that the tech winter was going to cause an outflow of deposits, meaning that those losses would eventually get realized. Any half-decent regulator should have seen that too. It’s incredible that they didn’t.
The Fed and other regulators succumbed to one bank’s threats to inflict upon ordinary Americans another financial crisis and recession.
The Fed also helped foster the deregulatory environment that boosted SVB. In 2019, then-vice chair of financial supervision Randal Quarles weakened discretionary regulatory standards for banks like SVB, following a directive from the bipartisan deregulation bill. Quarles has been gone since November 2021, yet Jerome Powell has led no effort to change those rules.
As Bob Kuttner has explained, the Fed’s low interest rate policy in the pandemic can spur speculative bubbles, and so you need to pair that with tight regulation to pop those bubbles. The Fed, manifestly, didn’t do that. Michael Barr, the new vice chair of supervision, is now leading a review of the supervision failures, which is only appropriate. (Sen. Warren wants Powell to recuse himself from this review.)
The fact that the CEO of Silicon Valley Bank was a director of the San Francisco Fed until last Friday, while not related to financial supervision, is also a huge black mark on the central bank’s reputation.
In the aftermath, the Fed and its colleagues decided to backstop the country’s entire $7 trillion-plus depositor base, and in a way, that’s the more minimal of their responses. They also initiated the Bank Term Funding Program, which will give loans to banks with “qualifying assets” at par, for up to a year. This is designed for banks like SVB to avoid having to realize losses from long-dated securities. As Daniela Gabor tweeted, this “goes against every risk management commandment of the past 30 years.” Any qualifying collateral with huge losses can now be exchanged at absurdly high rates. It incentivizes banks to take stupid risks.
In essence, the Fed and other regulators succumbed to one bank’s threats to inflict upon ordinary Americans another financial crisis and recession. It duped them into permanently changing the banking system (whether deposit insurance limits are statutorily raised or not, implicitly it’s clear that no depositor will ever take a loss again). It let poorly run banks that didn’t adapt to the new interest rate reality off the hook, and invited them to be more irresponsible.
Maybe that’s understandable to prevent contagion and crisis. But is it doing that? Moody’s just cut its rating on the entire banking system and said there was a “rapidly deteriorating operating environment.” As long as interest rates keep rising, more banks will be exposed, and not all of them can even use that backdoor bailout; First Republic, for example, doesn’t have the right securities in its portfolio.
This puts the Fed in an impossible scenario. It’s clear after yesterday’s inflation report that under normal conditions, the Fed would be hiking interest rates by half a point. But now it can’t, because the poison of higher interest rates hit a rich vein in the banking system. The market knows that the Fed must now pause, and that’s reset expectations.
That interest rates should be the primary tool at all for this bout of inflation is extremely contestable; interest rates won’t end the war in Ukraine or stop climate-induced supply crunches. But the bigger problem for the Fed is that its regulatory action on the banks could spur the inflation it claims to want to fight. We’re seeing asset prices reinflate, as the market internalizes the idea that there will be a Fed backstop on anything of importance. Even regional bank stocks rallied.
Inflated asset prices, however, recreate the exact circumstances that led to this series of collapses in crypto and banks like SVB. It heightens the potential for fraud. And asset price inflation is inflation, after all; it gives people more paper wealth. It’s the channel inflation will come through in the near term, and it will eventually lead to increased pressure on the economy. The cost of the bailout, which increasingly looks like a panic move, could be high.
We put way too much pressure on the Fed. Not only does it have its full-employment and price stability mandates (though as interpreted, it’s always more the latter than the former) and its role in bank supervision, it also needs in the absence of Congress to be the economic super-policymaker. But it takes on these side responsibilities along with its core ones, and it’s failing on almost all fronts. Its notoriously bank-friendly regulatory posture, which it sees as protecting the economy, is now harming the price stability mandate. And full employment has become a sideshow. It’s time for someone else to govern in Washington, because the Fed is too stressed, too captured, and too mismanaged to do the job.
UPDATE: An earlier version of this story said that the Federal Reserve was the primary supervisor of Signature Bank. They are actually a state non-member bank regulated by the FDIC. We regret the error.
