Francis Chung/POLITICO via AP Images
Federal Reserve Chair Jerome Powell testifies before the House Financial Services Committee on Capitol Hill, March 8, 2023.
The extraordinary back-to-back statements last Sunday, announcing the effective backstopping of the entire U.S. banking system, are mostly forward-looking in nature. Federal bank regulators at Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) stressed that “the U.S. banking system remains resilient and on a solid foundation,” avoiding any remarks about what led up to the Silicon Valley Bank collapse. That joint statement even highlighted Dodd-Frank Act reforms that ensured “better safeguards for the banking industry,” ignoring the rollback of some of those reforms in 2018, and their bearing on SVB’s failure.
Meanwhile, President Biden in his statement focused on finding “those responsible for this mess,” adding that his administration would be “continuing our efforts to strengthen oversight and regulation of larger banks so that we are not in this position again.” This was fairly vague about the regulatory and supervisory issues that precipitated the rescue.
In prepared remarks the next day, Biden was a bit more explicit. “There are important questions of how these banks got into these circumstances in the first place,” the president said. “During the Obama-Biden administration, we put in place tough requirements on banks … Unfortunately, the last administration rolled back some of these requirements. I’m going to ask Congress and the banking regulators to strengthen the rules.”
The dissonance between Biden’s comments on the collapse and the previous statements was deliberate. According to three sources with knowledge of the situation, Federal Reserve chair Jerome Powell was reluctant to sign off on anything that weekend that included references to the Fed’s role in supervision, regulation, or accountability, and fought efforts to do so.
The debate held up the final announcement for an indeterminate period of time, according to the sources. While the Fed did not allow any reference to regulation or supervision in the joint statement, that the central bank also tried to influence the presidential statement is novel, considering that they were not party to it.
The New York Times earlier on Thursday reported about the joint statement but not the presidential statement.
A Federal Reserve spokesperson declined to comment.
Powell’s hesitancy suggests that he wanted to keep a lid on the central bank having to field questions about accountability. “It should have been the opposite,” said Sheila Bair, former FDIC chair, when informed of Powell’s reticence. “They should have been emphasizing that there were unusual gaps in oversight risk management.”
The Federal Reserve was the primary bank examiner for Silicon Valley Bank, which failed over the weekend. It did not raise public flags regarding the shaky condition of either institution. (UPDATE: a Bloomberg article released on Friday stated that examiners sent private "matters requiring attention" letters to the bank, which did not lead to changes. It does not appear that examiners took corrective action after sending those letters.)
In addition, the Fed went above even the congressionally mandated deregulatory actions by establishing rules in 2019 that weakened oversight of large regional banks, like the two that failed. Former Fed attorney Jeremy Kress called the central bank’s actions “discretionary deregulation.” At the time, Fed governor Lael Brainard, now Biden’s National Economic Council director, warned that the changes would “increase risk to financial stability and the taxpayer.”
The Fed went above even the congressionally mandated deregulatory actions by establishing rules in 2019 that weakened oversight of large regional banks.
In the wake of the collapse, Powell has faced withering criticism for the supervisory and regulatory failure, most recently from a comprehensive ten-page letter sent by Sen. Elizabeth Warren (D-MA) on Wednesday. Warren’s opposition to the renomination of Powell as Fed chair in 2021 stemmed mostly from questions over financial regulation.
Lawmakers in both parties, in part to deflect blame from themselves, have pointed to the Fed’s inadequacies in spotting the problems at SVB.
Powell and vice chair of supervision Michael Barr have initiated an internal review of the supervisory issues, and have floated revisiting the weakened rules for large regional banks. But this would stand in contrast to Powell’s lengthy history of deregulation, as Americans for Financial Reform pointed out in 2021.
Sarah Bloom Raskin served on the Federal Reserve Board of Governors and at the Treasury Department during the Obama administration. She withdrew from her nomination by President Biden to be Fed vice chair of financial supervision due to opposition from corporate Senate Democrats. Raskin told the Prospect that she wasn’t aware of the internal discussions but that it wasn’t a surprise. “What they’re doing is really trying to brush the supervisory aspects under the rug,” she said. “I think it would be embarrassing about their fundamental failure.”
Raskin said that the Fed does not place bank supervision high in their list of priorities. “It is a sideline, marginal activity. It’s never brought into discussions at the Federal Open Market Committee,” she said. “Those people are economists, and they’re thinking about the macroeconomy without thinking about supervisory failures and how they can trigger contagion.”
WHILE THERE’S BEEN LOTS OF CROSSTALK over whether the 2018 deregulatory statute S.2155 played a role in Silicon Valley Bank’s collapse, it’s clear that the San Francisco Fed was not active enough in addressing basic risk management failures at the bank. The effect of rapid increases in interest rates (also perpetuated by the Fed) on banks that have long-dated securities doesn’t require a team of bank examiners to decipher. “The Federal Reserve System is not lacking for resources, personnel, authorities, or information when monitoring the health of its bank members,” wrote Skanda Amarnath of Employ America in a scathing report this week.
Silicon Valley Bank had billions in unrealized losses on its balance sheet that it hoped to avoid having to surface. It also had a tightly correlated, mostly uninsured depositor base, all largely from one industry and connected to each other, that represented significant flight risk if there were any signs of trouble. The rapid growth at the bank and its significant mismatch for liquidity purposes should have had the system flashing red.
“Banks have to prepare for interest rates to move,” said Raskin. “It’s basic banking.”
Sen. Jon Tester (D-MT), who voted for the 2018 deregulation, has used the Fed’s lack of supervision as a foil to deflect from his role. “They were supposed to tailor the regulations to the risk,” he told reporters this week. “If you look at this bank … very fast growing, over $200 billion, dealt with the tech industry, startups, a lot of folks without real stable deposits … I mean, where the hell were the regulators?”
When SVB failed, the Fed and other regulators had to invoke a “systemic risk” exception to backstop uninsured deposits, even though just two years earlier, Powell said in reference to a merger review that SVB would not present any danger to the broader financial system, The Lever reported. In addition, even the stress tests that bigger banks are subject to do not include any testing of a scenario where interest rates rise rapidly, the precise thing the Fed did to trigger the problems at SVB.
Yesterday, at a Senate Finance Committee hearing, Sen. Tim Scott (R-SC) called the supervision a “blatant failure,” and Warren and Mark Warner (D-VA) also had poor marks for the Fed’s supervisory qualities.
While there’s a fight right now over whether the internal Fed investigation that Barr announced would be sufficient or whether an independent monitor should look into the issue, Raskin questioned whether there needed to be any investigation of supervisory failures at all, since they are so obvious. “To jump into a special investigation perpetuates this myth that this was an oddball idiosyncratic, sinister story behind it,” she said.
Some have tried to excuse Powell by saying that he couldn’t be expected to know about the internal activities at one bank. Raskin, for her part, said that as chief banking regulator in Maryland, she would read every examiner report, and that the Board of Governors should be expected to take supervision and financial stability seriously.
Warren’s letter goes through each step the Fed was involved in, including Powell supporting S.2155, initiating the discretionary deregulation that went beyond it, and the Fed failing to supervise SVB. “This is an astonishing list of failures,” Warren writes, “and you owe the public an explanation for your actions.”
