Jeff Chiu/AP Photo
People wait outside the entrance to a Silicon Valley Bank in Santa Clara, California, March 10, 2023.
The Federal Reserve’s bank supervisors are busily trying to cover their collective backsides after the Silicon Valley Bank collapse. In the past few days, both Bloomberg and The New York Times have come forward with the same story: Frontline examiners saw the problems at SVB over a year ago and sent formal requests for the bank to fix deficiencies in operations and risk modeling.
So Fed officials weren’t entirely clueless. But I don’t think the people leaking this information realize how bad this makes the institution look. It’s an indictment of their role in financial regulatory policy—an effective admission that banks don’t really listen to them, confident in the knowledge that they won’t suffer any penalties for such impudence and will in fact be rescued if anything goes really wrong. Which, of course, is exactly what happened, so you can’t even blame Silicon Valley Bank for its confidence.
Let’s dive into these leaks. Both claim that, after the Federal Reserve Bank of San Francisco replaced the old bank examination team for SVB with a fresh set of eyes in late 2021, they immediately caught a host of problems. The bank’s models contained assumptions that higher interest rates would bring in more revenue on loans, offsetting the losses on long-dated securities in its portfolio. This was a wildly wrong interpretation. SVB also could not track its own interest rate risk in real time; BlackRock’s consulting firm told the bank after a review that it had poor risk controls compared to its peers, and was unable to even produce a weekly report of its securities portfolio.
Beyond the interest rate risks, there were indications that SVB would not be able to find enough liquid cash in the event of a flood of deposit withdrawals. In addition, as any bank examiner or interested citizen could easily see, SVB experienced extraordinary growth (a near-quadrupling of assets in four years), had a deposit base that by value was almost entirely uninsured and clustered in a tech sector that was having its own public struggles with higher interest rates, and was tapping the Federal Home Loan Bank system more than any other financial institution, a clear signal that they couldn’t get traditional lending.
The SF Fed examiners privately issued six warnings known as “matters requiring attention” and “matters requiring immediate attention.” In reality, they obviously didn’t require any attention. It’s pretty clear, given the total lack of alteration in the bank’s portfolio strategy, that SVB did nothing in response to the warnings. The examiners did put restrictions on SVB growing through acquisitions last July, but by this point the bank was already over $200 billion in assets and it had just bought Boston Private a year earlier, in 2021.
The Fed has several tools beyond stern letters to force banks in this shape to fix their problems— restricting dividends, for example, or threatening enforcement actions. You’d think officials would have been more aggressive given the stupendous damage caused by the 2008 crisis. But the only takeaway from the SVB situation is that this troubled bank with poor risk management did not fear its regulator.
The deregulatory S.2155 already sent the message that banks of this size should not be scrutinized too thoroughly.
That’s probably because the trajectory of regulatory policy had already been set by 2018, when Congress passed S.2155 to weaken enhanced supervision for large regionals like SVB. This had the effect of neutering the supervisors in the field, as Peter Conti-Brown of Penn Wharton has explained. Everybody knew for years that the Fed was deregulating, and therefore any heavy-handed intervention into a bank’s affairs was quietly discouraged, if by nothing else than through self-censorship.
Bank lobbyists are engaged in a pernicious effort to claim that SVB was well capitalized and would have passed all liquidity tests prior to S.2155, and that a mere act of God (or really antsy venture capitalists) brought them down. The Bank Policy Institute (BPI) gets wrong what liquidity ratio SVB would have been required to hit because of the bank’s foreign exposures; the result therefore accidentally shows that SVB would have barely crossed the requirement, which itself would have raised red flags. Moreover, BPI bases its calculations on figures from the end of 2022, when if SVB were subject to enhanced regulatory standards its liquidity situation would have been looked at daily, not based on outdated financial material.
But more important, the deregulatory S.2155 already sent the message that banks of this size should not be scrutinized too thoroughly. “The presumption [that SVB] was systemically risky was removed,” Mike Konczal of the Roosevelt Institute told the Prospect. This makes it impossible for bank examiners to fulfill their mission of ensuring bank stability; it’s clear their concerns were simply ignored.
Furthermore, there was more to S.2155 than the liquidity coverage ratio. Konczal’s Roosevelt colleague Todd Phillips notes that SVB was allowed to opt out of a requirement that banks must incorporate large unrealized losses on their balance sheets (known by the acronym AOCI) into their capital requirements. SVB also was exempted from several stress tests, and never had to submit a resolution plan, which would have included steps to make it fail better.
One of the major points supporters of S.2155 make is that it was intended to “tailor” regulation to the risks of the bank. But the Fed did this with a blunt instrument, simply slashing regulations based on asset size. The specifics of SVB should have dictated much stronger tailored requirements, because of the high flight risk on the depositor side, and the correlation between the effect of interest rate increases on SVB’s balance sheet and the finances of the vast majority of its depositors. That would be actual tailoring, not a one-way ratchet weakening scrutiny.
Sen. Elizabeth Warren (D-MA) and Rep. Katie Porter (D-CA) have a bill to reverse the worst aspects of S.2155. But the Fed, on a discretionary basis, went even further than the law prescribed with its tailoring law. Under new vice chair for supervision Michael Barr, it could reverse that, of course, but the agency seems basically uninterested in financial regulation. If that’s the case, it shouldn’t have the responsibility in its lap. Aaron Klein of Brookings notes that Congress took a vote on this during Dodd-Frank, and overwhelmingly voted to keep and even expand the Fed’s power. That was a catastrophic mistake and Congress shares the blame.
The bigger problem is that the entire regulatory architecture set up after the 2008 crisis has now been exposed as insufficient, given the deregulatory pummeling it has taken in the intervening years. And the bank sector has been revealed as incredibly fragile.
One regional bank collapse created a multitrillion-dollar bailout lending program and infinitely raised the government’s deposit insurance. Now, large regionals want to maintain that backstop for two years. Something like 200 banks in the U.S. see themselves at risk. First Republic was already rescued by private capital, and yet analysts say that won’t be enough. The panic has rippled overseas, finally toppling damaged lender Credit Suisse after a century and a half of operation. And the Fed is creating dollar swap lines with other central banks, which in the crisis years was the clear signal of a global recession.
All this emanating from a problem bank that was so obvious, supervisors caught it before interest rates started to rise, yet ended up doing nothing about it.
The pendulum usually swings from deregulation to crisis to re-regulation. We are at the crisis point now, and the opportunity to re-regulate exists. But it’s easy to see how it could be squandered.
