Andrew Harnik/AP Photo
Federal Reserve Board of Governors Vice Chair for Supervision Michael Barr testifies at a House Financial Services Committee hearing on recent bank failures, March 29, 2023, on Capitol Hill.
This story is part of a Big Ideas series that brings together experts to offer steps that the government can take to protect the financial system, after the collapse of Silicon Valley Bank showed its inherent fragility. You can read all of the stories in this series here.
On March 13, 2023, the day after the federal government announced a breathtaking intervention into our banking system by bailing out the uninsured depositors of Silicon Valley Bank and Signature Bank (the second- and third-largest bank failures in U.S. history), the Federal Reserve made a startling second announcement. Michael Barr, the Fed’s vice chair for supervision, would lead, in his words, “a careful and thorough review” of the supervision and regulation of Silicon Valley Bank, whose primary federal regulator was the Fed. Chair Jay Powell said the review must be “thorough, transparent, and swift.” The Fed even guaranteed a pre-announced deadline for the review’s disclosure on May 1, just six weeks later.
Powell and Barr have set the Fed on a path to spectacular failure. This review is an impossible task. In a perfect world, they would abandon this effort. There is no path to accomplish the conflicting goals to be thorough, transparent, swift, and careful, even with an open-ended review.
There are three basic problems with the review as the Fed has structured it. First, that the review is being conducted by Michael Barr, both the boss of the supervisors and regulators whom he will be interviewing and the chief investigator of this review. Second, the speed with which the conclusions will be announced. And third, that it is happening within the Fed at all.
We are not in a perfect world. The Fed will proceed. But there are important changes to make to this process that, if they occur, may mitigate the self-inflicted harm that this review has created.
Michael Barr’s Credibility
When Congress created the position of the vice chair for supervision at the Federal Reserve in the Dodd-Frank Act, it attempted to provide more accountability for the Fed’s extraordinary supervisory authorities, a part of the Fed that is wrapped in intense secrecy. Note that the title of the position is not “vice chair for regulation.” While the VCS does indeed manage the agenda-setting authority of much of the Fed’s regulatory portfolio, every regulatory decision must be made by the full Board of Governors. In that sense, Barr is just one among seven.
Supervision is different. For this largely hidden yet vital set of functions, Barr has significant authority second to none within the system, including the Fed chair.
For Barr to conduct an internal review with external disclosures of the very people he supervises is a recipe for disaster. He will not receive candor from his employees in the system; their jobs may be at stake, something Barr could not confirm or deny when asked at a recent hearing. If this were an internal review alone, this might be better managed. Conducting interviews that Barr intends to immediately disclose on an extremely tight timeline is to guarantee that he will be the victim and perpetrator of a major piece of theater.
For Barr to conduct an internal review with external disclosures of the very people he supervises is a recipe for disaster.
This theater is especially harmful for Barr’s credibility. Barr’s term as VCS still has more than three years left to run. During that time, he will manage the implementation of many of the reforms that this crisis will require, including some of the partisan priorities that the Biden administration has identified both before and after this crisis. These priorities including tailoring the regulation and supervision of some of our largest banks to better fit the risks they impose on society, including by undoing some of the deregulatory and desupervisory actions of the Trump administration.
These partisan priorities are appropriate and important: Elections have consequences, as the saying goes. With Barr at the helm of this theatrical review, however, he will not have the political and policy credibility to manage the contentious process that will follow. Republicans will not trust his results: They will adopt the banking industry’s perspective that this review and the subsequent policies will have a flavor of “ready, fire, aim,” as one of the bank’s chief lobbyists already declared. Democrats will not trust the results, either, wondering whether the rest of the Fed has provided the candor to evaluate the highly deregulatory and desupervisory policies under the Trump administration. The review will have no audience except future partisans, who will pore over it for talking points to defend their predetermined conclusions.
Why So Hasty?
The second major flaw in the architecture of this review is its pre-announced speed. There is no policy reason for a deadline of May 1st. We are only a few weeks into this banking crisis and, while the acute period seems to be over, we have no idea where it ends. During the next month, we should want VCS Barr and all of his supervisory staff focused on making sure that banks recognize the downsides of the undue risks they have taken, without imposing systemic consequences on the rest of us.
That is no easy feat: These banks will need to shrink, drop customers, raise capital, realize losses, and in some cases be acquired or liquidated. The policy attention required to manage these tensions will be among the most demanding that any central banker will face. Conducting an internal-external review simultaneously is guaranteed to divide the attention of our bank supervisory apparatus when we can least afford the distractions.
The Fed Cannot Investigate Itself
In 2009, one week after Barack Obama’s inauguration, the Senate confirmed Daniel Tarullo to be a member of the Fed’s Board of Governors. In that role, he became a de facto head of bank supervision and went on to seek changes in nearly every corner of bank supervision. His influence led some to call him “the most powerful man in banking.”
One of his first efforts was to conduct an internal review of what had failed at the Fed prior to the 2008 financial crisis. The results of that in-depth review, which have never been published (despite many denied FOIA attempts to unearth it, including by me), led to real change within the system. One Federal Reserve Bank even lost control over bank supervision for a time. (We know this only because some of these details were leaked to The Wall Street Journal.)
This kind of internal review is vital and necessary, even if—for the historical record—the Fed’s continued addictions to secrecy do not serve the public interest. But an external review, which this purports to be, is very different. The Fed throughout its history has demonstrated the ability to manage its reputation, even in periods of significant policy errors. It is inconceivable, despite Barr’s declaration for the need for humility, that the final report will shine a spotlight on the supervisory failures of the Board of Governors during Powell’s chairmanship. Powell has already blocked references to those potential failings. Why should we assume candor will occur now, while the Fed is simultaneously fighting inflation and fighting financial instability that its own policies have exacerbated?
The consequences are not just a review that will fall flat, without an audience to receive it. It is much worse than that. This review will create a rigid narrative that, despite the flaws caused by haste and institutional failures, will persist well after we have learned the more complete account.
What We Should Do Instead
The Fed has very loudly and very publicly committed itself to a review that is a disaster in the making. Much can be forgiven for actions taken during the fog of war. But now, as the smoke has cleared, we need to adjust so that the Fed can be saved from itself.
First, Barr should publicly appoint someone outside of supervision to take the lead on this review. He will still receive the final report and it will be issued under his name, but he should make clear that his attention is focused on fighting the crisis at hand.
Second, on May 1st, the Fed should release a preliminary report and emphasize that it is incomplete, that it can draw no firm conclusions, that it can only present the facts acquired that are separate from the individual subjective accounts of the key participants. This report should include information about the supervisory filings that the Fed staffers created in the year ahead of the bank’s collapse (some of which we already know about), the details of the “horizontal review,” the fact that the review will continue, a statement that personnel actions will occur but be necessarily confidential, and an advisory that other parts of its review cannot be published under law until after a relevant lag.
Third, the Senate Banking Committee should announce its own review, hiring an expert to lead a Pecora-style commission to look through every aspect of this crisis, in particular what the Fed knew and when it knew it. Ferdinand Pecora, the lawyer appointed in 1933 to lead a review on behalf of the Senate Banking Committee of the banking crises that afflicted the nation in the Great Depression, provides the model of a work of Congress through its committee structure, but not led by members of that committee.
Finally, when the Banking Committee makes this announcement, the Fed should immediately announce its enthusiasm for the effort, and its willingness to turn over all relevant personnel and materials (including so-called “confidential supervisory information”). The Fed should also consider this congressional oversight the key to making sure our factual understanding of the Silicon Valley Bank disaster and the accountability it requires belongs to the country’s elected representatives and the experts they appoint to assist them.
Conclusion
Over its 110-year history, politicians and the public have asked much of our central bank. It has erred, sometimes dramatically. It has also succeeded, sometimes dramatically. Its dizzying and conflicting tasks present a policy challenge unlike most others in government.
What it cannot do is investigate itself. It should not have been so hasty as to pretend that it could. What we need now is to recover the Fed’s credibility from this ill-advised policy path and construct a better way for us in the present to learn from the past while we make hard but important choices for the future.
