A new banking crisis
Several banks have failed or shown clear signs of financial weakness in recent weeks. Congress needs to revisit 2018 reforms that loosened the rules on financial institutions.
When even a few banks fail or teeter on the brink of collapse all at once, it’s apparent that something may be systemically wrong in the financial industry. It’s also obvious that Congress had better find out what — and do what it can to fix it.
The matter, though, is complicated by — what else? — politics. In this case it’s the optics of needing to fix something that many members of Congress, and a former president now running for reelection, may well have broken five years ago, setting the stage for the current crisis.
The roots of this peril go back to 2008, when the global economy was wrecked thanks in no small measure to the reckless behavior of too many banks. President Barack Obama and Congress responded with sweeping legislation, the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among the provisions, it increased protections for consumers against abusive financial services practices, and required “stress tests” to ensure banks could withstand some upheaval in the economy.
After 10 years without another major banking crisis, President Donald Trump and enough members of Congress, mostly Republicans but some Democrats as well, decided to loosen the reins on banks, which had complained the rules were too constraining. After all, why not tinker with a law that’s working the way it was designed to, especially when it affects a sector that spends more than $200 million a year on lobbying, the second-highest spending industry after health care interests?
In 2018, Congress passed, and President Trump signed, a bill that, among other things, exempted small- and medium-sized banks — those with under $250 billion in assets — from annual stress tests. Mid-sized banks — those with assets between $100 billion and $250 billion — went on a biennial cycle, and were also allowed to have less capital liquidity than larger lenders.
Not surprisingly, the first bank to fail this month, Silicon Valley Bank, fell under the radar thanks to these reforms — even though the Federal Reserve had raised questions about the bank’s stability several years earlier. Signature Bank followed, and a number of other banks that are similarly short on assets are scrambling to shore up their finances.
To be sure, it appears the catalyst for the current crisis was the steady rise in interest rates by the Federal Reserve, which made even conservative investments by banks worth less. But plenty of banks aren’t in a jam, at least not yet. What did they do right that others didn’t? And what did the banks that failed or are in trouble do that might have been avoided with better regulation?
There’s talk now of raising federal deposit insurance to protect consumers, but that’s treating the symptom, not the cause. Better insurance, on its own, might encourage more risk-taking by banks. It must be accompanied, at the very least, by measures aimed at ensuring that banks are on solid financial footing — including subjecting more of them to regular stress tests. President Joe Biden’s proposal to punish reckless bank officials could also impart a stronger sense of personal consequences for those who put the pursuit of profits ahead of prudence.
The first step, as they say in addiction recovery, is admitting you have a problem. The same prescription holds for Congress. It has to act, not simply defend its questionable past performance.