Fed criticized for missing red flags before bank collapse
Traders and analysts had noted the issues
WASHINGTON — The Federal Reserve is facing stinging criticism for missing what observers say were clear signs that Silicon Valley Bank was at high risk of collapsing into the second-largest bank failure in U.S. history.
Critics point to many red flags surrounding the bank, including its rapid growth since the pandemic, its unusually high level of uninsured deposits and its many investments in long-term government bonds and mortgage-backed securities, which tumbled in value as interest rates rose.
“It’s inexplicable how the Federal Reserve supervisors could not see this clear threat to the safety and soundness of banks, and to financial stability,” said Dennis Kelleher, chief executive of Better Markets, an advocacy group.
Wall Street traders and industry analysts “have been publicly screaming about these very issues for many, many months going back to last fall,” Kelleher added.
The Fed was the primary federal supervisor of the bank based in Santa Clara, California, that failed last week. The bank was also overseen by the California Department of Financial Protection and Innovation.
Now, the consequences of the fall of Silicon Valley Bank, along with New York-based Signature Bank, which failed over the weekend, are complicating the Fed’s upcoming decisions about how high to raise its benchmark interest rate in the fight against chronically high inflation.
Many economists say the central bank would likely have raised rates by an aggressive half-point next week at its meeting, which would amount to a step up in its inflation fight after the Fed implemented a quarter-point hike in February. Its rate currently stands at about 4.6%, the highest level in 15 years.
Last week, many economists suggested that Fed policymakers would raise their projection for future rates next week to 5.6%. Now, it’s suddenly unclear how many additional rate increases the Fed will forecast.
With the collapse of the two large banks fueling anxiety about other regional banks, the Fed may focus more on boosting confidence in the financial system than on its longterm drive to tame inflation.
The latest government report on inflation, released Tuesday, shows that price increases remain far higher than the Fed prefers, putting Chair Jerome Powell in a tougher spot. Core prices, which exclude volatile food and energy costs, and are seen as a better gauge of longerrun inflation, jumped 0.5% from January to February — the most since September. That is far higher than is consistent with the Fed’s 2% annual target.
“Absent the fallout from the bank failure, it may have been a close call, but I think it would have tipped them towards a half-point (rate hike) at this meeting,” said Kathy Bostjancic, chief economist at Nationwide.
On Monday, Powell announced the Fed would review its supervision of Silicon Valley to understand how it might have better managed its regulation of the bank. The review will be conducted by Michael Barr, the Fed vice chair who oversees bank oversight, and will be publicly released
May 1.
Elizabeth Smith, a spokeswoman for the California Department of Financial Protection and Innovation, said, “We are actively investigating the situation and conducting a thorough review to ensure the Department is doing everything we can to protect Californians.”
By all accounts, Silicon Valley was an unusual bank. Its management took excessive risks by buying billions of dollars of mortgage-backed securities and Treasury bonds when interest rates were low. As the Fed continually raised interest rates to fight inflation, leading to higher rates on Treasurys, the value of Silicon Valley Bank’s bonds fell steadily.
The bank had grown rapidly, its assets quadrupling in five years to $209 billion, making it the 16th-largest bank in the country. And roughly 94% of its deposits were uninsured because they exceeded the Federal Deposit Insurance Corporation’s $250,000 insurance cap. That percentage was the second-highest among banks with more than $50 billion in assets, according to ratings agency S&P. Signature had the fourth-highest percentage of uninsured deposits.
Such an unusually high proportion made Silicon Valley Bank highly susceptible to a classic bank run, which is exactly what happened.