Missed signals in bank failure
REGULATORS, FED OVERLOOKED FAULTS Government had power to probe SVB before fall
One week after the stunning collapse of Silicon Valley Bank, policymakers in Washington are confronting the uncomfortable prospect that they could have anticipated the trouble sooner and acted faster to head off financial tumult.
The new scrutiny focuses on the Federal Reserve, its regional bank in San Francisco, the state of California and lawmakers on Capitol Hill, after Washington moved in recent years to dial back oversight of important regional institutions. Roughly a decade and a half after the 2008 financial crisis sent the country into a deep recession, these government officials possessed vast power to probe SVB before it failed — yet they all seemed to miss key opportunities to prevent the meltdown.
For months, at least, SVB seemed to teeter on the precipice: A critical lender, investor and financial steward for the powerful technology set, the bank had grown at a breakneck pace, eventually accumulating a dubious balance sheet that raised doubt about the state of its assets.
But it was only after a swift, mass exodus of its customers — closely concentrated among venture-capital investors — that the government intervened last week. California assumed control of the bank last Friday, before the Biden administration orchestrated a dramatic rescue to make depositors whole while acting to prevent what might have been a widespread run on other institutions. Regulators soon after
closed New York-based Signature Bank and moved to guarantee its deposits, too.
Now, financial experts, lawmakers and former government officials have expressed alarm about the potential lack of rigorous oversight. Some have pointed the finger at the Fed, the nation’s supervisory central bank, arguing it should have scrutinized the books of SVB, which grew at a meteoric pace during the pandemic as the tech industry boomed. And others have raised concerns that past pushes for deregulation — enacted under President Donald Trump — had resulted in laws and political conditions ripe for neglect.
“It’s just hard for me to believe that a big piece of this was not a failure of the supervisors to look more closely at a fast-growing bank, which of course parallels the failure of the bank to adequately assess its funding risk,” said Daniel Tarullo, a professor at Harvard Law School who served as a member of the Federal Reserve Board from January 2009 to April 2017, overseeing supervision and regulation.
Appearing Thursday on Capitol Hill, Treasury Secretary Janet L. Yellen told lawmakers that more examination was warranted: “I think we need to look into the regulators — to exactly what happened to create the problems that these two banks that failed faced — and make sure that our regulatory system in supervision is appropriately geared so that banks manage their risks.”
For now, the Fed has announced an internal investigation to determine what it may have missed, while the state of California has opened its own probe into the matter. The Fed inquiry — led by Michael S. Barr, the board’s vice chair of supervision — aims to deliver its findings by May 1.
“The events surrounding Silicon Valley Bank demand a thorough, transparent, and swift review by the Federal Reserve,” said Jerome H. Powell, the chair of the Federal Reserve Board, in a statement earlier this week.
But some financial watchdogs have demanded a more independent investigation, arguing that the Fed’s failures were so significant that an internal review won’t suffice. And lawmakers from both parties in the House and Senate have signaled Congress could follow suit: Late Thursday, a bipartisan group led by Sens. Kyrsten Sinema (I-ariz.) and Thom Tillis (R-N.C.) demanded answers from the Fed, noting it is “gravely concerning” that the bank missed key warning signs that private investors had identified before the collapse.
“It’s inexplicable that the Federal Reserve did not act here,” said Dennis Kelleher, the president and chief executive at the advocacy group Better Markets, who served as a top aide to Senate Democrats during the debate over banking reforms after the 2008 financial crisis, a law known as Dodd-frank.
The Fed is working to be “completely thorough, completely transparent and let the chips fall where they may” with its own inquiry, but officials there would “very much welcome” other external reviews, said a person familiar with the central bank’s plans, who spoke on the condition of anonymity to discuss the ongoing matter.
On the eve of its collapse, SVB had an unusually high amount of uninsured deposits — large accounts exceeding $250,000 — that reflected its popularity among the well-heeled tech set. As deposits flowed in, the bank invested the cash to earn higher returns than it was paying out in interest.
A significant portion of those assets were long-term government bonds, typically considered quite safe. But those bonds, mostly purchased at low interest rates, became less valuable when the bank needed them most: As interest rates rose, the market value of the existing bonds issued at lower rates fell. That meant the bank couldn’t easily sell its investments in the face of a cash crunch. Compounding its trouble, the tech industry faced a downturn, so many of its customers began making withdrawals to meet their own cash needs. In other words, the higher rates squeezed SVB from both sides.
The bank’s failure triggered a frenetic 72 hours in government and throughout Silicon Valley, as the Biden administration raced to shore up the country’s financial system. But some congressional lawmakers began to question why state and federal regulators hadn’t noticed the underlying problem sooner.
Chartered in California and a part of the Federal Reserve System, SVB had submitted to both state and federal oversight — meaning regulators could have reviewed its finances and prodded the bank using their supervisory powers.
Aaron Klein, a former top official at the Treasury Department now serving as a senior fellow at the Brookings Institution, said the Fed and its regional bank in San Francisco should have spotted a number of “massive red flags.” That included the “explosive growth” at SVB, its high degree of uninsured deposits and its effort, months before it failed, to borrow money against its investment holdings — a move meant to create liquidity that it could return to depositors seeking withdrawals — from the Federal Home Loan Bank of San Francisco. By the end of last year, SVB was the biggest borrower at what is seen as a lender of nextto-last resort. U.S. officials and Wall Street banks had to rescue the second-largest borrower there, First Republic Bank, on Thursday, with larger institutions placing $30 billion on deposit there to ease concerns.
Instead, Klein said there is no evidence that the Fed ever intervened in SVB’S case. “You have a lot of authority to slow the institution’s growth,” Klein said. “How the Fed supervised them seems to be under greater lock and key than Area 51,” the secretive U.S. military base some believe is where the government stores evidence of alien spacecraft.
Adding a potentially uncomfortable wrinkle, the since-ousted chief executive at Silicon Valley Bank, Gregory Becker, served as a director at the Federal Reserve Bank of San Francisco until last week. A spokeswoman for the San Francisco Fed, Jennifer Chamberlain, said Becker “had no input or involvement on oversight activities.”
The fiasco came as a shock to many in Washington, roughly 15 years after the financial crisis resulted in the Dodd-frank bank
ing law. That 2010 act empowered regulators and cracked down on banks, limiting their trading and investing while subjecting the largest firms to enhanced oversight, including periodic checkups known as “stress testing.”
While banks chafed at these rules as too restrictive, the regulations ultimately helped stabilize the financial system and restore consumer confidence. By 2018, however, Congress seized on the relative calm to ease the law.
That year, GOP lawmakers led a bipartisan push to adopt the Economic Growth, Regulatory Relief and Consumer Protection Act, which revised Dodd-frank to loosen some of the requirements for stress tests on banks with less than $250 billion in assets — essentially all but the largest. That marked a dramatic weakening of the law, since banks at the time with assets above $50 billion would have been subject to higher scrutiny. Despite protests from some Democrats, the bill passed with support from both parties, and Trump signed it into law.
Even before it was implemented, it carried significant weight: The bipartisan agreement “had the effect of just changing the perception among regulators and supervisors about what the goal is,” said Todd Phillips, a senior fellow at the Roosevelt Institute and former official at the Federal Deposit Insurance Corporation. He cited the resonance of the overwhelmingly bipartisan vote in the usually gridlocked Senate. “You had two-thirds of the Senate voting to deregulate, basically, and that was just a vibe shift,” he said.
The banking industry cheered the measure, which some companies, including SVB, lobbied for months to advance. The firm then was just barely big enough to qualify for enhanced federal oversight, with roughly $51.2 billion in assets by the end of 2017, according to its annual reports. With the new law in place, it stood to avoid heightened scrutiny the following year, when it reported assets around $56.9 billion. (By the end of last year, several years into the looser regulatory regime, the bank reported more than $200 billion in assets.)
As the Fed implemented the law in 2019, it further eased scrutiny of banks with between $100 billion and $250 billion in assets. Even those who supported the spirit of the idea — meant to spare community banks — still warned about the potential for repercussions. Lael Brainard, now a senior economic adviser to Biden who then served on the Fed board, expressed fear that the deregulatory approach would “weaken core safeguards against the vulnerabilities that caused so much damage in the [financial] crisis.”
Despite her warnings, top Fed officials also pitched the public on a hands-off approach. Explaining the philosophy at a June 2021 conference, Randal K. Quarles, then the vice chair for supervision, emphasized his goal to create “more flexibility” in a bid to benefit the economy — and stressed that the government “should choose the [approach] that is less burdensome for the system.”
“The zeitgeist coming out of 2018 was to trust the banks to manage their own risk,” said Peter Conti-brown, a professor of financial regulation at the Wharton School at the University of Pennsylvania, recalling the longterm impact of the Trump administration and its actions. “The message from Congress to the Fed was: Back off.”
Conti-brown said he agreed with Brainard’s opposition to the 2019 rules. He said Fed supervisors must have been aware of the large pool of bonds SVB held that would lose value if interest rates rose. Fed supervisors also had the tools to intervene, Conti-brown said, yet they didn’t.
“A supervisor should have been hyper-keyed into this fact and should have been saying ‘If you do not diversify this asset class, we are going to have to take dramatic steps,’ including possibly shutting the bank down, which it had the power to do,” he said.
The Federal Reserve has also now commenced an investigation into its oversight of midsize banks worth between $100 billion and $250 billion, according to a source familiar with the deliberations, who spoke on the condition of anonymity to describe private conversations. The result could be tighter capital and liquidity requirements, as well as more strenuous “stress tests,” as reported by the Wall Street Journal on Tuesday.
But the uncertainty still has sparked new, fierce debate on Capitol Hill.
Some Democrats have pushed to repeal the 2018 law that deregulated the industry — and signaled the government needs other, tougher rules to probe banks and penalize their top executives.
“If they had been in place, they may have prevented this from happening,” former House speaker Nancy Pelosi (D- Calif.) said in a recent interview.
Republicans, meanwhile, have blasted Democrats for seizing on SVB to advance a policy agenda. Rep. Patrick T. Mchenry (R-N.C.), the leader of the powerful House Financial Services Committee, pledged in a recent interview to “get to the bottom of what happened here,” as he warded off new calls for regulation.
“What we did not have was a deficiency of regulation,” he said. “It was a deficiency of regulators.”