It has been a few weeks since the failures of Silicon Valley Bank (SVB), Signature Bank, and Silvergate Financial. Many are still staring into the abyss and scratching their heads, trying to figure out what happened. However, the American people can rest assured that the Republican and Democratic adults on Capitol Hill are taking this matter seriously by grandstanding and seizing the moment with sound bites. The Senate Banking, Housing, and Urban Affairs Committee held a March 28 hearing regarding the failures of Silicon Valley Bank and Signature Bank to determine what took place, who fell asleep at the wheel, and who can be blamed for these collapses.
2021: A Silicon Valley Bank Odyssey
During the upper chamber’s hearing, a key revelation was that the Federal Reserve identified “signs of distress” in the financial institution as early as 2021.
According to Fed Vice Chair for Supervision Michael S. Barr, the Eccles Building's supervisors came across deficiencies in Silicon Valley Bank's liquidity risk management. The Fed had presented six supervisory findings for the company's liquidity stress testing and risk management and contingency funding. By May 2022, supervisors issued three more findings over SVB's "ineffective board oversight, risk management weaknesses, and the bank’s internal audit function." Months later, supervisors slashed the California-based entity's management rating to "fair" and reduced its enterprise-wide governance and controls to "deficient-1." Indeed, the fact Silicon Valley Bank had no risk management officer but hired a diversity, equity, and inclusion leader demonstrates the bank's corporate governance priorities were out of whack.
(Photo by Beata Zawrzel/NurPhoto via Getty Images)
Last fall, supervisors engaged with SVB's senior management to warn about its interest rate risk profile and then soon after provided a supervisory finding on these threats to the bank. Leading to the second-largest bank failure in US history, Fed staff submitted a report to the Fed Board of Governors on the impact of higher rates on nearly two-dozen banks' financial conditions.
But how could nothing be done to address a potential calamity and black eye to the financial system? This is the $64,000 question that both sides of the political aisle tried to answer throughout the hearing.
Who’s to Blame?
The Republicans crafted a game plan that passed the buck to the US central bank and federal regulators. Despite identifying risks to the banks well ahead of the implosions, they refrained from acting to prevent a crisis. But while the regulators are requesting additional regulations and tools, some GOP lawmakers were taken aback by these requests. “If you can’t stay on mission and enforce the laws as they already are on the books,” said Sen. Tim Scott (R-SC), “how can you ask Congress for more authority with a straight face?”
Democrats blamed the event on former President Donald Trump and the bipartisan legislation: The Economic Growth, Regulatory Relief, and Consumer Protection Act. This removed regulatory barriers and burdens for small-sized and community banks while lifting the threshold considered too big to fail from $50 billion to $250 billion. This meant that SVB did not go through a stress test. So, was it a modest deregulatory push that caused this mess?
Even if SVB underwent a stress test, it would have passed with flying colors. This mechanism would have assessed how the bank would have survived in an environment of falling GDP, rising unemployment, and commercial real estate defaults instead of high inflation and rising interest rates. As Sen. John Kennedy (R-LA) pointed out: “It’s like somebody going in for a test for COVID and getting a test for cholera.”
The other component that Sen. Mike Crapo (R-ID) alluded to was that the legislation specifically gave the Fed the authority to modify regulations as it saw fit. In other words, it had carte blanche to rein in banks either on an individual basis or by category that considered a broad array of factors, such as capital structure, risk, and financial activities. Moreover, even under these categories, SVB was listed as "well-capitalized."
Sen. John Kennedy (R-LA) (Photo by Win McNamee/Getty Images)
The lengthy hearing revealed several other components of this banking saga:
SVB depositors tried to withdraw close to all of the bank's deposits over two days.
Regulators are assessing how much social media played a role in the bank run.
Resolving SVB and Signature will hit the FDIC's Deposit Insurance Fund (DIF) by $22.5 billion.
FDIC Chair Martin Gruenberg says the government needs to reassess how regulators monitor uninsured deposits.
At a fundamental level, Barr purported that it was a "textbook case of mismanagement."
Paging the Libertarians
Perhaps the best line of the roughly three-hour hearing came at the beginning when Sen. Sherrod Brown (D-OH) said in his opening statement: “Just as there are no atheists in foxholes, it appears that when there is a bank crash, there are no libertarians in Silicon Valley.” This is exactly correct. Despite justified criticisms of the Leviathan on Wall Street, where the idea that too much government hurts the economy is ubiquitous, there were many cheerleaders calling for the state to bail out the banks. While there is a debate on how it would work, there is also a bipartisan push in Washington to support uninsured depositors at some level. Any time the financial markets are on the brink of a reckoning, the corridors of power are quick to devise financial schemes to protect banks, investors, and wealthy depositors to stop a contagion event. All this accomplishes is fostering a climate of moral hazards and subsidizing malinvestment. Politicians might need to turn the mirror on themselves if they want to pass the blame on to anyone.
