More details have emerged about what was happening last weekend and over the weekend with Silicon Valley Bank (SVB) and DC officials. And as more information comes to light, we can more thoughtfully consider who may be to blame. We also look at any investigations that have been announced as a result of holding the appropriate people accountable and closing gaps in regulation/oversight. Finally, we take a look at the other banks swept up in the frenzy.
Fed to the rescue
SVB’s position was not news to the Federal Reserve last week. He was reportedly concerned about the decline in the value of the bank’s portfolio due to a rise in interest rates. The FDIC was concerned about a client base concentrated in the venture capital/tech start-up space. Both organizations were in-depth on the position Thursday. SVB first attempted to raise the money using advances from the Federal Home Loan Bank, which are typically used to meet needs. They also used the Fed’s discount window. The Fed provides temporary loans to banks, and the banks pledge collateral in support. It is used less frequently because of the stigma that only troubled banks fall into the discount window. One of the questions is why SVB sold those securities at a loss instead of using them as collateral at the discount window. In my view, selling securities at a loss is a stronger negative signal than going to the discount window, and apparently depositors did as well.
(For an excellent explanation of the Fed’s discount window as well as the adoption of the new Fed lending facility, see
Negotiations in Washington DC between Jerome Powell (Chairman of the Federal Reserve), Lael Brainard (Director of the White House National Economic Council), Martin Gruenberg (Chairman of the FDIC), and Treasury Secretary Janet Yellen boiled down to determining whether the SVB The move is justified by the use of a special law, the “systemic risk exception”, which allows the FDIC to guarantee deposits that exceed the $250,000 limit. Data showing outflows from Signature Bank on Friday and outflows from other midsize banks on Saturday led them to a “yes” conclusion by Sunday. Concurrently, the Federal Reserve Bank offered a special loan program to all banks to provide credit as needed.
Martin Gruenberg was reportedly the holdout. He was well aware of the potential downside of guaranteeing all deposits. If the government will keep your depositors full, what incentive would a bank have to stick to sound risk management practices? (See this WSJ article for more details—subscription may be required.)
This accessible article from the Bank Policy Institute does an excellent job of explaining the Fed’s discount window and how much money is moving in and out of the discount window and the new features the Fed created over the weekend.
Whose fault was it?
Initially, people were looking for someone to blame for this. One group alleged an easing of Dodd-Frank era regulations that prevented SVBs from being subjected to Fed “stress tests”. Regardless of your view of the bank needing to be “too big to fail”, the truth is that the stress test as currently configured would not have raised any red flags with the SVB. It was solvent. The issue was of liquidity, not solvency.
Should The Stress Test Be Revamped? In light of the new environment of rising interest rates (the interest rate environment was very different when the tests were developed, remember) I would suggest that the answer is ‘yes’.
The Fed was also the target of blame, both for keeping interest rates so low for so long, which resulted in more aggressive risk-taking as investors and venture capitalists looked for large returns, and then raised interest rates in a relatively short period of time. time period to increase.
Are venture capitalists to blame? First to pump so much money into so many businesses (many of which, in high interest rate scenarios, would never get funded.) Then to tell the startups they funded to get their cash out of SVB.
No one is disputing that the SVB management bears a great deal of responsibility. An accounting rule allowed him to hold his long-term bonds and mortgage-backed securities at par on his balance sheet because he intended to hold them to maturity. If they had “marked them to market”, reflecting their loss in value due to interest rate increases, they would have wiped out all of the bank’s equity, and then some. When he attempted to do this he needed to raise capital very quickly. The timing of the insider sale of the stock suggests that perhaps management knew what could happen (See next section.)
And what about auditors and regulators? A review by KPMG weeks before the crisis found no indication of any issues. Regulators are the people who write the rules. After this episode, there may be a need to change the rules. Supervisors are the people who enforce the rules. The Federal Reserve Bank announced that it would review its supervision of the bank because SVB’s position should have raised red flags. (See next section.)
For more on the blame game, check out this article from The Irrelevant Investor.
Test
Agencies may be at loggerheads over each other’s investigation of what happened at the Silicon Valley bank. (hill)
The Justice Department has launched an investigation, suggesting that they suspect there may be criminal wrongdoing in the (mis)management of the bank.
The SEC also announced that they would launch an investigation as they are responsible for protecting the interests of investors and would like to see if any federal securities laws were broken.
The Federal Reserve will conduct an internal investigation to see if their supervisory processes have failed and need to be improved.
Federal authorities will investigate insider stock trading by SVB executives in the weeks just before the failure. (Reuters)
Signature Bank, Credit Suisse and New Republic Bank
Signature Bank was the second bank to be seized by state regulators last week. This happened two days after the SVB was seized and $10 billion in deposits were withdrawn. The bank was heavily invested in New York City real estate, and between that and their crypto position, depositors were worried. To read more about the bank, check out this WSJ article (subscription may be required).
Credit Suisse and First Republic Bank were also facing potential failure this week. For Credit Suisse, the Bank of Switzerland provided funds to keep it afloat for the time being. (NPR) For the First Republic, a group of big US banks pooled in $30 billion in funds to save it. (AP) Rumors abound about a possible sale of the bank.
More NGPF Resources on SVB
Lesson Ideas/Discussion Questions
If you have not yet discussed the events with the class, use one of the first four NGPF resources to introduce the topic. The class can be divided into three groups, each assigned to one of the first three sections in this post, or choose one section for the whole class to tackle. Students can read the section of the blog and the linked article.
Group 1: Students can role-play the four key players in DC last weekend to determine what needs to be done to avert a full-blown crisis.
Would they have come up with the same decision (protect depositors but not the bank’s investors or management), or something different?
What are the potential issues that could arise if they decide to go ahead (bail out the banks themselves) or decide to do nothing?
Group 2: Students can debate and discuss which parties may be responsible for the crisis, going down the list in the article.
Do the students feel that the article has missed any point to support or refute the conclusion?
Group 3: These students may need to dig a little deeper here for information on rules and regulations being violated.
Students should end up with a list of possible parties and violations that may emerge from the investigation.
With regard to the Federal Reserve, the focus should have been on the role of bank supervisors, and they should have seen what was coming. For anyone really interested in this direction, here is the link of manual for commercial bank exams.