Originally published at Project-Syndicate | April 13th, 2023
In the month since Silicon Valley Bank collapsed, four possible culprits have emerged. But as long as we have banks, we will always have bank failures, which is why we need regulators to draw the right lessons from the SVB debacle, incorporate them into their procedures, and get back to work.
BERKELEY – When a banking crisis erupted in early March, pundits rushed to the battlements, or at least to their studies, to hammer out columns assigning the blame. Unsurprisingly, those early assessments, based on still-incomplete information, often contradicted one another. It is worth recalling Walter Raleigh’s dictum: those who follow too close on the heels of history risk getting kicked in the teeth.
A month later, the narrative has coalesced around four aspects, or interpretations, of the crisis. The first is what might be called the incompetent-management view. Silicon Valley Bank’s top management was better at glad-handing tech firms than taking prudent investment decisions. Astoundingly, for much of 2022, SVB, a $200 billion financial firm, had no chief risk officer. While their counterparts at other banks had returned to the office, work from home remained the norm for SVB’s key managers, who were spread across six time zones, from Hawaii to the US East Coast. Anyone who has first-hand experience with remote work will know that such arrangements are not conducive to taking hard decisions.
So, SVB managers, seeing the bank’s deposits soar, took the easy route and loaded up on Treasury bonds. They purchased hedges against interest-rate exposure, but then abandoned those positions in a cost-saving measure at the worst possible time.
The second interpretation is the incompetent-customer view. SVB’s corporate customers parked deposits at the bank that far exceeded the Federal Deposit Insurance Corporation’s $250,000 ceiling per account; prudent cash management would have dictated holding those balances at the largest banks with the strongest balance sheets or with money market funds. Then, having been rudely awakened to the fact that there is such a thing as uninsured deposits, SVB’s customers withdrew their funds in a panic, which spread like wildfire on social media.
A third view blames incompetent regulators. SVB’s CEO was no stranger to the Federal Reserve Bank of San Francisco: he served on its board of directors. The Fed was aware that SVB’s deposits had risen by 400% in five years, leaving it with more loanable funds than it knew what to do with. This should have been the regulatory equivalent of waving a red flag in front of a bull. But, starting in 2021, the Fed warned SVB only about “matters requiring attention.” On top of this, the Fed’s stress tests did not incorporate the possibility that inflation and interest rates might rise significantly.
The fourth view emphasizes ill-advised macroeconomic policies. A long period of low policy rates encouraged banks like SVB, stretching for yield, to pile into long-term bonds. Eventually, reckless deficit spending was inevitably followed by a burst of inflation, needed to bring down the government’s debt burden. More precisely, inflation reduced the debt burden by compelling the Fed to hike interest rates, which caused bond prices to crater, inflicting losses on the bondholders, including the banks.
The result is a bit like the conclusion of Agatha Christie’s Murder on the Orient Express: everyone did it.
The question is what to do about it now. While we can plump for better bank management, there will always be inexperienced bank managers, and board members too distracted to provide effective oversight. We can pass legislation allowing the FDIC to claw back bonuses paid to managers of failed banks. We can revisit double-liability laws from the nineteenth century, when a bank’s shareholders were on the hook for more than just the current value of its assets when it went bust.
We can seek to educate depositors better. But SVB’s customers were better educated than most. The reality is that bank customers generally, and not only high-tech entrepreneurs, have other things on their minds. To be sure, SVB’s failure was a wake-up call. But history tells us that, sooner or later, depositors will go back to sleep. The idea that depositor discipline can rein in excessive risk taking by banks is an illusion: the typical depositor is not a credit analyst. Congress should not hesitate, therefore, to raise the insured-deposit ceiling on transaction accounts.
Likewise, we can always make better macroeconomic policy. But, for many of those now arguing that monetary and fiscal policies fueled the March banking crisis, hindsight is 20/20. No one believes that the authorities are, or for that matter should be, prepared to subordinate interest-rate and fiscal policies – currently directed at maintaining low inflation and high employment – to the sole pursuit of financial stability.
It follows that the only viable solution is more effective bank regulation. Some argue that regulators cannot be trusted, and that regulation can never be effective. They invoke SVB as a case in point. This cynical view is in fact a counsel of despair. As long as we have banks, we will always have bank failures. Given this reality, we need regulators to draw lessons from the SVB debacle, incorporate them into their procedures, and get back to work.
Barry Eichengreen: Professor of Economics at the University of California, Berkeley, is a former senior policy adviser at the International Monetary Fund. He is the author of many books, including In Defense of Public Debt (Oxford University Press, 2021).