Did regulation fail in the recent bank failures?
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With the collapse and subsequent government takeover of Silicon Valley Bank and Signature Bank, questions are being raised about what happened in the leadup to the debacle — and why regulators didn’t act until the situation spiraled into a crisis.
Of particular debate is the Dodd-Frank bank regulation framework enshrined after the 2008 financial crisis. The law was meant to allow the government to better prevent bank collapses and strengthen the financial system. According to Peter Conti-Brown, professor of financial regulation at the Wharton School of Business, those checks likely failed this past week.
“Banking is different than your local restaurant or the place that sells you shoes or sporting goods — banks have supervisors that watch their every move,” he said in an interview with Marketplace’s David Brancaccio. “There were so many red flags in Silicon Valley Bank — [which] were not only ones that could have been spotted by the supervisors, but as we will learn, probably were spotted by the supervisors. And the question is now only, ‘Why didn’t they do anything about it?'”
The following is an edited transcript of their conversation.
David Brancaccio: Nothing like a bracing, savory session of Tuesday morning quarterbacking from the sidelines here, you and me. But let’s talk: was there a decent chance that regulators could have done more?
Peter Conti-Brown: I’d say those chances are better than decent. And indeed, I don’t think we’re Tuesday morning quarterbacking, we’re holding them to account — were the ones who need to do it. The friendly amendment I would offer is it’s not necessarily the regulators — those folks sitting in Washington writing big rules, although I think they have something to do here too. But banking is different than your local restaurant or the place that sells you shoes or sporting goods — banks have supervisors that watch their every move. They’re in those banks all the time, and the red flags — and there were so many red flags in Silicon Valley Bank — [which] were not only ones that could have been spotted by the supervisors, but as we will learn, probably were spotted by the supervisors. And the question is now only “Why didn’t they do anything about it?”
Brancaccio: So in the case of Silicon Valley Bank, people paying attention would have seen some hints that go beyond the macroeconomic stuff like, “Yes, the Fed is going to raise interest rates that could put stress on banks,” that there was certain signs there that should have been more aggressively pursued?
Conti-Brown: There are three sets of signs where the Silicon Valley Bank was acting in ways that should not have been done. One was on the asset side of their balance sheet, one was on the liability side of the balance sheet, and the other was the fact that they aspired to be a kind of venture capital incubator and financial services provider and basically non-banking services provider without a license. On the liability side, they have they had a ratio of 20 to one of uninsured deposits to insured deposits. To give you context, here, Bank of America is two-to-one in those same places. Chase is one-to-one. Bank supervisors have long known how flighty uninsured depositors are. And so this is something that banks supervisors would have been filing in their examination reports during this period of breathtaking deposit growth.
Brancaccio: And on the asset side?
Conti-Brown: On the asset side, it is no one’s surprise at all that the Fed in March of 2023, is in the middle of an interest rate hike cycle. The fact that Silicon Valley Bank had more than 50% of its assets in mortgage-backed securities that it had purchased when the interest rates were at the zero-lower-bound is something that they would have filed to the bank supervisors from the very first time they purchased those assets. It’s too late in the day to cry ignorance that they didn’t know interest rates were going to continue to go up. And so that’s just a mismanagement of that asset side. And it happens every single time the Fed goes through an interest rate hike cycle. Supervisors coordinate with banks to say, “Hey, are you managing this OK? Are you still able to get what’s called net interest income, by having assets that generate more interest in you’re paying on liabilities?” And for reasons that we simply don’t know, neither supervisors nor Silicon Valley Bank took steps to neutralize these challenges until so far too late in the day.
Brancaccio: Here, I’ll try to become a bank lobbyist three weeks ago, before this unfolded: “Just a medium-sized bank, leave us alone, we don’t pose a systemic risk, let us do what we got to do.” I mean, that had been sort of part of the thinking.
Conti-Brown: And I think those bank lobbyists make a really good point. I think what we’re looking at right now is either we saw, in Washington, a dramatic overreaction, because this “medium-sized bank” with much distress to its uninsured depositor customers, and much distress to the VC and tech ecosystem, probably should have failed with a less dramatic guarantee and intervention. And, or, in fact, they did pose a systemic risk in our banking system that is hyper-fragile. And that all of the efforts that we made in 2008 and 2010 have come to naught. Neither is a good story to tell. And one of them has to be true.
Brancaccio: I mean, let’s follow up on that. We’ve spent so much time on this program covering the creation of the new rules that followed the 2008 financial collapse, the implementation, the legacy, talking about, for instance, Dodd-Frank. And the idea, right, was that we don’t want to do another bailout in the future of financial companies, the big ones that pose risks to the wider financial system. Now, there are bailouts of, I guess, medium-sized banks. What does that tell you?
Conti-Brown: Let’s be clear that this is not just a bailout of Silicon Valley Bank’s uninsured depositors or Signature Bank. This is a bailout of every other poorly managed bank that the market was ready to send into insolvency. As a referendum on that bad management, and the government’s actions weekend stopped that — either because we were facing a full-blown financial panic, or because those stakeholders were spared the downside risks of the recklessness. Dodd-Frank was meant to stop all of this, and it didn’t.
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