Fed hit for failure to see signs of bank collapse

OVERSIGHT A Silicon Valley Bank (SVB) sign is shown in San Francisco on Monday, March 13, 2023. The Federal Reserve is being criticized for failing to see the red flags that the SVB was headed for a collapse. AP PHOTO

WASHINGTON, D.C.: The Federal Reserve (Fed) is facing stinging criticism for missing what observers say were clear signs that Silicon Valley Bank (SVB) was at high risk of collapsing into the second-largest bank failure in US history.

Critics point to many red flags surrounding the bank, including its rapid growth since the pandemic, its unusually high level of uninsured deposits and its many investments in long-term government bonds and mortgage-backed securities, which tumbled in value as interest rates rose.

“It’s inexplicable how the Federal Reserve supervisors could not see this clear threat to the safety and soundness of banks, and to financial stability,” said Dennis Kelleher, chief executive of Better Markets, an advocacy group.

Wall Street traders and industry analysts “have been publicly screaming about these very issues for many, many months going back to last fall,” Kelleher added.

The Fed was the primary federal supervisor of the bank based in Santa Clara, California that failed last week. The bank was also overseen by the California Department of Financial Protection and Innovation.

Now the consequences of the fall of SVB, along with New York-based Signature Bank, which failed over the weekend, are complicating the Fed’s upcoming decisions about how high to raise its benchmark interest rate in the fight against chronically high inflation.

Many economists say the central bank would likely have raised rates by an aggressive half-point next week at its meeting, which would amount to a step-up in its inflation fight, after the Fed implemented a quarter-point hike in February. Its rate currently stands at about 4.6 percent, the highest level in 15 years.

Last week, many economists suggested that Fed policymakers would raise their projection for future rates next week to 5.6 percent. Now it’s suddenly unclear how many additional rate increases the Fed will forecast.

With the collapse of the two large banks fueling anxiety about other regional banks, the Fed may focus more on boosting confidence in the financial system than on its long-term drive to tame inflation.

The latest government report on inflation, released on Tuesday, shows that price increases remain far higher than the Fed prefers, putting Chairman Jerome Powell in a tougher spot. Core prices, which exclude volatile food and energy costs, and are seen as a better gauge of longer-run inflation, jumped 0.5 percent from January to February — the most since September.

“Absent the fallout from the bank failure, it may have been a close call, but I think it would have tipped them toward a half-point [rate hike] at this meeting,” said Kathy Bostjancic, chief economist at Nationwide.

On Monday, Powell announced that the Fed would review its supervision of Silicon Valley to understand how it might have better managed its regulation of the bank. The review will be conducted by Michael Barr, the Fed vice chairman who oversees bank oversight, and will be publicly released on May 1.

The bank failures will likely color an upcoming Fed review of rules that set out how much money large banks must hold in reserve. Barr said last year that he wanted to conduct a “holistic” review of those requirements, raising concerns in the banking industry that the review would lead to rules forcing banks to hold more reserves, which would limit their ability to lend.

Many critics also point to a 2018 law as softening bank regulations in ways that contributed to Silicon Valley’s failure. Pushed by the Trump administration with bipartisan support in Congress, the law exempted banks with $100 billion to $250 billion in assets from requirements that included regular examinations of how they would fare in tough economic times, known as “stress tests.”

Silicon Valley’s chief executive officer, Greg Becker, had lobbied Congress in support of the rollback in regulations, and he served on the board of the Federal Reserve Bank of San Francisco until the day of the collapse.

Sen. Elizabeth Warren, a Democrat from Massachusetts, asked him about his lobbying in a letter released Tuesday.

“These rules were designed to safeguard our banking system and economy from the negligence of bank executives like yourself — and their rollback, along with atrocious risk management policies at your bank, have been implicated as chief causes of its failure,” Warren’s letter said.

The 2018 law also provided the Fed with more discretion in its bank oversight. The central bank subsequently voted to further reduce regulation for banks the size of Silicon Valley.

In October 2019, the Fed voted to effectively reduce the capital those banks had to hold in reserve.

Kelleher said the Fed still could have pushed Silicon Valley Bank to take steps to protect itself.

“Nothing in that law prevented in any way the Federal Reserve supervisors from doing their job,” Kelleher said.