Silicon Valley Bank—here we go again

By now I am sure many people are aware of the Federal Deposit Insurance Corporation’s (FDIC) takeover of three failed banks:  Silicon Valley Bank (SVB), Signature Bank, and Silver Gate. The banks failed when they did not have the funds in reserve to pay depositors who needed to withdraw their money loaned to the bank. During the Pandemic the Federal Reserve removed the requirement for banks to maintain a reserve on their deposits. The Biden Administration determined that the pandemic emergency was over in 2022, but the banks are still not required to maintain a reserve which would make them better able to handle a crisis.  Ninety percent of the deposits at SVB were not insured by the FDIC. The customers have been told that they will be made whole for the full amount that they have on deposit at the bank, even if it is more than the FDIC’s $250,000 cap. President Biden and Treasury Secretary Yellen have assured the public that this is not a bail out. No taxpayer dollars are being given to the banks. I think it may be too early to tell. The plan that they came up with over the weekend to cover depositors could work if the next bank run isn’t more than $25 billion which is the amount currently proposed for this fund. The problem is that there are over $1 trillion of uninsured funds among banks in the U.S.

Abating Fears
I understand the need to quell fears on Main Street and Wall Street necessitated pulling together a plan over the weekend. SVB held accounts for tech startups. Tech companies are a major industry for the U.S. Startups are cash poor and rely heavily upon their investors to keep their companies afloat. It is vital to their cash flow so that they can continue operation and pay employees. It is amazing to see how quickly the government moves to shore up the economic system when it is abused by the “titans of industry.” I hope that these measures may stem the uncertainty in the banking market, but I have my doubts. Moody’s, the rating agency, has already downgraded the ratings for six other banks:  Comerica Bank, First Republic Bank, Intrust Bank, UMB Bank, Western Alliance Bank, and Zions Bank. These banks show signs of the same liquidity problem as SVB.

Relaxing Regulations
Dodd Frank regulations were rolled back in 2018 for community and mid-sized banks to help lessen their reporting burdens. They lobbied Congress that the laws were better suited for larger banking entities and did not apply to financial institutions of their size. SVB was one of the banks lobbying Congress. At the time, Senator Elizabeth Warren warned that rolling back the regulations was going to lead to more failures, and she was correct. Former Massachusetts Senator Barney Frank, who helped to craft the Dodd Frank regulations after the financial meltdown in 2008, now sits on the board of the failed Signature Bank where he lobbied Congress to roll back those laws that he originally wrote while a member of Congress.

Rising Interest Rates
It seems like the Federal Reserve Bank’s rapid rise in interest rates also assisted the collapse of SVB. When interest rates were low the bank invested in Long Term Treasury Bonds, unfortunately when the Fed began raising rates the value of the bonds decreased. The bank did not rethink their strategy. When customers pressured them for their deposits the bank had to try and sell the bonds before they reached maturity, doing so at a loss. The sale could not cover their obligations when depositors began taking their money out of the institution. The rapid rise in interest rates has all kinds of effects besides triggering a recession and raising unemployment as the Federal Reserve hopes to slow down the economy.

Poor Risk Management
There was also poor management by the bank leadership and depositors alike. Many depositors had put all their eggs in the SVB basket and were left without any recourse when the bank began to fail. We are talking about millions of dollars in deposits, not a few thousand. SVB’s clientele was a high concentration of tech startups which are risky by nature. Diversification helps to spread risk and you would think SVB would be well aware of this and encourage a variety of businesses to become customers. The leaders at the bank saw where things were going and sold their stock interests before they lost too much value. They should have been offset by a distribution of clients with lower risk profiles. As the bank was losing solvency the SVB executives cashed out of their positions and gave themselves bonuses. The CEO of SVB, Greg Becker, sold off 3.5 million in stocks before the collapse.

Moral Hazard
Some are concerned that this new FDIC plan will encourage ‘moral hazard’ among the banks. Now that they have the government guaranteeing their deposits. It will make it harder for them to fail and may encourage even more reckless risk taking. We keep hearing from the current Congressional majority that the government spends too much money. With the country growing in population and the increase in man made disasters like bank failures, not to mention natural disasters, how do you keep from spending to maintain the status quo?

The FDIC is backed by the full faith and credit of the U.S. Government. If the 25 billion fund proposed is depleted, the U.S. Government will keep the program afloat by having the Federal Reserve lend it money. The plan is to assess the banks to fund the FDIC program that guarantees depositors will get all their money, not limited to the $250,000 cap. In return, the banks will have to repay the loan and fees for participating in the program. President Biden asserts that this is not a bail out. He is promising the banks will be back stopped by the Fed with a limitless supply of cash for their depositors. There is nothing to stop the banks from passing on their costs to the customers—nothing so far. The Federal Reserve may once again be injecting money into the economy, which we are told contributes to inflation that the interest rate hikes are supposed to address.

Conclusion
The banks were rescued over the weekend. Meanwhile, there is still hand wringing over whether to forgive $10,000 to $20,000 of student loan debt used for the purpose of education. The people of East Palestine, OH are still waiting for a thorough examination of their environment. The land has not yet been tested for the presence of dioxins. They don’t know if it is safe to return to their homes or how they will be able to sell their homes if they decide to leave the area. If they require medical attention because of the toxic spill, how will they pay for health care? Where is the help for these people who, through no fault of their own, suffered this great tragedy that could possibly have been avoided by proper regulation of the freight rail industry? The rail line responsible for the crash, Norfolk Southern, has lobbied against many safety regulations that would cut into the highly profitable company’s bottom line. The failure at the banks, the failure at FTX, the failure of Norfolk Southern are all related through a very small appetite for necessary regulation and little concern for safety and stability. It is more important to have a strong quarter-showing for the shareholders.

Lauryn Hill says, Consequence is no coincidence.