Democratic U.S. Sen. Elizabeth Warren thinks she knows who to blame for the collapse of Silicon Valley Bank, and the financial fallout that followed.
The bank’s chief executive officer? Its board of directors?
They have some culpability, for sure. But the liberal senator from Massachusetts mostly delights in faulting Federal Reserve Chair Jerome Powell, who, she said in a tweet, “directly contributed” to the bank’s failure.
The political blame game over the banking industry’s latest belly flop is in full swing, with Democrats pointing the finger at Powell and his role in deregulation under ex-President Donald Trump, while the GOP is even more far-fetched in blaming progressive sustainability policies for the “woke” San Francisco bank’s failure.
Powell has had to keep the economy moving despite dysfunction on Capitol Hill and a worldwide reckoning after two decades of easy-money policies, followed by excessive amounts of pandemic relief, sent inflation soaring. And while this latest financial disaster shines a spotlight on broader economic problems, it has become obvious that Silicon Valley Bank was its own worst enemy.
The blame ought to be placed where it belongs: The bank’s leaders blew it. This high-flying institution, which rode the wave of big-money tech startups, would still be around had it taken to heart the lessons that turned Chicago’s financial markets into world beaters, beginning in the 1980s.
How so?
Our city’s exchanges pioneered the use of sophisticated financial products for managing interest-rate risk. Working together with the swaps industry, its Treasury and eurodollar contracts made it easy and affordable for banks and other institutions to hedge against big swings in rates. Essentially, the exchanges sold insurance for the day when interest rates moved against fixed-income investments. Many banks routinely use these and related financial products to protect their portfolios.
Silicon Valley Bank had invested in Treasuries and highly rated mortgage-backed securities that are generally viewed as safe. But when rates go up, even high-quality bonds stand to decline in value. As the Fed launched its campaign against inflation, rapidly sending rates higher to cool down prices, the obvious move for the bank was to beef up the hedge on its vulnerable holdings. A comprehensive insurance plan would have saved it, and the bank had more than a year to get its act together.
Its leaders instead rolled the dice, evidently deciding to pocket the money that would have gone to hedging, while leaving the bank dangerously exposed. What happened next was predictable, at least to the Chicago market savants who coincidentally gathered this week for an annual industry conference.
Speaking at the Futures Industry Association confab on Tuesday, Terry Duffy, chairman and CEO of Chicago’s CME Group, echoed a common sentiment among the participants: “Banks need to manage their risk just like farmers need to manage their crops,” he said. “We just did not see that.”
Rather, Duffy said, he saw “a complete failure” of risk management from an institution that could “easily” have averted the crisis. “People need to make sure they’re mitigating and managing risk.”
No kidding. The only good news, from Duffy’s perspective, was that CME and other financial markets performed smoothly even as panicky sellers sent trading volumes soaring. The markets passed a stress test with flying colors.
Silicon Valley Bank, of course, didn’t, and it’s not alone. Two other tech-centric banks, Signature and Silvergate, also failed, while the much-larger Credit Suisse came under pressure, causing Switzerland’s central bank to offer rescue funding Wednesday.
One of the mistakes that Warren places at Powell’s feet is a 2018 banking deregulation bill that Trump signed into law. The legislation exempted the San Francisco institution and other mid-size and smaller banks from many of the rules adopted after the 2008 financial crash.
Powell supported the main features of the bill, as did the GOP and 17 of Warren’s fellow Senate Democrats. Much of the bill made sense, as it helped to support smaller players in a banking industry dominated by giants that had to be bailed out on a massive scale during the crisis 15 years ago.
But, as we know now, it was overly trusting to expect all those smaller banks to conduct routine risk-management functions, such as stress testing and scenario planning for sharply higher interest rates. And while it would have been satisfying to let the chips fall at Silicon Valley Bank, the Fed, Treasury and Federal Deposit Insurance Corp. were prudent in stepping in to save depositors, as this page noted Monday.
The appropriate response at this point is to idiot-proof the regulations, and we expect banking regulators to tweak their rules to protect bad bank managers from themselves. The wrong response is to lose sight of the bigger threat to the global economy.
Inflation needs to be whipped. The Warrens of the world are campaigning against the Fed’s efforts to bring down prices, urging its policymakers to sit on their hands when they meet next week.
We don’t know yet all the knock-on effects from the current market turmoil, but we know this much: Compared with a run on a mid-size bank, or even a string of small bank failures, inflation is much more destructive to the economy and the lives of everyday people. The U.S. has not experienced price increases at the current levels in decades. Battling inflation is job No. 1 for Powell and the world’s other central bankers. Let’s hope they do their job, in careful, measured fashion, even if the stewards of Silicon Valley Bank failed in their responsibilities.
