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https://apnews.com/article/federal-reserve-silicon-valley-bank-regulation-609bde9b9248fbc590ff98775e0c8d49
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Fatima Hussein
Fatima covers the U.S. Treasury Department
fatimathefatimafhussein@ap.org
https://apnews.com/article/federal-reserve-silicon-valley-bank-regulation-609bde9b9248fbc590ff98775e0c8d49
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* Technology
* Business
* Financial services
* Federal Reserve System
* U.S. News

FED CRITICIZED FOR MISSING RED FLAGS BEFORE BANK COLLAPSE

By CHRISTOPHER RUGABER and FATIMA HUSSEINyesterday

1 of 4
A pedestrian passes a Silicon Valley Bank branch in San Francisco, Monday, March
13, 2023. As the primary regulator of the bank, the Federal Reserve is coming
under sharp criticism from financial watchdogs and banking experts. (AP
Photo/Jeff Chiu)

WASHINGTON (AP) — The Federal Reserve is facing stinging criticism for missing
what observers say were clear signs that Silicon Valley Bank was at high risk of
collapsing into the second-largest bank failure in U.S. 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 Silicon Valley Bank, 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.

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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%, 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%. 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 Tuesday, shows that price
increases remain far higher than the Fed prefers, putting Chair 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% from January to
February — the most since September. That is far higher than is consistent with
the Fed’s 2% annual target.

Silicon Valley Bank customers line up to withdraw money
Business customers of Silicon Valley Bank expressed relief as they waited to
withdraw their money on Monday after the federal government stepped in to
guarantee deposits following the bank's stunning collapse. (March 13) (AP
Video/Terry Chea)

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“Absent the fallout from the bank failure, it may have been a close call, but I
think it would have tipped them towards 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 chair who
oversees bank oversight, and will be publicly released May 1.

A Federal Reserve spokesperson declined to comment further.

Elizabeth Smith, a spokeswoman for the California Department of Financial
Protection and Innovation, said, “We are actively investigating the situation
and conducting a thorough review to ensure the Department is doing everything we
can to protect Californians.”

By all accounts, Silicon Valley was an unusual bank. Its management took
excessive risks by buying billions of dollars of mortgage-backed securities and
Treasury bonds when interest rates were low. As the Fed continually raised
interest rates to fight inflation, leading to higher rates on Treasurys, the
value of Silicon Valley Bank’s bonds steadily lost value.

Most banks would have sought to make other investments to offset that risk. The
Fed could have also forced the bank to raise additional capital.

The bank had grown rapidly. Its assets quadrupled in five years to $209 billion,
making it the 16th-largest bank in the country. And roughly 94% of its deposits
were uninsured because they exceeded the Federal Deposit Insurance Corporation’s
$250,000 insurance cap.

That percentage was the second highest among banks with more than $50 billion in
assets, according to ratings agency S&P. Signature had the fourth-highest
percentage of uninsured deposits.

Such an unusually high proportion made Silicon Valley Bank highly susceptible to
the risk that depositors would quickly withdraw their money at the first sign of
trouble — a classic bank run — which is exactly what happened.

“I’m at a loss for words to understand how this business model was deemed
acceptable by their regulators,” said Aaron Klein, a former congressional aide,
now at the Brookings Institution, who worked on the Dodd-Frank banking
regulation law that was passed after the 2008 financial crisis.

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 — Silicon Valley’s size — from requirements that included
regular examinations of how they would fare in tough economic times, known as
“stress tests.”

Silicon Valley’s CEO, 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 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.

___

AP Economics Writer Paul Wiseman contributed to this report.

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After two historic US bank failures, here’s what comes nextWASHINGTON (AP) — Two
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