U.S. bank turmoil reflects blatant failure by the Fed, expert says
Nicolas Veron says move to secure all deposits raises risk of future instability
WASHINGTON -- Financial markets worldwide are rattled by the bankruptcy protection filing by Silicon Valley Bank and troubles faced by other American banks.
How did U.S. regulators not detect the potential crisis until recently, and was the handling of the bankruptcy appropriate?
Nicolas Veron, a senior fellow at the U.S.-based Peterson Institute for International Economics, accuses the Federal Reserve of failing to supervise Silicon Valley Bank and says there was "no proper monitoring of interest rate risk" as rates were increased to fight inflation.
This excerpt from his recent interview with Nikkei has been edited for brevity and clarity.
Q: Do you think the response by the U.S. Treasury and Federal Reserve has been good?
A: It has probably been sufficient to end the crisis moment, at least temporarily. But it doesn't look very good, for two reasons. One is, of course, the supervisory failure on Silicon Valley Bank. The other point is more in terms of the crisis management.
There was a supervisory failure of the Federal Reserve System, and the failure is pretty blatant. There apparently was no proper monitoring of interest rate risk. That doesn't look good.
Silicon Valley Bank was allowed to expand its balance sheet very significantly. It roughly tripled in three years, without a viable business model. That is supervisory failure.
The supervisory failure cannot just be excused by the Trump administration's deregulation. To be sure, all the stuff the Trump administration did, in terms of loosening the regulations on medium-size banks like Silicon Valley Bank, looks very bad now.
But that doesn't justify the Federal Reserve's supervisory failure. Even if the regulatory framework is not demanding enough, the Fed should look for this kind of risk, should make sure that supervised banks have a viable business model, so we cannot blame it all on Trump.
Q: Your opinion is that fully reimbursing all deposits of SVB and Signature Bank will have a long-term negative impact?
A: They didn't have to do that. They could have handled it, from a financial stability perspective, by the normal playbook.
It is possible, even likely, that the uninsured depositors may not have gotten all their money back. I think they would have gotten at least half of their money back quite quickly, but maybe not all of it, certainly not all of it quickly. But my argument is that the crisis could have been managed, probably, and it would have been better to try to do it that way, without this unlimited guarantee on deposits.
And then you have to ask, "So why did it do it?" I think the short answer is to bail out Silicon Valley -- not to bail out the banking sector, [but] to bail out the innovation ecosystem of Silicon Valley.
Q: Do you mean that fully reimbursing deposits is the wrong way, at this time?
A: I put it in the U.S. context. This notion of the limited guarantee on deposits -- the idea that there is a federal guarantee, but up to a certain threshold, which at this point is $250,000 per account -- has been a central feature of the U.S. system for almost 90 years. There was a departure from that at the peak of the crisis in 2008, at the moment when there was general instability in the financial system, which required extraordinary measures. But I don't think we had that last Friday.
Conditions were pretty calm until Friday morning last week. Silicon Valley Bank was large, but not "that" large. I think it's reasonable to infer that the authorities will make the exact same decision for future cases -- for medium-size banks at least, if not small banks.
During her Senate hearing on Thursday, [Treasury Secretary] Janet Yellen denied that. She appeared to mean, "No, no, no, this is just about those two banks, and you shouldn't extrapolate anything about the future." I don't think that was very convincing.
And I don't think there is a satisfactory answer to that. In my view, there has been a pretty strong signal sent that the same will be done in the future for other banks. If that's not the case, then I think you have more instability down the line, because it's perfectly reasonable for depositors, large depositors at this point, to expect that their deposits will be insured well beyond the ostensible limit, and in practice for unlimited amounts, going forward.
If they do [the same in the future], then they confirm what I suspect, which is, in practice, an unlimited guarantee is permanent and general. Now, if they don't, I think they trigger a very significant episode of instability. Maybe it will be manageable; maybe not.
That's why I'm very critical of that decision, because I think it creates a new reality. It raises a number of questions.
And then the question on the fact, what the consequences of that will be, from the moral hazard and future bad behavior or instability. That's much more difficult to predict with any degree of confidence.
I think they didn't handle it very well, and now there is a lot of doubt about the very signal that the Sunday package was supposed to send, which is, you know, that deposits are secure.
Q: In Japan, deposits were fully insured until 2005. The reason for lifting the full insurance was that the banks needed to regain their discipline so as not to take too much risk.
A: That's a very good point. You could create a theory that unlimited deposit insurance in the U.S., if indeed it's now general and permanent, will undermine the dynamism of U.S. capital markets.
Q: The outflow of deposits from Silicon Valley Bank or Signature Bank was very rapid. It was caused by social media and messaging apps. The depositors were using bank apps and could move their money very easily and very quickly. Does this new type of bank run require new regulation?
A: There was conventional wisdom that deposits are "sticky," to use the usual wording. Clearly, the deposits of Silicon Valley Bank were not sticky. Conversely, the Greek crisis in 2015: Greece is a cash economy, to a certain extent, but many people in Greece in 2015 already had those banking apps on their smartphone, and deposits were very sticky. I think it's a bit more complicated than that.
I think it makes crisis management more challenging. But I'm not convinced it changes the fundamentals of bank crisis management.