Three BU experts on banking, law, and financing answer three questions about Silicon Valley, Signature Bank, and what happens next
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March 13, 2023
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- Rich Barlow
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Reacting to the collapse of Silicon Valley Bank late last week, the second-largest bank failure in US history, President Biden on Monday vowed to do “whatever is needed” to forestall more runs. “Americans can rest assured that our banking system is safe, your deposits are safe,” Biden said.
How can he be sure?
SVB collapsed after many of its start-up depositors made a run on the bank amid a venture capital crunch in the tech sector. Then on Sunday, New York’s Signature Bank also closed after a run touched off in part by panic over Silicon Valley’s shuttering. The double whammy spooked observers about a possible contagion spreading to other banks and causing a financial crisis. But government regulators promised that depositors at both failed banks would be covered for their losses, overriding federal deposit insurance’s normal cap of covering deposits only up to $250,000.
Some politicians warned against a taxpayer bailout of banks that may have acted rashly, and Adam Guren, associate professor of economics at Boston University’s College of Arts & Sciences, says once the crisis is dealt with, analyzing what happened and why will be critical.
“Right now, we’re in the fire phase. We need to put the fire out,” says Guren. “Then we need to do the postmortem on what went wrong and how do we change our fire code.” BU Today asked Guren; Mark Williams, master lecturer in finance at BU’s Questrom School of Business, a former bank examiner for the Federal Reserve, and author of a book on the 2008 crisis; and Cornelius Hurley, adjunct professor at the School of Law, for some perspective on what happened, and what’s next.
Q&A
with Adam Guren, Mark Williams, and Cornelius Hurley
BU Today: Big question first: How worried are you that this will cascade into a financial crisis?
Guren: Not that worried, but we always have to be aware of downside risk. It seems like the government is taking that very seriously. I think it’s possible that other, particularly small and regional banks fail. The Fed is guaranteeing all the deposits. In a situation where it does turn out to be a run, the Fed would just lend like crazy to big banks against their fundamentally good collateral, when prices drop and there’s a fire sale, and backstop the panic. The prices of the collateral would come back up, and the Fed would sell it back to the banks. So, I’m not super worried about the biggest banks at this point. I think people are looking at pulling their money out of smaller banks, moving money from Bank of Insert Town Name Here to Bank of America or JPMorgan Chase or Wells Fargo. The concern is those smaller banks don’t have the assets to pay off all their depositors. This isn’t new, we know what the problems are. The government is saying the deposits are good, regardless of whether they’re insured, and their hope is that that stops the panic. SVB was special. I don’t have enough cash in a bank to go above the FDIC [insured] limit. The concern is that businesses, which have over $250,000 in cash at times to do things like clear payroll, would be worried about banking with a smaller bank and set off a run. I don’t think anybody with less than $250,000 should be worried that deposit insurance isn’t going to work. Two, [SVB] grew like crazy in 2020 to 2022. When your deposits grow like crazy, you need to hold assets to back those deposits, so they bought a bunch of mortgage-backed securities and Treasuries at extremely low interest rates.
Williams: The sudden bank run and [bank] collapses in less than 48 hours is very concerning.Based on asset size, these represent the second- and third-largest bank failures in US history. If not quelled, bank runs can spread like wildfire, crippling even the soundest of banks. This is why President Biden spoke before the markets opened Monday. His goal was to eliminate depositor concerns. Ironically, 90 years ago almost to the day, President Roosevelt gave a similar speech during the throes of the Great Depression. [By] the way markets have responded to Biden’s speech, and continued run on First Republic Bank of San Francisco, it appears the crisis of confidence is far from over.
Hurley: I think what [regulators] did quelled the beast for the near term. But the FDIC insurance cap is $250,000. That was yesterday. Today, it’s infinity. Uninsured depositors [at the two banks] are guaranteed to infinity. I think it’s overkill, because it calls into question the very nature of our financial services system. If everybody’s deposit is insured, who needs regulators anymore? What they did applies to two banks, [but] they’re sending the signal that any bank can borrow from the Fed now. It used to be that if a bank borrowed from the Fed, there was a certain stigma that went with that. Now, it’s just open enrollment, as long as you have collateral, the capital.
Right now, we’re in the fire phase. We need to put the fire out.
BU Today: Are circ*mstances materially different from the 2008 financial meltdown, such that we’ll avoid a broader financial crisis?
Guren: Yes. They’ve weakened Dodd-Frank, but one of the things Dodd-Frank did is, all the banks have living wills, so that the federal government can take them over [if necessary] and unwind them. I like to think of 2008 as a run on the shadow banking system [financial institutions that acted like banks but without banks’ regulation]. In 2008, we didn’t have the information on this stuff. Now the Fed has a lot more information and can unwind things. I also think the main difference is the collateral that the banks are holding is US Treasuries, and [in 2008] it was mortgages that were foreclosing. I don’t think we need to worry about US Treasuries not being fundamentally good collateral. The person who essentially created the field of central banking, Walter Bagehot, an editor for The Economist in the 1860s and 1870s, had this dictum: [central banks] should lend freely at a high rate of interest, on fundamentally good collateral, to banks. That’s been the guiding light for central bankers in these sorts of crises. In this case, the collateral is fundamentally good: it’s US Treasuries.
Hurley: Yes, I think so. Number one, the banking industry itself—that’s why I think this was overkill—is materially better off today in terms of capital, liquidity, and stress tests. Point two is that the crisis of ’08 was largely a credit crisis. This is a balance sheet crisis. [The 2008 crisis] was all about subprime [mortgages] and shadow banking and not being able to determine the value of subprime assets [banks held]. That was more systemic. This, I believe, could be more contained. Silicon was an outlier. They had well over $100 billion of uninsured deposits that they turned around and bought 10-year Treasuries with. There aren’t many banks as vulnerable as Silicon was.
Williams: Yes. The big difference is that banks failed [in 2008] because of bad loans and poor credit underwriting. By the time the Great Recession ended, over 600 banks failed. Today’s banking crisis was triggered by bad risk management practices around deposit management and interest rates. Each of the failed banks focused on a risky, concentrated customer segment, quickly grew deposits, converted these funds into loans and bonds when interest rates were low, and assumed interest rates would not quickly rise. Based on this array of flawed assumptions and mismanagement, each bank put billions of funds to work, some in loans and others in bonds.Most of these investments were made at lower interest rates.As inflation increased, by 2022, interest rates skyrocketed and these longer-term loans and bonds lost market value. The Achilles’ heel was that these banks never thought their concentrated customer base would ever fall on hard times or as depositors stampede for the door. It was also as if they took it as fact that depositors would always keep their monies at the bank, even if in excess of FDIC insurance limits.
BU Today: Are the reforms made back then, like the Dodd-Frank Act, and the Biden administration’s current efforts enough to address this problem?
Guren: I think yes. There’s a chance that everybody still freaks out and pulls their money out of these banks, despite essentially guaranteeing deposits. But if a lot of businesses pull their money out, I think [the government] is going to step in and allow the banking system to consolidate [into fewer, bigger banks]. There’s a big policy question, which is, “Do we want the banking system to consolidate?” I don’t have an answer right now, but regulators and politicians need to ask themselves, is that something they’re OK with? What am I concerned about? One, if this does get out of hand, can the US Treasury do what it needs to do if it’s backed up against the debt limit [which some House Republicans are opposed to raising]. I am not underestimating the ability of Congress to do this under the gun, but that’s one concern. The other concern is we still have an inflation problem; does this give the Fed concern about raising rates? My sense is probably not, but maybe it does. We need to figure out what went wrong with the regulators here and increase deposit insurance. Because obviously, $250,000 just isn’t cutting it. The areas in which [Dodd-Frank] has been watered down is to limit the extent of regulation on small to medium banks. To the extent that everybody’s concerned about the contagion to smaller banks, those are precisely the banks that we’re not regulating as toughly.
Williams: The 2008 financial crisis demonstrated the need for stronger regulation to prevent banks from engaging in excessive risk-taking. After Dodd-Frank was passed, it was watered down under the Trump administration. One area that changed was in defining what banks would receive the highest oversight, designated as Systemically Important Financial Institutions. This important threshold was eventually moved up to only include the biggest banks, with assets of $250 billion and above.
In 2023 it is clear that watering down Dodd-Frank was a bad policy decision, as Silicon Valley Bank, at $210 billion, and Signature Bank, at $110 billion, clearly were systemically significant banks that should have been more closely scrutinized.
The Biden administration policy of adding additional [government lending to] banks to buffer against future bank runs is a helpful first step.As is charging banks higher FDIC fees to pay for insurance needed to help defer the cost of those banks that fail. Hearings to better understand why these banks failed so rapidly will also help in developing future preventative measures. Most importantly, the president made it clear that stronger bank regulation over risky bank behavior would be put in place. In essence, some of the holes in Dodd-Frank would be sealed up.
One additional reform idea—banks should be required to maintain greater capital levels,not just based on the amount of credit risk, but also on the amount of interest rate risk they are willing to take.
Hurley: They weakened the Dodd-Frank regulations in 2013, ’14, ’15 that allowed this to go on. I think we need to read those regulations and where they need to be strengthened. The problems were there lurking in plain sight, and it was a problem of the regulators more than a problem of the regulations. I’ll give you a concrete example: There’s an agency I’ve been writing about, the Federal Home Loan Bank system. It loans to banks and insurance companies. Silicon Valley, at the time that it failed, had $20 billion in advances from the Home Loan Bank of San Francisco. That’s crazy high. It was the largest borrower from the Home Loan Bank of San Francisco at the time that it failed. It also was the largest borrower six months ago. That was a canary in the coal mine. What the regulators should have done is look at that level of borrowing back last summer, go into the bank, slap a cease and desist on them, fire many of the executives, and say, look, you have 90 days to raise capital. If you can’t, find a merger partner.
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