The Fed Passes the Buck on Bank Failures Michael Barr’s excuses for regulatory blunders are simply unbelievable.
One certainty in politics is that the Federal Reserve will never accept responsibility for any financial problem. Fed Vice Chair for Supervision Michael Barr played that self-exoneration game on Tuesday before the Senate as he blamed bankers and Congress for Silicon Valley Bank’s failure. This act is simply unbelievable.
No one disputes that bankers failed to hedge the risk posed by rising interest rates to asset prices and deposits. What Mr. Barr didn’t say is that the Fed’s historic monetary mistake created the incentives for the bank blunders. The Fed fueled the fantastic deposit growth at SVB and other banks with its prolonged quantitative easing and zero interest-rate policy that caused banks to pile into longer-term, higher-yielding assets.
Federal Deposit Insurance Corp. Chairman Martin Gruenberg noted in his testimony Tuesday that SVB’s balance sheet more than tripled in size between the end of 2019 and 2022, “coinciding with rapid growth in the innovation economy and a significant increase in the valuation placed on public and private companies.” That’s a cagey way of saying the Fed inflated tech valuations.
Silicon Valley investors cashed out shares at elevated prices and poured their windfall into startups with SVB accounts. SVB had more deposits than it could safely lend, so it loaded up on long-dated Treasurys and Fannie Mae securities that offered relatively high yields and were deemed low or no risk by regulators. What could go wrong?
When near-zero interest rates persist for nearly 13 years with hardly a blip upward, some bankers will bet this will last forever as they hunt for yield. The Fed had also assured the world until very late in 2021 that it had no plans to change its policies because inflation was transitory.
The Fed’s rapid and necessary course correction last year to subdue inflation seemingly caught banks like SVB off guard. SVB’s long-dated assets lost value and had to be sold at a loss to cover deposit outflows as startups burned cash and customers moved their money into money-market funds or Treasurys.
Mr. Barr also passes the buck on the failures of bank supervision. He claims Fed supervisors flagged deficiencies in SVB’s liquidity risk management, stress testing and contingency funding in late 2021 and with its board oversight, risk management and internal audits in May 2022. In October 2022, he says, supervisors raised concerns with senior management over its interest rate risk profile.
He blames bank managers for failing to heed those warnings. But are these supervisors helpless bystanders? Surely they had the power to raise a louder fuss with management or kick the matter up to more senior regulatory officials. Congress should subpoena all of the internal supervisory documents and emails.
Mr. Barr’s exoneration of supervisors contradicts his narrative blaming a 2018 bipartisan law for liberating midsize banks from too-big-to-fail regulations. But SVB had higher capital than some bigger banks and likely would have met Dodd-Frank’s liquidity coverage ratio requirement, according to the Bank Policy Institute.
Mr. Barr acknowledged that the 2018 law gave the Fed “substantial discretion” to impose too-big-to-fail regulations on banks with more than $100 billion in assets to promote financial stability and soundness. Fed supervisors therefore could have demanded that SVB comply with too-big-to-fail regulation had they deemed the bank systemically important.
Yet regulators only did so after SVB’s collapse so they could guarantee its uninsured deposits. In any case, the Fed’s “severely adverse scenario” stress test in February 2022 forecast a hypothetical world in which the three-month Treasury rate stayed near zero while the 10-year Treasury yield declined to 0.75%. This suggests the Fed staff in Washington were oblivious to risks from rising interest rates.
When monetary policy creates perverse incentives with negative real interest rates for years, regulators have a particular obligation to watch for banking mistakes and rising risks. And when interest rates suddenly turn upward to correct the Fed’s monetary mistake, examiners have an obligation to impel bankers to hedge or unwind their interest-rate risks.
Why regulators and supervisors failed to do so is a question that Mr. Barr needs to be asked with far more vigor when he appears before the House on Wednesday.
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