Silicon Valley Bank Collapse: Is the Federal Reserve to Blame?

As it turns out, the Federal Reserve moves fast and breaks things, but few people noticed until the collapse of Silicon Valley Bank.



Over the past year, the Fed has been aggressively and rapidly raising interest rates in an effort to curb high inflation in the United States. The common saying on Wall Street is that the Fed will raise rates until something breaks. Until last week, the question was what was going on. Rate hikes generally take some time to work their way through the economy, but some people were a little scratching their heads over how long that lag seemed to be. The labor market, which rate hikes aim to cool, has remained strong. The economy is generally in surprisingly good shape. Sure, things looked a bit ugly in crypto and tech, but maybe the issues would be mitigated there.

Now the landscape looks very different and we know what broke the Fed: Silicon Valley Bank or SVB. (Disclosure: Vox Media, owner of Vox, banked with SVB before the shutdown.)

It will be a long time before we fully understand what exactly happened in the rapid, staggering fall in the SVB, but there is little doubt that interest rate hikes contributed to this. They also likely played a role in the demise of Silvergate and Signature Bank, both of which closed in March.

“It’s always a surprise. We didn’t know what was going to break, apparently it was this,” said Alexander Yokum, an analyst at CFRA Research who focuses on banking. “This wouldn’t have happened if interest rates hadn’t risen so fast and these portfolios hadn’t gone so far under water.”

If interest rates continue to rise rapidly, it could spell more trouble for more banks. That has gotten the Fed into a bit of trouble – it wants to tame inflation, which remains high, and it also wants to ensure financial stability. Both fronts look rather tricky.

“We don’t know what risks are lurking and what institutions are less healthy than we might have thought, especially if interest rates continue to rise,” said Morgan Ricks, a professor of banking and finance at Vanderbilt University. “We saw an inflationary print [for February] that was slightly higher than expected, and the Fed may end up between a rock and a hard place here.”

The scenario is also a stark reminder of what is at stake in the Fed’s efforts to combat the high prices and potential rate hikes that will affect the economy.

“The Fed wanted to do things until something broke, and something broke. And the next thing that breaks through is that 2 million people will lose their jobs if unemployment rises,” said Mike Konczal, director of macroeconomic analysis at the Roosevelt Institute.

Rate hikes can be a solid deal for banks as they allow them to charge more for loans and make more money, but as the SVB has shown, there are also risks for them.

SVB’s demise was the result of a bank run after signs of trouble began to emerge at the bank in the second week of March. The bank – which in SVB’s case is largely focused on technology, startups and venture capital – takes customer deposits and invests them in generally safe securities, such as bonds. Because the Fed has raised interest rates, those bonds have lost value. That wouldn’t normally be a problem – SVB would just wait for those bonds to mature. But as there has been a slowdown in venture capital and technology more broadly, in part because there’s less free and cheap money floating around, deposit inflows slowed and customers started withdrawing their money. It became clear that SVB was in the middle of a cash crisis, which caused panic and eventually brought the bank down.

The concern is that interest rate hikes could also pose a threat to other banks. The more rates rise, the more banks can become a problem.

“The rapid cycle of Fed rate hikes is having more effect on the U.S. economy than many people at all levels, I think, realized even a few weeks ago,” said Josh Lipsky, senior director of the Atlantic Council’s GeoEconomics Center. . “I think we can say with confidence that these are interest rates showing their teeth in the economy.”

Of course, the SVB had other details. It targeted a monolithic clientele, meaning it was highly exposed to one industry and if that industry faltered, so would it. It also had a high amount of uninsured deposits. Silvergate and Signature, which also collapsed, were dipped in crypto, which also struggled.

Megan Greene, Kroll’s global chief economist, said the unique nature of these banks is worth considering, especially in light of the suggestion that this is all a result of the Fed tightening monetary conditions too much. “I’d be more sympathetic to that argument if Silicon Valley Bank and Silvergate weren’t so idiosyncratic,” she said. As central banks change conditions, “we will hit more pockets of disruption.” SVB also made some real miscalculations about the possible impact of inflation increases. “Uniquely, SVB did not cover interest rate risk at all, which is simply astounding,” said Greene.

Still, SVB is not a complete outlier, and interest rate hikes pose a threat to other banks as well, especially if the Fed continues to be aggressive about it. “As interest rates rise, bond prices are depressed, and any institutions that are on the wrong side could end up in a less healthy financial state than we would like,” Ricks said.

That interest rate hikes might be a problem for banks is now becoming a problem for the Fed, because it doesn’t want to destroy the banking sector. Before the collapse of the SVB, many investors expected the central bank to keep pace with rate hikes when policymakers meet on March 21 and 22. a percentage point, as in February, or half a percentage point, as in December. Now that has changed – many investors, analysts and pundits think they will slow it down or even pause it altogether.

“They absolutely should, in part because they’ve tightened up so much already,” Konczal said. He added that economic activity in itself could cool down a bit “because everyone is just a little scared and shocked” about SVB.

“Now they’re in a position where they’re going for a walk [half a percentage point] at the next meeting that will add fuel to the fire,” John Fagan, former director of the market group at the Treasury Department, told Politico.

It’s a tricky situation. Inflation seems to be declining, but remains high. The Consumer Price Index rose by 6 percent in February compared to last year.

Gustavo Schwenkler, an associate professor of finance at Santa Clara University Leavey School of Business, said he doesn’t believe the Fed’s overall goals of reducing inflation and cooling the economy have changed in light of the collapse of the economy. SVB. “The goals they have now are much bigger than making sure the tech sector is okay, but I definitely think they’re very concerned about how investors will react to the steps they’re taking,” he said. “We may hear different ways of communicating from the Fed about what its next actions will be… to dispel any uncertainty about this.”

On Sunday, after the FDIC, the Treasury Department and the Fed announced they would ensure that all funds from SVB and Signature Banks would be guaranteed. The Fed also said it would also open a facility to make funding available to other financial institutions in the form of one-year loans. The goal is to try to contain contagion across the entire banking sector and prevent other bank runs, such as what happened with the SVB. It’s an attempt by the Fed to boost confidence so people don’t panic. Greene stressed that the Fed can raise rates as well as open a new facility at the same time. “I don’t think this will change the Fed rate path at all,” she said.

Beyond the ins and outs of what rate hikes mean for a handful of regional banks, who may or may not be in a pinch, SVB’s rapid collapse points to a bigger problem: The Fed’s actions will have numerous ripple effects across the economy, including some can do a lot of damage and surprise people.

“Everyone was wondering when something would break in the Fed’s rate hike cycle, and this was the first,” Konczal said. “This is just the beginning if they want to keep walking at the pace they’ve been walking.”

The conventional economic wisdom is that fighting inflation requires rising interest rates to slow down the economy, which ultimately leads to people losing their jobs. The Fed has been quite open about aiming for an increase in the unemployment rate. Someone being laid off or laid off may not make as many headlines as a bank collapse, but it is still catastrophic in people’s individual lives and, if it happens on a larger scale, for the economy. Once the layoffs start, it’s also hard to stop them, and the Fed can’t step in to boost workers like it has to the banks.

The horizon is not all doom and gloom. The economy could still make a soft landing without being pushed into a recession, and the labor market could perhaps slow down without leaving millions of people out of work. The SVB crisis could also lead banks to tighten lending terms and standards, meaning the Fed could decide to raise interest rates less than it thinks to meet its inflation-reducing goals, Donald Kohn said , former Fed Vice Chairman, in an email.

But for months now, it has felt like something terrible is lurking in the economy, even though no one can quite put their finger on it. The demise of SVB reminds us how quickly the tides can turn and how unforeseen they can be. In fighting inflation, this may not be the only thing breaking the Fed.

“It’s in the nature of financial events to unfold quickly,” Ricks said. “No one can tell you with any certainty, no one can tell anyone with any certainty that there isn’t another shoe to drop here.”


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