There’s a deeper story to Silicon Valley Bank’s failure. What can we learn from it?

Financial deregulation lead to the crash in 2008 and it could again in 2023. It’s time to make banking boring again.

On Friday, bank regulators closed Silicon Valley Bank, based in Santa Clara, California. Its failure was the second largest in US history and the largest since the financial crisis of 2008.

Will other banks fail? On Sunday, regulators closed New York-based Signature Bank.

As they rushed to contain the fallout, government regulators at the Federal Reserve, Treasury and Federal Deposit Insurance Corporation announced in a joint statement on Sunday that depositors in Silicon Valley Bank would have access to all of their money starting Monday. They’d enact a similar program for Signature Bank.

They stressed that the bank losses would not be borne by taxpayers but by bank shareholders.

What happened?

The surface story of the Silicon Valley Bank debacle is straightforward. During the pandemic, startups and technology companies enjoyed heady profits, some of which they deposited in the Silicon Valley Bank. Flush with their cash, the bank did what banks do: it kept a fraction on hand and invested the rest – putting a large share into long-dated Treasury bonds that promised good returns when interest rates were low.

But then, starting a little more than a year ago, the Fed raised interest rates from near zero to over 4.5%. As a result, two things happened. The value of the Silicon Valley Bank’s holdings of Treasury bonds plummeted because newer bonds paid more interest. And, as interest rates rose, the gusher of venture capital funding to startup and tech companies slowed, because venture funds had to pay more to borrow money. As a result, these startup and tech companies had to withdraw more of their money from the bank to meet their payrolls and other expenses.

But the bank didn’t have enough money on hand.

There’s a deeper story here. Remember the scene in It’s a Wonderful Life where the Jimmy Stewart character tries to quell a run on his bank by explaining to depositors that their money went to loans to others in the same community, and if they’d just be patient, they’d get their deposits back?

In the early 1930s, such bank runs were common. But the Roosevelt administration enacted laws and regulations requiring banks to have more money on hand, barring them from investing their depositors’ money for profit (in the Glass-Steagall Act), insuring deposits and tightly overseeing the banks. Banking became more secure, and boring.

That lasted until the 1980s when Wall Street financiers, seeing the potential for big money, pushed to dismantle these laws and regulations – culminating in 1999, when Bill Clinton and Congress repealed what remained of Glass-Steagall.

Then, of course, came the 2008 financial crisis, the worst collapse since 1929. It was the direct result of financial deregulation. Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006, called it “a once-in-a-century credit tsunami”, but pressed by critics, Greenspan acknowledged that the crisis had forced him to rethink his free market ideology. “I have found a flaw,” he told a congressional committee. “I made a mistake … I was shocked.”

Shocked? Really?

Once banking was deregulated, such a crash was inevitable. In the 1950s and 60s, when banking was boring, the financial sector accounted for just 10 to 15% of US corporate profits. But deregulation made finance exciting and exceedingly profitable. By the mid-1980s, the financial sector claimed 30% of corporate profits, and by 2001 – by which time Wall Street had become a gigantic betting parlor in which the house took a big share of the bets – it claimed a whopping 40%. That was more than four times the profits made in all US manufacturing.

When the bubble burst in 2008, the Bush administration moved to protect investment banks. The treasury secretary, Hank Paulson, former CEO of Goldman Sachs, and Timothy Geithner, president of the New York Fed, arranged a rescue of the investment firm Bear Stearns but allowed Lehman Brothers to go under. The stock market crashed. AIG, an insurance giant that had underwritten hundreds of billions’ worth of credit on the Street, faced collapse. So did Citigroup (to which Robert Rubin, Clinton’s former treasury secretary, had moved after he successfully pushed for the Glass-Steagall repeal), which had bet heavily on risky mortgage-related assets.

Paulson asked Congress for $700bn to bail out the financial industry. He and Ben Bernanke, the Fed chair, insisted that a taxpayer bailout of Wall Street was the only way to avoid another Great Depression.

Obama endorsed the Wall Street bailout and appointed a team of Clinton-era economic advisers (led by Geithner, who became Obama’s treasury secretary, and Lawrence Summers, who became director of the national economic council). These were the same people who, working under Rubin in the 1990s, had prepared the way for the financial crisis by deregulating Wall Street. Geithner, as chair of the New York Fed, had been responsible for overseeing Wall Street in the years leading up to the crisis.

Which brings us to Friday’s failure of the Silicon Valley Bank. You didn’t have to be a rocket scientist to know that when the Fed raised interest rates as much and as fast as it did, the financial cushions behind some banks that had invested in Treasury bonds would shrink. Why didn’t regulators move in?

Because even the thin protections of Dodd-Frank were rolled back by Donald Trump, who in 2018 signed a bill that reduced scrutiny over many regional banks and removed the requirement that banks with assets under $250bn submit to stress testing and reduced the amount of cash they had to keep on their balance sheets to protect against shock. This freed smaller banks – such as Silicon Valley Bank (and the Signature Bank) – to invest more of their deposits and make more money for their shareholders (and their CEOs, whose pay is linked to profits).

Not surprisingly, Silicon Valley Bank’s own chief executive, Greg Becker, had been a strong supporter of Trump’s rollback. Becker had served on the San Francisco Fed’s board of directors.

Oh, and Becker sold $3.6m of Silicon Valley Bank stock under a trading plan less than two weeks before the firm disclosed extensive losses that led to its failure. There’s nothing illegal about corporate trading plans like the one Becker used, and the timing could merely have been coincidental. But it smells awful.
– Robert Reich (Contd.)

 
 
 
 
 
 
 

Article URL : https://www.theguardian.com/commentisfree/2023/mar/13/svb-collapse-2008-financial-crisis