Federal Reserve slammed for missing red flags ahead of SVB collapse

WASHINGTON (AP) — The Federal Reserve is facing scathing criticism for missing what observers say are clear signs that Silicon Valley Bank was at high risk of collapse in the second-largest bank failure in state history. -United.

Critics point to many red flags surrounding the bank, including its rapid growth since the pandemic, its unusually high level of uninsured deposits, and its extensive investments in long-term government bonds and mortgage-backed securities, including the value fell as interest rates rose..

“It is inexplicable that Federal Reserve supervisors could not see this clear threat to the safety and soundness of banks and to financial stability,” said Dennis Kelleher, chief executive of Better Markets, an advocacy group .

Wall Street traders and industry analysts “have been publicly shouting about these same issues for many, many months since last fall,” Kelleher added.

The Fed was the lead federal supervisor of the Santa Clara, Calif.-based bank, which went bankrupt last week. The bank was also overseen by the California Department of Financial Protection and Innovation.

Now the aftermath of the fall of Silicon Valley Bank, as well as the New York-based Signature Bankthat failed over the weekend, complicates the Fed’s next decisions how far to raise its benchmark interest rate in the fight against chronically high inflation.

Many economists say the central bank would likely have raised rates an aggressive half point next week at its meeting, which would amount to an intensification of its fight against inflation, after the Fed put in place a quarter-point increase in February.. Its rate is currently around 4.6%, its highest level in 15 years.

Last week, many economists suggested that Fed policymakers would raise their projection of future rates next week to 5.6%. Now it’s suddenly hard to know how many more rate hikes the Fed is planning.

With the collapse of the two big banks fueling concern about other regional banks, the Fed may be more focused on bolstering confidence in the financial system than on its long-term desire to bring inflation under control.

The latest government inflation report, released on Tuesday, shows that price increases remain well above what the Fed prefers, putting Chairman Jerome Powell in a more difficult position. Core prices, which exclude volatile food and energy costs and are considered a better indicator of long-term inflation, jumped 0.5% from January to February, the most since September. This is well above what is consistent with the Fed’s 2% annual target.

“Absent the fallout from the bank failure, it might have been a close call, but I think it would have tipped them half a point (rate hike) at this meeting,” Kathy said. Bostjancic, chief economist at Nationwide.

On Monday, Powell announced that the Fed would review its oversight of Silicon Valley to understand how it could have better managed its regulation of the bank. The review will be led by Michael Barr, the Fed’s vice chairman who oversees banking supervision, and will be made public on May 1.

A Federal Reserve spokesman declined to comment further.

Elizabeth Smith, spokeswoman for the California Department of Financial Protection and Innovation, said, “We are actively investigating the situation and conducting a thorough review to ensure the Department is doing everything possible to protect Californians. ”

By all accounts, Silicon Valley was an unusual bank. Its management took excessive risks by buying billions of dollars of mortgage-backed securities and treasury bills when interest rates were low. As the Fed continually raised interest rates to fight inflation, driving higher rates on Treasuries, the value of Silicon Valley Bank bonds steadily declined.

Most banks would have sought to make other investments to offset this risk. The Fed could also have forced the bank to raise additional capital.

The bank had grown rapidly. Its assets have quadrupled in five years to $209 billion, making it the 16th largest bank in the country. And about 94% of his deposits were uninsured because they exceeded the Federal Deposit Insurance Corporation’s $250,000 insurance limit.

That percentage was the second highest among banks with more than $50 billion in assets, according to ratings agency S&P. Signature had the fourth highest percentage of uninsured deposits.

Such a high proportion made Silicon Valley Bank very sensitive to the risk that depositors would quickly withdraw their money at the first sign of trouble – a classic bank run – which is exactly what happened.

“I’m at a loss for words to understand how this business model was deemed acceptable by their regulators,” said Aaron Klein, a former congressional aide, now at the Brookings Institution, who worked on the Dodd- Frank who was adopted after the 2008 financial crisis.

Bank failures will likely color an upcoming Fed review of the rules that define how much money big banks must hold in reserve. Barr said last year he wanted to conduct a ‘holistic’ review of these requirements, raising fears in the banking industry that the review would lead to rules requiring banks to hold more reserves, which would limit their ability to lend. .

Many critics also point to a 2018 law loosening banking regulations in a way that contributed to Silicon Valley’s failure. Pushed by the Trump administration with bipartisan support from Congress, the law exempted banks with $100 billion to $250 billion in assets — the size of Silicon Valley — from requirements that included regular reviews of how they would fare in difficult economic times, known as “stress tests”. ”

Silicon Valley CEO Greg Becker had lobbied Congress to support rolling back regulations, and he served on the board of directors of the Federal Reserve Bank of San Francisco until the day of the collapse .

Senator Elizabeth Warren, a Democrat from Massachusetts, asked him about his lobbying in a letter released Tuesday.

“These rules were designed to protect our banking system and our economy from the negligence of bank executives like you – and their backtracking, along with your bank’s atrocious risk management policies, have been implicated as the primary causes. of its failure,” Warren said in his letter.

The 2018 law also gave the Fed more discretion in its banking oversight. The central bank then voted to further reduce regulation of banks the size of Silicon Valley.

In October 2019, the Fed voted to effectively reduce the capital these banks were required to hold in reserve.

Kelleher said the Fed could always have pushed Silicon Valley Bank to take action to protect itself.

“Nothing in this law in any way prevented Federal Reserve supervisors from doing their job,” Kelleher said.


AP Economics Writer Paul Wiseman contributed to this report.

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