Why Are Major Banks Failing?
It is likely that both management issues and deregulation played a role in the recent failure of the Silicon Valley Bank and Signature Bank. But it's not like 2008.
We never seem to learn this lesson. In the years following the Civil War, an assortment of financial crises and bank panics led to new regulations. The Great Depression of the 1930s gave rise to significant reforms (especially the Glass-Steagall Act - the Depression-era bank regulation that kept different types of financial institutions separate). The 1980s saw a move toward deregulation, under the Reagan administration, soon followed by re-regulation in the wake of the subprime mortgage crisis and the Great Recession of the early 2000s. During the Clinton administration (in 1999), the Glass-Steagall Act was finally killed, but only after prior administrations had whittled the Act down so much that it was no longer meaningful or consequent. The Gramm-Leach-Bliley Act of 1999 repealed significant aspects of the Glass-Steagall Act as well as the Bank Holding Act of 1956, both of which had served to sever investment banking and insurance services from commercial banking.
So, from 1999 onward, banks could now offer commercial banking, securities, and insurance services under one roof. As banks became bigger, their financial services and products became more complex. Banks started to offer new products like derivatives. They also started packaging traditional financial assets like mortgages and selling them to investors through the process of securitization.
Then came 2007. The subprime mortgage meltdown beginning in 2007, the ensuing global financial crisis, and the need to bail out banks deemed "too big to fail" caused the government to rethink the financial regulatory framework. In response to the 2007/2008 crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.
The Act was sufficient to ensure bank stability for nearly a decade, but then came president Trump's administration. Some of Dodd-Frank's protections were rolled back under the Trump administration in 2018.
Red-state Democrats facing difficult reelection prospects joined forces with Republicans to reverse banking regulations that had been put in place to prevent bank failures. The rollback was leveraged with a lobbying campaign that cost tens of millions of dollars that drew an army of hundreds of lobbyists and it was seeded with ample campaign contributions.
In particular, the new rules relaxed the restrictions/oversight on institutions with under $250 billion in assets and eliminated the need for them to pass stress tests (the threshold was $50 billion, prior to the Trump era Bill).
The Biden administration recognized the problem and introduced plans to fix it. in 2021, the newly arrived Biden administration signaled its intention to tighten the government's oversight of banks. A July 2021 executive order on promoting competition in the American economy called for greater scrutiny of bank mergers by the Department of Justice and federal banking regulators. "Excessive consolidation," the order explained, "raises costs for consumers, restricts credit for small businesses, and harms low-income communities. But it was too little, and it came too late.
One can only wonder what the impact the 2018 law that partially rolled back the Dodd-Frank Act may have had, as mentioned above. “Had Congress and the Federal Reserve not rolled back the stricter oversight, S.V.B. and Signature would have been subject to stronger liquidity and capital requirements to withstand financial shocks,” Elizabeth Warren wrote, calling for congressional action to reverse the 2018 changes.
As of September 30, 2022, there were 4,157 commercial banks in the U.S. insured by the Federal Deposit Insurance Corporation (FDIC) with US$23.6 trillion in assets. Depending upon how you count, this number could be anything between 4,000 and 5,000 because of the various methodologies for ranking banks. The average bank asset size is $4 billion. The median asset size, by contrast, is $241 million. Based on asset size ranking, the Silicon Valley Bank is ranked 29th. At the end of last year, the bank had more than $175 billion in mostly uninsured deposits and $209 billion in total assets. Despite it's size, the bank fell far below the current oversight threshold. What is significant, however is that, as a result of the 2018 Dodd-Frank Act rollback and, specifically, the change in the threshold trigger for oversight and stress testing from $50 billion in assets to $250 billion, only 34 of these banks were subjected to stress testing in 2022 and, hence, many more banks were subject to much less restrictive financial-safety (liquidity) requirements than were originally targeted by the Dodd-Frank Act. And this was the case for both of the banks that recently failed, Silicon Valley Bank and Signature Bank.
But deregulation was not the only issue at work here. Another aspect of the SVB Bank failure was the Bank management's use of risky strategies —which involved investing depositors’ money into long-term Treasury bonds that became less valuable as interest rates increased. This was the bank’s fault.
And this was not the only reason these banks failed. Among other problems, Silicon Valley Bank and Signature had significant exposure to crypto markets, which made them outliers in the banking world. Additionally, unlike most banks, SVB's customer portfolio was decidedly not diversified - bank management concentrated almost exclusively on the tech sector — and when that sector began to experience problems, so did SVB.
Ted Rossman, senior industry analyst at Bankrate.com believes that there is a big difference between the collapse of Silicon Valley Bank and Signature Bank and the banking crisis that happened in 2008.
“SVB was allowed by the Federal Reserve, their primary regulator, to build up a massive position on mortgage-backed securities with little to no hedging for interest rates,” he wrote. “ It has been reported that SVB relied on uninsured bank deposits at level far beyond the norms for other banks. "SVB’s assets quadrupled in 4 years with explosive growth that ought to raise flags,” he wrote.
In any event, the bank crisis will likely induce the FED to pause its rate hike campaign. While it is possible that the FED will add one more 25 basis point increase, it is likely to stop there. Goldman Sachs economists are even more optomistic and have said that they don’t expect any new rate hikes by the Fed in the near-term, contra to their prediction of a 25-basis-point hike before the bank failures. And Sheila Bair, former chair of the FDIC also said that if the Fed chose to pause its interest rate hikes, the decision would have a “settling effect” on the markets.
Sources:
https://www.investopedia.com/articles/investing/011916/brief-history-us-banking-regulation.asp
https://www.cato.org/policy-analysis/repeal-glass-steagall-act-myth-reality
https://crsreports.congress.gov/product/pdf/R/R44349/3
https://www.mx.com/blog/biggest-banks-by-asset-size-united-states/
https://www.google.com/amp/s/www.nytimes.com/2023/03/13/business/signature-silicon-valley-bank-dodd-frank-regulation.amp.html
https://www.latimes.com/politics/story/2023-03-14/did-deregulation-lead-to-silicon-valley-banks-collapse
https://newjerseymonitor.com/2023/03/14/silicon-valley-banks-collapse-differs-from-our-last-financial-crisis/
https://www.federalreserve.gov/publications/2022-june-dodd-frank-act-stress-test-background.htm#x2cd7af2
https://apnews.com/article/banking-crisis-congress-lobbying-svb-c2bc00ad41ae7fd1ec9d0ffb781383f2