Regulators end week like they started — tamping down fears, rescuing a bank
A sign is posted on the exterior of a First Republic Bank office on March 16, 2023 in San Francisco, California. A week after Silicon Valley Bank and Signature Bank failed, First Republic Bank is considering a sale following a dramatic 60 percent drop in its stock price over the past week. The bank also received $70 billion in emergency loans from JP Morgan Chase and the Federal Reserve. (Photo by Justin Sullivan / Getty Images)
Financial regulators, policymakers, and bank executives spent the week trying to abate fears that a banking crisis will spread across the U.S. financial system.
On Friday, President Joe Biden released a statement calling on Congress to take action to make it easier for regulators to hold senior bank executives accountable for their mismanagement.
“It should be easier for regulators to claw back compensation from executives, to impose civil penalties, and to ban executives from working in the banking industry again,” the president said. On Monday, after the collapse of Silicon Valley Bank and takeover of Signature Bank by New York regulators, Biden had reassured Americans their money was safe and said “the management of these banks will be fired.”
On Thursday, senators pressed Treasury Secretary Janet Yellen on future responses to bank collapses. Yellen assured them that “our banking system is sound” but also made it clear that deposits of all sizes would only be covered if “failure to protect uninsured depositors would create systemic risk and significant economic and financial consequences.”
Over the weekend, regulators announced additional funding to help banks meet their obligations. The Bank Term Funding Program provides banks loans for up to one year by offering assets as collateral to “safeguard deposits and ensure the ongoing provision of money and credit to the economy.” Yellen approved the use of up to $25 billion as a backstop for the fund. Banks have borrowed $11.9 billion so far, the Federal Reserve said on Thursday.
When the mid-sized San Francisco-based First Republic Bank signaled it was in trouble this week as depositors began to flee, Yellen worked on a plan with Jamie Dimon, JP Morgan Chase’s chairman and CEO, to stabilize it. On Friday, 11 large banks provided an influx of cash — $30 billion. On Thursday,the Swiss National Bank said it would provide billions in liquidity if needed to support Credit Suisse, a global investment bank based in Switzerland that has had numerous financial issues over the past few months.
No reason to panic
Economists say that there is still no reason for most Americans to panic over recent bank runs because the banking system is more stable than it was during the financial crisis over a decade ago. But the current crises could still have effects on the economy as the Federal Reserve decides whether to hike rates again to reduce inflation and federal regulators consider how to move forward with banking policy.
The Federal Deposit Insurance Corporation (FDIC) has historically insured up to $250,000 of deposits when a bank fails and economists say consumers should be careful if they have a bank deposit over that limit.
Matthew Rognlie, assistant professor of economics at Northwestern University, said Americans who have more than $250,000 should spread that money between a few banks.
People also may be concerned about the damage of the banking crisis to their 401(k), since in most cases, they would not be protected, but if you have a failing investment in a bank stock, you shouldn’t sell at the bottom of the market either, said Galina Hale, professor of economics at University of California Santa Cruz.
“So if you hold stocks of the banks, yes, there is a little bit of market decline because of their concerns and there’s not too much information about the health of an average bank. What I would say to people who are holding bank stocks is wait and see,” she said.
Although it is hard for people to watch the value deteriorate, the value is going to recover because there isn’t a “fundamental problem in the economy that would justify a prolonged decline of the stock market at the moment,” Hale added.
How SVB was different from most banks
The panic over the stability of the banking system and the federal government stepping in to try to prevent damage to the economy may understandably remind people of the 2008 financial crisis, and the resulting shutdown of hundreds of banks, but there are a lot of differences to keep in mind, Hale and Rognlie said.
“A financial crisis is more likely when there is a risk that banks have suffered serious losses. This was certainly true in 2008, when the real estate sector (accounting for by far the largest share of borrowing in the financial sector) was collapsing, and many risky mortgages had been issued. I don’t see anything comparable this time around,” Rognlie stated in an email.
In this case, Silicon Valley Bank had billions in unrealized losses, or an asset losing value but hadn’t been sold yet, on bonds, and many of its assets were in U.S. government bonds with long-term maturities. Because customers, most of whom were not insured, began to take their money out of the bank, the bank had to sell its securities portfolio at a loss, which led to a bank run and actual losses. First Republic, which also catered to wealthy clients, was running into similar problems. But the majority of banks don’t have the same liquidity risk and benefit from what is called a deposit franchise, which makes it easier for banks to take on interest rate risk. And large banks have benefitted from depositors looking for a safer place to put their funds.
Rognlie said that Silicon Valley Bank and similar banks are different from most banks, which have more stable deposits.
“Most importantly, if a financial crisis became a threat, then interest rates would fall, and Treasuries and [mortgage-backed securities] would rise in price … So under current circumstances, a financial crisis is to some extent a self-correcting problem,” he added.
Policymakers are calling for more regulation of the banking industry in the aftermath of recent bank failures, especially since the rollback of some of the 2010 banking reforms that they say could have helped avert the current crisis. But consumers should be somewhat assured by the fact that the regulatory environment is still far better than it was in 2008, Hale said.
“We did not have that regulation that is now requiring banks, especially large banks, to have a lot of capital. We have regulations that require large banks to have a lot of liquidity, so even a run on a large bank — they should be able to survive. I don’t see a repetition of the Lehman crisis and things like that,” she said.
But that doesn’t mean that there aren’t risks to the economy right now. Hale said the downside of the federal government stepping in and covering all depositors is the risk that people will assume that this intervention will occur in the future.
“It can create a moral hazard … Suppose I’m running a small business and I have more than $250,000 to put in a bank deposit and I’m not going to worry too much about that insurance limit because I’m going to say, ‘Well in the past the government gave money to everybody, not just the insured deposits, so I’m not going to waste time and make them complicated. I’m just going to put in half a million dollars.’ But that might not happen in this picture, right?” she said.
Rognlie said that he is still concerned about another important factor in the economy’s health — the Federal Reserve’s decisions on how much to raise interest rates. Since March 2022, the Fed has continued to raise the federal funds rate to bring down inflation and indicated during its last announcement on its decision to raise rates that it will continue to do so in the near future. The banking crisis has called into question whether the Fed will continue to raise rates as high as they have been or if they will raise rates at all when they meet next week.
“To the extent I’m worried about anything, it’s that this will add uncertainty to the Fed’s anti-inflation drive,” Rognlie said. “A week and a half ago, the Fed was planning to rapidly raise rates, and the most likely macro outcome was a moderate slowdown (perhaps a mild recession) in the economy in order to reduce inflation.
“Now, the Fed is going to be more cautious in raising rates — at least in the short term — because of concerns about the financial sector. I wonder if the Fed will not raise rates enough now and then change course abruptly in a few months if it becomes clear that inflation is not yet slowing down enough.”
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