Some thoughts on Public reaction to SVB and Co.
Many are arguing that the US didn't have the right regulations on the books, or that prior administrations are at fault due to deregulation initiatives. This is simplistic and inaccurate.
Many people attribute the SVB (and other banks') issues to regulatory policy change/implementation or reform of prior regulations. This is true in some regards, but the current situation is more complex than "there were no regulations." Both parties have controlled the White House, and over time, both have failed when it comes to enforcing the regulations we do have. The regulations are there. Where there was an issue was enforcing the regulatory oversight required by law. If blame is going to be laid, it should be on the central bank and its misguided policies that inflated markets, ultimately requiring dramatic, historic increases in borrowing rates in the order of months.
Banks can't readjust their balance sheets on a dime. With so many deposits flowing in due to the easy monetary environment, determining where that cash should be held became a huge issue. We often associate the phrase risk-free with US government debt, and that’s usually the case, but we have seen unprecedented perversions of the rate curve, inverting to cataphoric levels. Banks depend on an upward-sloping yield curve. Now we have a downward-sloping yield curve - the most dramatic in, maybe, ever. As a result of such a dramatic and rapid change in the yield curve, and combined with the massive increase in deposits, the banks were caught flat-footed,
and the banking system's asset & liability management completely failed.
It is the issue of deposits and balance sheet holdings where a regulatory duty was mishandled. Allowing a situation where 93% of depositors were above the FDIC-insured level was highly irresponsible. So was not keeping an eye on deposit levels that exploded directly due to huge fiscal stimulus, zero interest rate policies, several hundred percent increases in the money supply, and a dramatic increase in the cost of borrowing. Most blame can be set at the feet of a decade-plus era of easy, cheap money and an incompetent central bank.
This bank crisis took several unprecedented developments in the economic system, ranging from a dramatic fiscal policy, a pandemic, a risk asset valuation boom, historically high inflation rates, and a rapid collapse of treasury prices. This was a freak situation (though preventable with more rigorous oversight from the Fed) that even the best risk model could be understood to miss. There was no historical precedence to model against and certainly no reasonable foresight to see a collapse in treasury prices. Treasuries are (essentially) risk-free, so I can understand why this was missed from a bank manager's perspective. This wasn't a result of major risk-taking in poorly understood securities like in 2007-2008, where banks compounded leverage and concentrated it into highly complex derivative positions.
No past US regulation would have prevented what took place at SVB and elsewhere. There was never a regulation against concentrated holdings of US debt obligations. In fact, regulators look for and consider treasury holdings as a net positive, not a potential risk. In the current regulatory framework, and historically, treasury obligations, in any duration, are considered the gold standard for low-risk holdings.
That said, despite what I've said about treasury debt, those at the banks should have been hedging their interest-rate debt more thoroughly. Ironically, given interest rate swaps' reputation as risky trades, their absence helped lead to the current situation. If you hold billions of debt for a long duration, you know you have to partially hedge the interest rate risk it comes with. I.e., enter trades that reduce the possible net gain/loss on debt holdings when rates change. That is really where blame can be laid at the bank's feet, carrying on with an assumption that interest rates would permanently remain at the zero bound, and that US debt was risk-free and immune from price collapse. That interest rate hedging could be completely thrown to the wind (the Fed more or less encouraged this belief through their policy actions and communications over the last decade).
This was not a regulation law issue. This was a three-part issue. The first issue is a series of unprecedented events, starting with a pandemic and continuing to extreme monetary and economic developments. The second issue - is very badly handled management of matching assets, liabilities, and duration. Those first two issues were then allowed to metastasize into, as we know, a banking disaster. This resulted from a third issue, a failure to implement regulatory safeguards put in place to protect the system. Those regulatory safeguards are (theoretically) imposed through the oversight duties entrusted to the Federal Reserve. The Fed is given substantial power to meet those regulatory requirements. They have weeping powers over the banking system, from outright seizure of private banks, revocation of banking charters, the right to shut banks down or restrict deposits, and the power to force balance sheet adjustments. Those regulations are there to prevent a systemic banking disaster. Unfortunately, those regulations failed to be enforced.
Contrary to what many say, the regulations we needed to prevent this crisis DO exist, untouched by any prior administration, dating back to the 1910s. More thorough oversight and awareness of bank balance sheet holdings by the Federal Reserve (which created this problem in many ways), would have triggered an intervention before the risk became systemic.
Our current banking crisis was also the result of a failure of the imagination. Like the bank executives, they (the fed) truly believed that rates would stay at zero perpetually and that inflation was generally a historical relic. They also believed that the US treasuries are risk-free assets considered on par with cash. As a result, by making assumptions about the path of rate levels and believing that low-interest rates were the new normal and that US treasuries were immune to market forces, they failed to see this coming. By believing inflation was permanently dead, a fundamental framework was embedded into regulatory thinking: that we lived in a world where interest rates would never rise again, certainly not several hundred percent, let alone in just a half year's time! This situation simply didn't fit their model. The regulator’s worldview that Treasuries were risk-free assets and their adherence to low-interest rate monetary policy made it impossible for the nation's bankers to foresee any possible issues. Issues that we are now finding out are quite possible and quite severe. In their eyes, this situation was not possible.
These are our nation's economic experts, the same group who missed inflation for a year and a half. How can they expect us to hold confidence in their management going forward??