There needs to be a safe place for businesses to place their reserves and working capital
Gerald Epstein is Professor of Economics and a founding Co-Director of the Political Economy Research Institute (PERI) at the University of Massachusetts, Amherst
Cross-posted from the Institute for New Economic Thinking
Theatre poster 1895 – Library of Congress
There are five main causes of the SVB collapse and the subsequent knock-on problems facing the US and global financial system: the Federal Reserve’s anti-inflation obsession causing it to raise interest rates too high and too fast; the inherent fragility of banking which for centuries has periodically erupted in crises; inadequate regulation of this fragile system which often leads to high profits that accrue to bankers’ and their wealthy owners; the corruption and self-dealing that often result from banks’ insufficient supervision; and the lack of public alternatives for financial institutions and services that could perform many of the key functions of banking and finance with less risk and without the private financiers taking their cut. Some of the huge profits the financiers make from this system are funneled back to buy support from the politicians to prevent adequate regulation, and to secure bail-outs when the system crashes.
The rapid increase in central bank interest rates to fight inflation is a major precipitating factor driving the financial problems facing the banks today. The more than 4 percentage point increase in the Fed’s rates in the last year rapidly led the prices of Treasury bonds and mortgage-backed securities to plummet, wiping billions off the balance sheets of SVP’s books. When SVB sold these to cover deposit losses from big venture capital firms and their start-ups, SVB had to sell bonds and realize these losses, cutting deeply into SVB’s already insufficient capital levels.
Importantly, though, the problem of low-interest rate government bonds and mortgage securities threatened by the Fed’s excessive tightening is not confined to SVB. The potential losses on banks’ balance sheets from the interest rate hikes have been estimated to be as much as $1 trillion if these had to be marked down. This interest rate overshooting by the Fed is, as my colleague Bob Pollin and his co-author Hannae Bouazza have shown, due to their wrong-headed commitment to driving inflation down to its arbitrary 2% target.
Some of the origins of these huge holdings of lower interest rate bonds stem from the zero interest rate policy the Fed has operated since the great financial crisis (GFC) and reinstituted during the Covid pandemic. At such low-interest rates, banks and other financial institutions loaded up with somewhat higher-rate securities such as long-term Treasuries. Ignorant of their risks or confident of a bail-out, some of these banks like SVB failed to hedge their interest rate risks which cost money.
These banks are to blame, of course, for taking such massive risks with their depositor’s money. But also to blame is the Fed. The Fed implemented a zero-rate monetary policy for years, followed by a rapid increase in interest rates to slay mostly supply-side and foreign-initiated inflation. But the Fed did not implement regulatory or supervisory policies to make sure these monetary policies did not wreak havoc with the solvency and stability of the financial industry, or to ensure the healthy allocation of credit by the banks.
During the low-interest period, the Fed did not make sure that banks – including medium size banks – kept reasonable levels of leverage and adequate liquidity based on the types of deposits they attacked. And when the Fed raised rates dramatically, they did make sure their regulatory and supervisory ducks were in line to limit the possible financial stability problems.
What is the point of having both the monetary and regulatory/supervisory roles under one roof at the Federal Reserve if the Fed is not going to coordinate these policies in a coherent way for the good of the public? During the debate over Dodd-Frank, the Fed insisted on keeping and indeed enlarging its roles in this area. To what purpose? As Aaron Medlin and I have suggested, the purpose is to coordinate monetary and regulatory policy to help protect the wealth of the top 1% during low inflation periods by pumping up asset prices and to protect the real value of these assets when inflation increases by increasing interest rates and bailing out the financiers potentially hurt by the collateral damage.
A surge in bank deposits in recent years is also an important part of this story. In SVB’s case, the need to sell Treasuries was precipitated by withdrawals from the bank’s tech-oriented venture capitalists and other tech-connected depositors. A newer source of massive deposits is connected to cryptocurrencies. Signature Bank was closely tied into the crypto universe; Silvergate, a bank that collapsed a few weeks before SVB was primarily a crypto-connected bank. SVB had over $ 3 billion in deposits from crypto platform Circle – the issuer of its USD crypto-connected “stable-coin”. These are Circle’s U.S. dollar reserves to try to maintain a 1 to 1 relation to its “stable” coin. When SVP went under, USD fell off its peg to about 80 cents. When the Treasury, FDIC, and Fed announced that all depositors at SVB would make made whole, they implemented the first major government bail-out of the cryptocurrency industry. US financial regulators such as the SEC’s Gary Gensler had warned that these so-called stable coins were unstable and could only be made stable with bailouts. Gensler was proved right by the SVB depositor rescue operation.
Many critics have pointed to the Trump era partial deregulation of medium-sized banks (less than $250 billion in assets) which contributed to SVB’s failure: SVB’s capital and liquidity requirements were reduced, mandatory stress tests were eliminated, the rules against proprietary trading (the Volcker Rule) was suspended, and the need to prepare plans in case the bank became insolvent (so-called ‘living wills”) was eliminated. These stricter rules would have made it much more likely that the problems with SVB would have been dealt with by the Federal Reserve and FDIC sooner and in a much less disruptive way. Others have pointed to the lack of supervision from the San Francisco Regional Federal Reserve Bank which was supposed to be supervising SVB. The fact that SVB’s CEO Greg Becker was on the board of the San Francisco Federal Reserve points to possible serious conflicts of interest between banker influence on the Fed and the ability of the Fed to serve the public interest.
The recent crisis highlights a structural problem in our current financial system: there needs to be a safe place for businesses to place their reserves and working capital without providing funds to speculative financiers, and without fear that their deposits will be wiped out in a bank failure. That, among other reasons, is why we need publicly provided accounts where households and businesses can hold their money, risk-free. A healthy economy needs a set of basic institutions that provide financial services to families and businesses that facilitate their productive and necessary activities. The problem with private, more speculative, banks like the ones that dominate our economy is that they provide poor and costly services to most families and smaller businesses, and when they do, such as offer deposit accounts, they often put these at risk by engaging in highly leveraged and overly risky activities that often have little social value.
Thirty years ago, my colleague Jane D’Arista wrote a prescient piece on the need for widespread, unlimited deposit insurance for transaction accounts.[1]
More recent proposals along these lines, such as for FED Accounts or updated Postal Savings Bank accounts are important to consider.
But busting this Fed – Big banker de-regulate and bail-out cycle, initiated in the 1990s and only temporarily paused following the GFC, is the only real fix for the financial problems that have erupted again in these last few weeks. It’s a bipartisan problem, one that needs an energetic response from the rest of us.
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