Federal Reserve criticized for missing red flags before Silicon Valley bank collapse – Chicago Tribune

WASHINGTON — The Federal Reserve is facing sharp criticism for missing what observers say are clear signs that a Silicon Valley bank is at high risk of failing and becoming the second-largest bank in U.S. history.

Critics point to many anxieties surrounding the bank, including its rapid growth since the pandemic, its unusually high level of uninsured deposits and its many investments in long-term government bonds and mortgage-backed securities, which have fallen in value as interest rates have risen.

“It is inexplicable how Federal Reserve officials failed to see this obvious threat to the safety and soundness of banks and financial stability,” said Dennis Kelleher, executive director of the advocacy group Better Markets.

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

The Fed was the top federal supervisor of the Santa Clara, Calif.-based bank that collapsed last week. The bank was also under the supervision of the California Department of Financial Protection and Innovation.

Now, the fallout from Silicon Valley Bank, along with New York’s Signature Bank, which collapsed over the weekend, is complicating the Fed’s future decisions on how high to raise the benchmark interest rate to combat chronically high inflation.

Many economists say the central bank would likely raise rates by an aggressive half-point at its meeting next week, marking a step forward in its fight against inflation after the Fed raised rates by a quarter point in February. It now stands at around 4.6%, the highest level in 15 years.

Last week, many economists assumed that Fed policymakers would raise their forecast for future rates next week to 5.6%. Now, it’s suddenly unclear how many additional rate hikes the Fed is predicting.

With the collapse of two major banks raising concerns about other regional banks, the Fed may be focusing more on building confidence in the financial system than on the long-term quest to curb inflation.

The government’s latest inflation report, released on Tuesday, showed that price increases remain much larger than the Fed prefers, putting Chairman Jerome Powell in a tougher position. Core prices, which exclude volatile food and energy costs and are seen as the best gauge of longer-term inflation, jumped 0.5% from January to February, the most since September. That’s well above the Fed’s 2% annual target.

“If it weren’t for the fallout from the bank failure, it might have been very difficult, but I think it would have taken them to a half point (rate hike) at that meeting,” said Kathy Bostiancic, Nationwide’s chief economist.

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

A spokesman for the Federal Reserve declined to comment further. A spokesman for the California Department of Financial Protection also declined to comment.

By all accounts, Silicon Valley was an unusual bank. His management took excessive risks, buying billions of dollars in mortgage-backed securities and Treasuries when interest rates were low. As the Fed kept raising interest rates to fight inflation, which drove up Treasury yields, the value of Silicon Valley’s bonds steadily lost value.

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

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

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

That unusually high stake made Silicon Valley Bank highly vulnerable to depositors quickly withdrawing 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 regulators found this business model acceptable,” said Aaron Klein, a congressional aide now at the Brookings Institution who worked on the Dodd-Frank banking regulation that passed. after the 2008 financial crisis.

Bank failures are likely to color the Fed’s upcoming review of rules that determine how much money big banks must keep in reserves. Last year, Barr said he wanted a “comprehensive” review of those requirements, sparking fears in the banking industry that the review would lead to rules forcing banks to hold more reserves, limiting their ability to lend.

Many critics also point out that the 2018 law relaxes banking regulations in ways that contributed to the collapse of Silicon Valley. Pushed by the Trump administration with bipartisan support in Congress, the law exempted banks with between $100 billion and $250 billion in assets — the size of Silicon Valley — from requirements that included regular reviews of how they would fare in tough economic times, known as “stress tests.” tests”. »

Silicon Valley CEO Greg Becker lobbied Congress in support of deregulation, and he served on the board of the Federal Reserve Bank of San Francisco until the day of the collapse.

Sen. Elizabeth Warren, D-Massachusetts, questioned him about his lobbying in a letter released Tuesday.

“These rules were designed to protect our banking system and economy from the negligence of bank managers like you, and their kickbacks, along with your bank’s harsh risk management policies, were implicated as the main causes of its collapse,” the letter said. Warren.

The 2018 law also gave the Fed more latitude in supervising banks. After that, the central bank voted to further reduce regulation for banks the size of Silicon Valley.

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

Kelleher said the Fed could still push the Silicon Valley bank to take defensive action.

“Nothing in this law in any way prevented the governors of the Federal Reserve System from doing their jobs,” Kelleher said.

AP Economics writer Paul Wiseman contributed to this report.