Silicon Valley Bank (SVB) is a failure of SIVB, a failure of federal supervision and regulation. The two terms are used interchangeably, but have different concepts: regulation is about making rules, supervision is about enforcing them. Initial reactions to the failure of the SVB focused on the debate over whether Trump-era deregulation caused the failure, but this ignores the fundamental question of whether existing regulations were being properly enforced. The answer is that they were not, and the Federal Reserve failed as bank supervisor. The Fed supervised SVB from head to toe, with the San Francisco Federal Reserve Bank in charge of both the bank and its larger parent holding company, SVB Financial Group. SVB was the largest bank supervised by the SF Fed. SVB’s CEO also sat on the SF Fed’s board of directors until the bank failed. “Each of these four red flags should trigger further investigation by the Federal Reserve. ” I count at least four red flags of bank conduct that should have set off alarm bells, which the Fed seems not to have heard. 1. Explosive Wealth Growth: SVB has nearly quadrupled its assets in four years. 2. Over-reliance on uninsured deposits: About 90% of SVB’s deposits were from customers with more than the FDIC limit ($250,000), often tech firms. Uninsured depositors are more likely to run, which makes the bank inherently less stable. 3. Greater interest rate risk: During the period of explosive growth between 2019 and 2021, SVB purchased more than $100 billion of mortgage-backed securities issued at low interest rates. The bank failed to purchase a hedge to protect the value of the securities if interest rates rise. 4. Dash for Cash in Federal Home Loan Bank: As SVB needed cash, it used the arcane federal home loan bank system to borrow heavily—it became the San Francisco FHLB’s top borrower of $20 billion. Lender of Next-to-Last Resort To understand how important this is, know that FHLBs are called lenders of next-to-last resort. When a bank fails, the FHLB is the only entity that is paid before the FDIC. The more debtors a bank has on the FHLB, the greater the loss by the taxpayer if the bank fails. Each of these red flags should warrant further investigation from the Federal Reserve. Combined, they scream for further investigation. After all, SVB is not, and never has been, a Main Street bank. Regional banks of its size ($200B) typically operate about 1,000 branches: SVB had 16. This also does not include questions about the relationship between SVB’s venture-capital arm and the bank’s customer base, a potential red flag for Fed regulation of the bank. The holding company should do the analysis. Read: The Fed’s new loan program appears to favor SVB over other regional banks The Fed has already launched an investigation into its own failure, but that is likely to be insufficient. For example, the Fed’s self-investigation did not reveal information leaked by the president of Richmond Bank (the FBI discovered it and the executive resigned in disgrace). Another Fed investigation failed to reveal the dates of unethical trading by the Dallas and Boston bank presidents. The Fed is ultimately accountable to Congress. Congress needs to investigate what happened with its own investigation. It’s not enough for the Fed to simply tell regional banks to fix themselves. For example, legislation requiring Fed regional banks to integrate their boards passed in the 1970s was widely ignored; The Kansas City Federal Reserve did not integrate its all-white board until 1992. Improving Fed governance is important, but insufficient. Bank regulators keep their supervisory reports from the public, so we never know what condition these banks are in or whether regulators are doing a good job. Bank regulators must make these reports, known as “CAMELS,” public, so Americans can judge both how banks are doing and how well agencies are supervising them. For example, learning what grade the SF Fed gave SVB would go a long way to understanding how poorly they supervised the bank. Congress writes financial regulation with two possible outcomes: empowering regulators to set specific rules or find details in the law. In both cases, Congress relies on regulators to enforce the rules. Congress cannot legislate judgments or merits. The US financial regulatory system places considerable trust in the judgment and competence of bank regulators, particularly the most powerful: the Federal Reserve. In the case of Silicon Valley Bank, it was misplaced. As monetary policy setter, bank regulator, lender of last resort, payment system operator and regulator, producer of economic research and statistics, and more, the Fed has been assigned ever more responsibility. Perhaps it is time to fundamentally rethink the role of the central bank. An often forgotten fact is that Senator Christopher Dodd’s original proposal, which in law became Dodd-Frank, envisioned banks like SVB being supervised away from the Fed. That idea was voted down 91-9. Dodd-Frank ultimately expanded the Fed’s authority and power over the nation’s banking system. In the case of SVB, it has failed. Aaron Klein Miriam K. is a Carliner Chair and Senior Fellow at the Brookings Institution. He served as Deputy Assistant Secretary of the Treasury from 2009-2012 and as Chief Economist under both Senate Banking, Housing and Urban Affairs Committee Chairmen Chris Dodd and Paul Sarbanes. In those roles he helped draft, secure passage, and implement the Dodd-Frank Act. More: Silicon Valley banks survived the dot-com crash and the Great Recession, but SVB met its match in Powell’s hawkish fade. Also read: Why Ray Dalio says SVB’s collapse is a ‘canary in the coal mine’
