In 2015, in the midst of a furious lobbying effort on behalf of the banking industry, the C.E.O. and founder of Silicon Valley Bank, Gregory Becker, submitted a statement to the Senate Banking Committee that now reads like something out of a dark comedy. “SVB, like our mid-sized bank peers, does not present systemic risk,” he wrote. “We do not engage in market making, securities underwriting or other global investment banking activities. We also do not engage in complex derivatives transactions or dealing, offer complicated structured products, or participate in other activities of the sort that contributed to the financial crisis.” He went on to emphasize to the senators concerned about the security of the financial system how utterly boring his company was; its main business was traditional banking: taking money from depositors and lending it to companies that were growing and also to the investors in those companies—activities that are fundamental to creating jobs.
The context surrounding Becker’s statement exemplifies the corruption that plagues our regulatory system. In 2010, Congress passed an eight-hundred-and-forty-eight-page bill called the Dodd-Frank Wall Street Reform and Consumer Protection Act in response to the 2008 financial crisis. One of the major goals of the legislation was to place restrictions on the kinds of risk-taking activities that had contributed to the crisis. The financial industry lobbied aggressively to weaken the bill before it passed, and was successful on various fronts. Then, when the bill became law, the push continued to weaken it further. In 2018, shortly after the Donald Trump-led Republican Party pushed through a tax-cut package that drastically reduced corporate taxes and disproportionately benefitted wealthy executives and investors, Congress approved another bill that loosened the Dodd-Frank rules. The bill raised the threshold over which banks would be required to submit to extra regulations and oversight, from fifty billion dollars in assets to two hundred and fifty billion. Once the bill passed, many banks under the threshold did not need to conduct mandated stress tests to see how they would manage during adverse economic conditions; it also lowered the amount of cash that these banks needed to have on hand in case of hiccups in the market; and they were no longer required to have a plan to quickly shut down without disrupting the rest of the financial system, should an unspeakable crisis arise. The lobbyists’ arguments, which were echoed by many members of Congress (Democrats as well as Republicans) taking money from the companies that the lobbyists represented, were that the enhanced restrictions were suffocating small-town banks with unnecessary costs and demands that made it hard for them to compete. In response to many statements like the one that Becker sent to the Senate Banking Committee, the bill, called the Economic Growth, Regulatory Relief, and Consumer Protection Act, was signed into law in May of 2018.
Just two weeks ago, Silicon Valley Bank’s shares plummeted more than sixty per cent. Becker held a conference call with the bank’s clients and urged everyone to remain calm. The following day, the Federal Deposit Insurance Corporation announced that it was taking over Silicon Valley Bank after depositors rushed to withdraw their money and the bank didn’t have enough available cash. It was a classic run on the bank of the sort depicted in the film “It’s a Wonderful Life,” and the second-largest bank failure the U.S. has ever seen. Within the next few days, Signature Bank was seized by regulators for similar reasons. A few days after that, regulators helped arrange a rescue of First Republic Bank; the crisis at First Republic is still ongoing, and its stock was halted several times on Monday because it was falling so fast. People are worried about where the panic could spread next. Senator Elizabeth Warren, one of the most incisive critics of banking-industry practices, partly placed the blame on our political system, wherein mighty industries such as the banking system can pressure members of Congress to do their bidding. “No one should be mistaken about what unfolded over the past few days in the U.S. banking system,” she wrote in an Op-Ed in the Times. “These recent bank failures are the direct result of leaders in Washington weakening the financial rules.”
Warren is right in placing the blame on Washington. But responsibility also lies with a culture of magical thinking that permeates the financial world, where those running large, profitable organizations seem to assume that the success of their companies is due entirely to their exceptional business skills rather than to luck and other external factors. In this mind-set, executives fail to consider the possibility that the incredibly favorable conditions they are experiencing at one time might one day change. “Businesses take risks, and sometimes those risks result in the failure of the institution,” Kathryn Judge, a law professor at Columbia University who studies bank regulation, said. Although, she added, in the case of S.V.B., the fact that the government had to step in quickly and take extraordinary measures points to a regulatory and supervisory failure as well.
To be sure, the old, pre-2018 banking requirements might have lessened the crisis for Silicon Valley Bank, by potentially forcing the bank to contemplate alternative scenarios and to do the math to see what would happen if interest rates were to increase sharply in a relatively short period of time, and by mandating that the bank retain more cash on hand as a cushion in case it fell under stress. But, as long as Becker and the others running the bank were focussed on aggressive profit maximization, and believed that the profit-enhancing environment of near-zero interest rates was not subject to change, the bank was always likely to run into serious problems.
Traditional banking, as Becker describes it, plays a crucial role in our society. At its core, it entails taking in deposits, gathering that money, and then lending it to businesses that need it to grow. A key part of the job of running a bank is managing these different pools of money and making sure that the balance of money coming in as deposits and going out as loans is just right, so that if someone comes in one day wanting to take money out of their account, the money is there. Interest rates have a dramatic impact on the financial calculus of a bank manager. The challenge is made even more complex when banks take a depositor’s money and invest it rather than lend. In this case, Silicon Valley Bank invested a large chunk of its deposits in long-dated Treasury bonds. Normally, this would be one of the safest investments one can make. When interest rates go up, though, newer Treasury bonds paying higher rates are worth more, and the older ones decline in value. This creates a cash crisis if too many depositors want their money back all at once and the bank is forced to liquidate a bunch of bonds that are worth less than they paid for them. As S.V.B.’s tech clients started struggling to raise venture-capital funds, they withdrew their deposits from the bank to meet their cash demands, forcing a liquidity-strapped S.V.B. to sell billions of government bonds at a nearly two-billion-dollar loss.
Judge likened recent events to the savings-and-loan crisis of the nineteen-eighties, which occurred under a similar set of circumstances. Savings-and-loan institutions, which are also referred to as thrifts, specialized in issuing mortgages to people buying houses, in essence taking deposits from customers and then lending them out as long-term fixed-rate housing loans. When, in the early nineteen-eighties, interest rates started to rise steeply, partly in response to inflation, the value of the mortgage loans declined and the S. & L.s faced a similar challenge to S.V.B.: depositors asked for their money back, and thrifts didn’t have it to give them.
“It’s tricky to get your mind around, but it’s core to banking,” Judge said. “For anyone familiar with the industry, this is the most classic risk that exists.” All banks struggle with managing these risks, and being diversified is one way to reduce them. But, Judge noted, there are also instruments that exist in the market now that didn’t in the nineteen-eighties which allow banks to hedge this risk. So far, it’s unclear why Silicon Valley Bank did not make adequate use of these tools.
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