Part 1 – What Just Happened?
Just as “Everything, Everywhere All at Once” was sweeping the Oscars and the NCAA March Madness tournament final selections were being locked in – that is to say, just the other day – the U.S. saw two of the largest bank failures in history, including the second largest ever. Silicon Valley Bank (SVB), with more than $200 billion in assets, failed Thursday evening, and Signature Bank (SB), with just under $100 billion in assets, failed on Sunday.
The swift collapse of SVB, the regulators’ decision to seize Signature, and the announcement by the Fed, Treasury and FDIC at 6:15pm on Sunday evening “to protect the U.S. economy by strengthening public confidence in our banking system,” including invoking the “systemic risk exception” to guarantee uninsured deposits at the two banks – effectively brought an end to the bipartisan post-Dodd-Frank assumption that the banking system would never again be bailed out. Regardless of what happens next, the influence of the collapse of SVB will be felt for years.
This analysis explores what happened with SVB and what it reveals about the state of the U.S. financial regulatory framework. It also explores the potential impact of SVB’s collapse on the overall Congressional and regulatory outlook for financial services policy.
1. Silicon Valley Bank
Founded in 1983, SVB was historically a small venture fund and bank to Silicon Valley’s many startups. While many other banks have a significant number customers who are individuals, SVB’s clients were overwhelmingly businesses. Instead of deposit accounts below the $250,000 cap for FDIC deposit insurance, the vast majority of SVB’s accounts were “uninsured deposits,” 10x, 20x, or even greater than the legal threshold for FDIC insurance. (By way of comparison, as of late last year, while JPMorgan Chase’s deposit base was just over 40% uninsured, SVB’s was nearly 90%.) Importantly, large chunks of those uninsured deposits were being used by corporations to pay rents, make payroll, and pay other corporate expenses. The top priority for those corporations was to be able to use their deposits when necessary, not to earn any kind of profit.
SVB grew rapidly in size over the past decade, perhaps in large part due to the Federal Reserve’s easy money policies that increased securities’ valuations. In December 2016, SVB’s held $45 billion in assets, which increased to $115 billion by the end of 2020 and to $211 billion by the end of 2021. Because it was bringing in so many deposits, while its customers had little need for loans (thanks to venture capital and other funding), SVB used its deposit base to buy low-interest rate bonds.
But SVB’s managers made a huge mistake by not hedging its assets’ interest-rate risk, and as interest rates rose, the market value of those bonds fell, leaving SVB with unrealized losses. By March 3, 2023, as the Federal Open Markets Committee (FOMC) continued to “to rapidly increase interest rates and reduce its securities holdings,” the value of SBCs securities holdings continued to plunge.
It is worth noting that SVB was not the only bank in this situation. According to FDIC data, total unrealized losses in the banking system were about $620 billion at the end of 2022, and as FDIC Chair Martin Gruenberg noted recently, “unrealized losses weaken a bank’s future ability to meet unexpected liquidity needs,” which is what we saw last week.
2. The “Run” on SVB and Government Receivership
Media reports indicate that SVB was facing a credit downgrade, and in order to avoid that, SVB conducted a capital raise by selling $21 billion in available-for-sale (already marked to market) securities. Commenters, however, saw this as a threat to the bank’s stability and called for businesses using SVB to move their deposits to other, larger institutions.
Given the nature of SVB’s depositors—tech firms run by digitally connected executives who move in crowds—they saw these calls through Twitter, Slack, and other social media channels and largely tried to withdraw their deposits en masse. California notes that SVB saw $42 billion in withdrawals in a short period.
SVB did not have enough cash on hand to meet these redemption requests, so it had to sell assets it held, realizing the losses that had previously been unrealized. It sold about $20 billion in Treasuries at a loss of $1.8 billion. And once the losses were realized, the bank had to backfill the gap from the losses. It tried to sell $1.75 billion in stock on Thursday, but the sales were not completed.
On Thursday night, it was clear SVB was insolvent. The California Department of Financial Protection and Innovation took possession of SVB and appointed the FDIC as receiver. The FDIC created the Deposit Insurance National Bank of Santa Clara (DINB), moved all insured deposits over to the DINB, and began looking for a buyer of SVB’s assets.
The FDIC put SVB ’s assets up for auction, but no buyer appears to have been found. Several potential purchasers are said to have looked at SVB’s assets and passed.
3. Sunday Night Safety
Without a buyer, the regulators were left with a choice: Announce that no buyer had been found and that SVB’s uninsured depositors were not going to be made whole, or take unprecedented action. They chose the latter, likely because over the preceding day Signature Bank had also failed, indicating that more banks were going to fall without government intervention.
Sunday evening, the Fed, FDIC, and Treasury jointly announced that they were making use of the “systemic risk exception” in the FDIC’s laws to make uninsured depositors at SVB and Signature Bank whole. While shareholders and certain unsecured debt holders would be wiped out and senior management would be removed, uninsured depositors would be made whole.
Simultaneously, the Fed announced a new facility allowing it to buy bonds at a premium from banks that may be facing a similarly rocky future. Under the new Bank Term Funding Facility, the Fed will purchase US Treasuries, agency debt, mortgage-backed securities, and certain other securities at par value as collateral for loans to banks for up to one year. This facility allows banks to sell assets with unrealized losses to the Fed in exchange for clean cash—essentially, an infusion of capital into banks that may be on the brink of failing. The program is backstopped with $25 billion from the Treasury Department’s Exchange Stabilization Fund. (Interestingly, this also means that banks may be able to buy certain bonds trading at less than par from nonbanks and sell them to the Fed for a profit—the implications of this are unclear.)
Part 2 – What Does This Mean for Washington?
Today’s analysis is of course based on what we know so far, and it will be a while before the dust settles and we can figure out exactly what the events of the past four days mean.
On the one hand, with federal officials all the way up to the President fully engaged in the policy response, it seems likely that the next several days will set the tone for a week that could see Republicans and Democrats abruptly forced to shelve major parts of their respective legislative and regulatory goals, at least temporarily. On the other hand, Congress’s ability to adjust for the impact of these changes has been hobbled by the fact that the Senate doesn’t return to session until this evening, and the House is out on recess until next week.
Members will need to make decisions by Thursday about reshuffle hearing calendars for next week.
1. The Politics of SVB’s Collapse are Taking Shape but Still Unsettled.
One of the interesting things we heard in conversations with Congressional staff on Monday was the suggestion that policymakers are still wrestling with the political implications of the government’s decision to rescue SVB.
We also found it notable that on Sunday evening, Congressional leaders failed to release any joint statement expressing bipartisan support for the emergency steps taken by the Federal Reserve – as was the case in 2008, and 2020.
Instead, at 9:43PM on Sunday evening, the top Democrats on the relevant Congressional committees with jurisdiction over banking and the banking sector – Sen. Sherrod Brown (D-OH) and Rep. Maxine Waters (D-CA) – released a statement stating that they “appreciate [regulators] coming together to address the Silicon Valley Bank and Signature Bank failures and protect the financial system,” and characterizing the actions as necessary to “enable workers to receive their paychecks and for small businesses to survive, while providing depository institutions with more liquidity options to weather the storm.”
The following day, in an apparent effort to cement unity in the face of political uncertainty, the top Democrats in Congress, Senate Majority Leader Chuck Schumer (D-NY) and House Minority Leader Hakeem Jefferies (D-NY) issued a joint statement expressing support for the Administration’s and regulators’ “swift action to safeguard depositors & maintain confidence in the banking system,” and pleading that “in the coming days and weeks, Congress will be looking closely at the causes behind the run on Silicon Valley Bank and other banks and how we can prevent a similar crisis in the future.”
This all dovetails with the President’s remarks on Monday.
Thus, the message from Democrats seems to be relatively unified in support of the extraordinary steps taken by regulators to protect depositors – including uninsured depositors – at SVB. Conversations with Congressional staff on Monday suggested this view is grounded in the depositors are not at fault for the banks’ failure or risk mismanagement, and that the consequences of that mismanagement should not fall on small businesses and their employees.
One emerging vector of Democratic criticism is a 2018 law that weakened oversight of many regional banks. On Monday, for example, Rep. Ayanna Pressley (D-Mass.) called for a hearing to investigate “how Republicans’ 2018 bank deregulation bill contributed to SVB’s risky behavior and jeopardized financial stability for far too many.” Rep. Katie Porter (D-CA), who’s running for a newly open Senate seat in California, said she would introduce legislation to undo the 2018 law. Other progressives, such as Sen. Elizabeth Warren (D-MA), on Monday used the SVB fiasco to excoriate “Wall Street lobbyists and Republicans in Congress” for “pushing Fed Chair Powell for weak capital requirements at exactly the wrong time.” By Tuesday morning, Sen. Warren had sent SVB’s CEO, Gregory Becker, a letter requesting information “about your successful efforts to roll back banking regulations and exempt your bank from the protections Congress enacted with the Dodd-Frank [Act]…designed to safeguard our banking system and economy from the negligence of bank executives like yourself[.]
Now – Senator Warren has every reason to feel vindicated. She called it.
However, progressive efforts to pin responsibility for the collapse on the 2018 changes will make things uncomfortable for other Democrats, especially moderate Senate Democrats like Jon Tester (D-MT) and Joe Manchin (D-MT), who face reelection this cycle. They also confront the apparent fact that Becker and other SVB executives have donated heavily to Democrats.
By contrast, Republicans have thus far been notably more mixed and sometimes muted in their comments, both with respect to the SVB situation and the regulatory response. According to reporting by the Wall Street Journal, in a call with House Republican on Monday night Speaker Kevin McCarthy (R-CA) “blamed the failure in part on President Biden’s spending policies that GOP lawmakers say contributed to inflation, as well as actions by bank management and regulators.”
One day earlier, on March 12th, House Financial Services Committee (HFSC) Chairman McHenry released a statement characterizing the collapse of SVB as “the first Twitter fueled bank run,” and voicing “confidence in our financial regulators and the protections already in place to ensure the safety and soundness of our financial system.” For his part, Sen. Tim Scott (R-SC), the Ranking Member of the Senate Banking Committee, issued a statement observing that “[b]uilding a culture of government intervention does nothing to stop future institutions from relying on the government to swoop in after taking excessive risks.” (Sen. Minority Leader Mitch McConnell (R-KY) was discharged from a hospital stay for a concussion on Monday afternoon and has had little if anything to say on the matter.)
Senate Republicans in general – and Sen. Scott in particular – find themselves in an awkward spot, having recently and vocally championed the 2018 law that relaxed regulation on regional banks and appear to have contributed to the collapse. In fact, only a week before the collapse, on March 3, Sen. Scott and nine other Republican Senators sent a letter to the Federal Reserve expressing concern that an FRB review of regional banks (like SVB) might go beyond the purview of the 2018 law, “unjustly increase[ing] capital requirements” and having a “chilling effect on market making activities and availability of financial services.” This is not a great look for Senate Republicans.
Finally, just as the 2008 bailouts energized the populist wings in both parties, the longer that the upheaval in the banking sector continues the more likely it will become that some version of this phenomenon will repeat itself. Already by Sunday, Rep. Marjorie Taylor Greene (R-GA) took to twitter to lambast the Fed for “extending loans against high quality assets to banks for nearly zero interest to prevent a run on the banks Monday all because SVB didn’t insure over 89% of their deposits and instead hedged on failing funds that offered ‘sustainable finance and carbon neutral operations to support a healthier planet,” while Sen. Bernie Sanders (I-VT) had inveighed against “a bailout” of SVB, arguing that policymakers “cannot continue down the road of more socialism for the rich and rugged individualism for everyone else.”
Additionally, the ultimate wild card still exists in the former president’s potential reemergence, which will likely do little to dampen the populist wing of the Republican party. Indeed, in addition to Trump, for every day that the crisis remains in the headlines, it becomes more likely that one or another of the announced and assumed presidential candidates will take a political position on the situation – intentionally or inadvertently – that complicates the Congressional picture.
2. There are Potential Legislative Policy Implications.
When the U.S. Congress adjourned on March 10, plans for the remainder of the Spring seemed largely set. The HFSC, for example, was planning to hold a hearing on March 23, tying together three recent subcommittee hearings dealing with securities de-regulatory legislation. The following week, the HFSC had planned to undertake a markup of more than 30 bills, primarily relating to capital markets and securities – including a smattering of bipartisan bills.
By Monday evening, the outlook for the remainder of the month and indeed the spring appeared suddenly up in the air. While indicating that the official order line was generally to continue work according to plan, Congressional staff speaking confidentially observed that “last week feels like it was 10 years ago,” in discussing how “powerful” the events of the weekend have been and “how much they have crowded out everything else.” Thus, it is quite possible that the legislative policy implications of the events of the past 4-5 days could end up proving more lasting and consequential than any actual, enduring economic or financial impact of SVB’s collapse.
Given the decision to once again break the rules to prevent banks from failing, Congress has little choice but to reconsider the post-Dodd-Frank regulatory regime in general. This reality seems to be sinking in with at least some members, too. As Rep. Josh Harder (D-Calif.) explained on Monday: “I really don’t see an avenue where there is not some sort of central legislation to deal with the after-impacts of this, even if it’s just to really cement what happened this weekend.” We agree. Indeed, to the extent that the collapse of SVB raises any lingering question about the ability of U.S. financial services regulators to effectively guarantee the safety and soundness of U.S. banks and the banking system – and prevent bank runs – it is almost impossible to envision the relevant Congressional committees prioritizing any other issue.
At a bare minimum, it seems clear that Congress is going to be required to devote significant and unplanned time and attention to examining the current bank regulatory regime. We anticipate that various elements of the past week’s policy failure – including failures by the Fed and FDIC, the role of 2018 rollbacks, the peculiarities of the framework for oversight of state-chartered financial institutions, the role of the San Francisco Fed, the payment of bonuses to executives just hours prior to collapse – to each, in turn, come under significant scrutiny.
Finally, crucially, and what remains to be seen, is whether the present “minor crisis” will metastasize into something that will consume the political economy and policy bandwidth of the HFSC and Senate Banking Committees for months rather than weeks, crowding out previously anticipated policies focused on capital markets reform, digital assets regulation, data privacy reform, among many other issues. At the very least, chaos in the regional banking sector seem poised to delay and dilute some of the extensive oversight House Republicans have been preparing to unleash on the SEC and CFPB. At the other end of the realm of possibilities is that SVB’s failure may an inflection point for the HFSC and Senate Banking in the 118th Congress, shifting the focus away from capital markets and other issues, and bank toward banks.
3. There are Potential Regulatory Policy Implications.
The Federal Reserve Board has already announced that it is conducting a review of the supervision and regulation of SVB, with Chair Jerome Powell saying that “The events surrounding [SVB] demand a thorough, transparent, and swift review.” The Fed expects this review to be completed by the beginning of May.
SVB was supervised by both the State of California and the Federal Reserve Bank of San Francisco, and both deserve blame for letting SVB get to a point where it could fail. One thing in particular that we are looking at is whether the fact that SVB’s CEO served as a director of the San Francisco Fed played any role in the lax oversight. Time will tell.
Next, we expect the bank regulators to tighten prudential regulations of banks between $100 billion and $250 billion in assets. The 2018 law that weakened parts of Dodd-Frank permits regulators to impose tailored capital and liquidity rules on these institutions. Similarly, while the law required these institutions to submit resolution plans explaining how they could be resolved in bankruptcy and submit to stress tests “periodically,” we expect regulators to increase the frequency of these requirements to annually. We may also see new rules around reporting the fair value of bank assets and reporting of losses.
Further, as the new operator of SVB and Signature Bank, the FDIC is likely to attempt to clawback ill-gotten compensation from the banks’ executives. This attempt will be the first test of new executive compensation rules enacted following Dodd-Frank, and we expect litigation. If the FDIC is not able to effectively clawback the compensation, we expect new regulations to be enacted making it easier for clawbacks to occur following the next crisis. Additionally, one of the executive compensation rules required by Dodd-Frank has yet to be completed; perhaps this crisis will spur regulators to finally act.
Lastly, we expect the Securities and Exchange Commission (SEC) to investigate whether SVB executives violated any securities laws, including those related to insider trading and self-dealing, as well as whether there were any material misrepresentations in corporate filings. While no new regulations are expected, enforcement actions certainly are. We also anticipate other potential probes, including from the Department of Justice, regarding potentially inappropriate attempts to influence the decision to rescue SVB.
4. There are Potential Monetary Policy Implications.
Finally – important questions have been raised about the SVB failure’s impact on interest rates and other macroeconomic policies. We don’t necessarily disagree with Goldman Sachs and the many others who have suggested that the events of the past 4 days could force the Fed to change course with respect to its policies on interest rates. However, that is outside the scope of this analysis, which focuses on likely implications for legislative and regulatory policy.
Concluding Thoughts:
It is unclear if the divided government in Washington will be capable of having an adult conversation about banking regulation. We are about to find out.
Republicans clearly sense a political opportunity. Some House Republications are saying that SVB failed because it was “woke,” and media reports indicate that Speaker McCarthy is blaming President Biden’s “failed fiscal policies” for causing the run on SVB.
At the same time, Democrats are confronted with something they’re not used to dealing with: a problem in Dodd-Frank framework that requires a legislative fix. Democrats will also need to be able to work with the new GOP majority in the House, something that has not yet meaningfully happened in the new 118th Congress, and that will be tested early by the SVB failure.
For both parties, however, as the realization sets in among elected officials and the public that what the central bank just did was a bailout of the tech sector, resentment is sure to grow.
Democrats can correctly claim that the regional banks have only themselves to blame for their situation. And that issue is sure to be debated during the upcoming election. However, in the near-term, that determination is not really relevant, and any irony is lost on the American public. Americans – blue state and red state – don’t like bank panics. And neither do their politicians.
It is hard to predict what will happen until the dust settles, perhaps in a week or two, but if any more regional banks fail and are placed into receivership, financial policy-making in Washington faces a tectonic shift. We may just need to wait and see.
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