BANK DEREGULATION FAILS AGAIN
Deregulation of “mid-sized” banks in 2018 and 2019, along with failures of banking oversight by the Federal Reserve, led to the collapse of three banks in the last ten days. The Chair of the Federal Reserve, Jerome Powell, bears significant responsibility for the conditions that allowed these bank failures to occur.
(Note: If you find my posts too much to read on occasion, please just read the bolded portions. They present the key points I’m making.)
The collapse of three banks in the last weeks has been widely reported. What hasn’t been nearly as widely reported are the factors that led to these failures. Greed and mismanagement by the banks’ executives caused their collapses, of course. However, this wouldn’t have happened without deregulation and failures of oversight by bank regulators (primarily the Federal Reserve). Deregulation in banking and other industries over the last 40 years has not lived up to its promises of greater efficiencies and better products and prices for consumers. Moreover, in many cases, it has harmed employees, customers, and taxpayers. (See this previous post for more details on the failures of deregulation.)
This banking system crisis is a somewhat surprising repeat (on a smaller scale) of the banking crisis in 2008, although it was predictable in some experts’ eyes. Again, as in 2008, fifteen short years ago, the banks and wealthy depositors are being bailed out by the federal government.
After the 2008 debacle, the Dodd-Frank Act was passed in 2010 to enhance bank regulation and (hopefully) prevent a recurrence. However, Dodd-Frank wasn’t as strong as many experts would have liked and efforts to weaken it further began immediately. These efforts were led by the banks and Wall St. financial corporations, with support from most Republicans and some Democrats – and some of the federal banking regulators. The efforts included a focus on weakening and delaying the implementation of the regulations required by Dodd-Frank.
In 2018, the Trump administration and the Republicans in control of Congress (with some Democratic support), passed a law significantly reducing banking regulation, primarily for “mid-sized” banks (i.e., ones with assets between $50 billion and $250 billion). The three banks that collapsed recently are in this group.
The Chair of the Federal Reserve (the Fed), Jerome Powell, lobbied for the 2018 deregulation law, despite the fact that the Fed is the primary regulator of these banks. He is a former investment banker and was nominated to the post by President Trump. Many supporters of strong banking regulation were dismayed when President Biden renominated him in 2021.
The collapse of these three banks is due in part to the failure of the Fed’s oversight (what’s referred to in the business as “supervision”). Banking experts, investors, rating agencies, and even some in the media had identified risks at Silicon Valley Bank (SVB) that the Fed seems to have missed or ignored. SVB was the first of the three banks to collapse and is the 2nd biggest bank failure in U.S. history. (There would have been other bigger ones in 2008 if the government hadn’t stepped in to rescue them.) SVB had grown rapidly, had deposits largely from one industry and from companies that were inter-related, had significant individual deposits over the insurance limit of $250,000, and had invested lots of its cash in long-term investments that heightened risk if interest rates went up or depositors wanted money back on short notice. All of these factors are flags that should have drawn the attention of the Fed long before SVB’s collapse. Senator Warren (D-MA) and other banking watchdogs have called the collapse of these three banks a glaring failure of oversight by the Fed.
The federal government released a statement on Sunday, March 12, to reassure the public about safety and security of the country’s banking system and their bank deposits. Fed Chair Powell delayed the release of the statement with his insistence that the statement not mention the failures of the Fed in overseeing SVB and other banks. [1]
On March 15, Senator Warren sent a scathing 10-page letter to Fed Chair Powell detailing his and the Fed’s role in aiding and abetting the collapse of these banks. She wrote to Powell that these banks collapsed “under faulty supervision and in a weakened regulatory environment that you helped create.” She noted that Powell had “led and vigorously supported efforts to weaken the regulations” for these banks. In 2018, Powell, as Fed Chair, supported the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCP), which rolled back some provisions of the Dodd-Frank law, dramatically weakening regulation of banks, particularly those with $50 billion to $250 billion in assets. At that time, a Wall Street Journal editorial warned that the bill would make the financial system more vulnerable and a Bloomberg editorial warned that the bill chipped away at the bedrock of financial resilience. Powell supported it anyway.
Furthermore, in 2019, Powell took additional deregulatory steps that weakened or eliminated guardrails that would have applied to SVB. As he was doing so, a federal Reserve Board member warned that safeguards at the core of the system were being weakened. A Federal Deposit Insurance Corporation (FDIC) Board member objected to Powell’s deregulatory steps, warning at the time that they significantly underestimated the risks of banks SVB’s size, noting that banks of this size experienced significant stress in the 2008 debacle and would have collapsed without government bailouts.
Just three days before the SVB collapse, when asked by Senate Republicans if he would continue to weaken banking regulation, Powell replied, “Yes, I can easily commit to that.” Ironically, Powell’s strong and persistent push to raise interest rates causes the value of long-term bonds to fall. SVB and other banks holding long-term bonds therefore would see the value of their investments fall which would threaten their ability to sell them to deliver cash to depositors. This was a key factor in the collapse of SVB and, although Powell’s actions at the Fed precipitated it, he and the Fed apparently did not anticipate their negative effects on banks.
Senator Warren’s letter concludes by noting that Powell contributed to the bank failures in three ways:
· Powell actively supported legislation that weakened the Dodd-Frank law,
· Powell implemented regulations that further weakened bank regulation, and
· Powell failed to ensure that the oversight of the Fed was effective in preventing the banks’ collapses.
Warren’s letter states that Powell should recuse himself from the internal review the Fed has announced into the oversight and regulation of SVB, given his direct involvement in and responsibility for the chain of events that led to the bank’s collapse.
As-of March 17, a week after SVB’s collapse, it and other banks that have collapsed or are at-risk have borrowed a total of $165 billion from the Fed to bail them out. The U.S. Treasury and the FDIC have committed to protect all depositors at the failed banks, bailing out the start-up companies and their venture capital funders, particularly the ones that had over $250,000 on deposit at a bank that collapsed.
My next post will provide a few more details about the collapse of these three banks and will discuss efforts to prevent this from happening again.
[1] Johnson, J., 3/17/23, “‘An abomination’: Powell cut mention of regulatory failures from bank bailout statement,” Common Dreams (https://www.commondreams.org/news/powell-cut-regulatory-failures-mention)