PREVENTING BANK FAILURES

A history of greed, mismanagement, deregulation, and weak regulatory oversight has created a litany of banking and financial system crises over the last 40 years. Future crises can be prevented by:

·         Reversing the deregulation of a 2018 law,

·         Strengthening regulation,

·         Increasing deposit insurance, and

·         Making bank executives personally liable and culpable.

(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.)

Greed and mismanagement by bank executives led to the collapse of three banks in early March. Deregulation of “mid-size” banks in 2018 and 2019, along with failures of banking oversight by the Federal Reserve (the Fed), were also major factors in the banks’ collapses. The Chair of the Federal Reserve, Jerome Powell, bears significant responsibility for the conditions that led to these bank failures. (See this previous post for more details.)

The ultimate trigger for the collapse of Silicon Valley Bank (SVB), the first of the three to collapse, is an interesting story of conflicts of interest and hypocrisy. On Wednesday afternoon, March 8, SVB announced it needed to raise capital, presumably because the value of its long-term bond holdings had fallen, meaning its assets weren’t sufficient to meet its required level of capital. Hearing this, the venture capitalists who had invested in many of the companies with deposits at SVB, warned their companies (who further spread the word) that SVB was in trouble and they should withdraw their deposits. This was especially important for those with deposits above the $250,000 federal insurance cap, which was 90% of SVB’s depositors and 97% of its deposits. For example, Roku, the media streaming company, had $500 million on deposit at SVB. As a result, depositors withdrew $42 billion from SVB in the next 24-hours, causing the bank to collapse because it could not come up with sufficient cash to cover the withdrawals. [1]

The venture capitalists and the start-up companies, along with the failed banks’ executives, then insisted that the federal government should cover the uninsured deposits (roughly $175 billion) and make cash available to depositors immediately (both of which it did), even though they were the ones who had triggered the run on the bank that led to its collapse. Furthermore, the venture capitalists (who I believe deserve the moniker “vulture capitalists”) threatened to withdraw money from other banks and cause them to collapse if the government didn’t fully cover the deposits at the three failed banks. The resultant bailout is, in effect, a gift to a few very wealthy people who are happy to walk away with the profits of their risky behavior while dumping the costs of its failures on the government and taxpayers. Furthermore, until they need a bailout, they demand that government should stay out of their business.

This is a blatant display of hypocrisy, as many of these venture capitalists and bankers had pushed (and will push again, undoubtedly) for the deregulation that was a major contributing factor to the banks’ collapses. Notably, SVB CEO Greg Becker had vigorously lobbied for the 2018 law that dramatically reduced regulation of his bank.

The history of bank and financial deregulation is one of repeated bank and financial system crises. Most notably, there were the savings and loan crisis in the late 1980s and 1990s, and the financial collapse of 2008. In addition, there were the junk bond scandal of 1990, the Prudential Insurance scandal in 1994, the dot-com bubble bust of 2000 - 2002, and the Enron scandal of 2001. There have also been small numbers of banks failing from time to time as has just happened.  [2]

This history makes it clear that strong regulation of banks and the financial industry is necessary. Banking by institutions with federally (i.e., taxpayer) insured deposits should be safe and boring. Financial activities with high risk and potentially higher returns should be separated from insured bank deposits. This is what the Glass-Steagall Act did until it was repealed in 1999.

To prevent future banking and financial system crises, the following steps should be taken:

·         Reverse the deregulation of the 2018 law,

·         Strengthen regulation,

·         Increase deposit insurance, and

·         Make bank executives personally liable and culpable.

REVERSE THE DEREGULATION: Key provisions of the 2018 deregulation law, the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCP), should be reversed. Most notably, the provision that exempted “mid-size” banks (i.e., those with assets of $50 billion to $250 billion) from most regulation should be repealed. The argument was that these banks weren’t systemically important and therefore didn’t warrant strong regulation. Recent events have proved this wrong as the Federal Reserve formally declared the failure of these three “mid-size” banks as a systemic crisis. A multi-trillion-dollar bailout program was required to stabilize the banking industry.

STRENGTHEN REGULATION: The further weakening of regulations for “mid-size” banks (in addition to those in the 2018 law) that the Fed put in place in 2019 should be reversed. Regulations required or allowed by the 2010 Dodd-Frank law that have still not been implemented, such as regulation of bank executives’ compensation, should be implemented quickly and strongly. Dodd-Frank prohibits compensation that incentivizes inappropriate risk-taking, such as compensation heavily based on a bank’s stock price. Because of the Feds’ failure to implement this prohibition, between 2019 and 2022, SVB CEO Becker made $58 million from stock-based compensation as the SVB stock price went from $100 to $700 over six years due to his inappropriate risk-taking. [3]

The use of Deferred Prosecution Agreements (DPAs) must stop. These are settlements with regulators where banks pay fines and agree to stop bad behavior, but there’s no prosecution of executives. DPAs have become the norm since 2003. Bank executives used to be prosecuted, as in the savings and loan crisis of the 1980s and 1990s when more than 1,000 bank executives were prosecuted and many went to jail.

SVB ignored six formal warnings from the Fed over the course in 2021 and 2022, apparently assuming (correctly) that there would be no consequences. The Fed did little to follow-up on or enforce its warnings. This must change. Furthermore, SVB had no chief risk officer for almost a year. [4] [5]

INCREASE DEPOSIT INSURANCE: Deposit insurance by the Federal Deposit Insurance Corporation (FDIC) should be increased, along with appropriate fees to pay for it. The current $250,000 limit should be increased substantially, perhaps to $10 million, as even a relatively small business today needs more than $250,000 on hand to meet payroll and other routine expenses. [6]

My next post will describe how bank executives should be held personally liable and culpable for the failures of their banks. It will also present some specific steps that can be taken to prevent future banking and financial system crises.

[1]      Dayen, D., 3/13/23, “The Silicon Valley Bank bailout didn’t need to happen,” The American Prospect (https://prospect.org/economy/2023-03-13-silicon-valley-bank-bailout-deregulation/)

[2]      Miller, K., 3/21/23, “Seeking the roots of banking turmoil,” The Boston Globe

[3]      Anderson, S., 3/21/23, “Curbing bad behavior of bank CEOs isn’t as hard as they make it seem,” Common Dreams (https://www.commondreams.org/opinion/curbing-big-bank-ceo-greed)

[4]      Dayen, D., 3/21/23, “The Fed’s Silicon Valley Bank coverup won’t work,” The American Prospect (https://prospect.org/economy/2023-03-21-fed-supervision-silicon-valley-bank)

[5]      Smialek, J., 3/20/23, “Failed bank ignored Fed’s warnings,” The Boston Globe

[6]      Smialek, J., 3/20/23, see above