The Real Story Behind Silicon Valley’s Banking Debacle – OpEd – Eurasia Review

On Friday, banking regulators shut down Silicon Valley Bank, based in Santa Clara, Calif. His failure was the second biggest in US history and the biggest since the 2008 financial crisis.

Regulators closed New York-based Signature Bank on Sunday.

As they rushed to contain the fallout, officials from the Federal Reserve, Treasury and Federal Deposit Insurance Corporation announced in a joint statement on Sunday that Silicon Valley Bank depositors would have access to all their money from of Monday. They would adopt a similar program for Signature Bank.

They pointed out that bank losses would not be borne by taxpayers, but who will bear them? What the hell happened? And what lessons should we draw from this?

The surface story of the Silicon Valley Bank debacle is simple. During the pandemic, startups and tech companies have made sky-high profits, some of which have been deposited at Silicon Valley Bank. Rich in cash, the bank did what banks do: it kept a fraction on hand and invested the rest – placing a significant portion in long-term treasury bills that promised good returns when rates interest were low.

But then, just over a year ago, the Fed raised interest rates from near zero to over 4.5%. As a result, two things happened. The value of Silicon Valley Bank’s Treasury bond holdings fell because the new bonds were paying more interest. And, as interest rates rose, the spurt of venture capital funding for startups and tech companies slowed, as venture capital funds had to pay more to borrow money. As a result, these startups and tech companies have had to take more of their money out of the bank to meet their salaries and other expenses.

But the bank didn’t have enough money on hand.

There is a deeper story here. Remember the scene in It’s a wonderful lifewhere Jimmy Stewart’s character tries to quell a run on his bank by explaining to depositors that their money was loaned to other people in the same community, and that if they were patient, they would get their deposits back?

In the early 1930s, such bank runs were common. But the Roosevelt administration enacted laws and regulations requiring banks to have more cash on hand, preventing them from investing their depositors’ money for profit (in the Glass-Steagall Act), insure deposits and monitor banks closely. Banking has become more secure and boring.

This lasted until the 1980s, when Wall Street financiers, seeing the potential of money, pushed to dismantle these laws and regulations – culminating in 1999, when Bill Clinton and Congress repealed what remained of Glass. -Steagall.

Then, of course, came the financial crisis of 2008, the worst meltdown since 1929. It was a direct result of financial deregulation. Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006, called it “the only credit tsunami in a century,” but pressed by critics, Greenspan acknowledged that the crisis had forced him to rethink his market ideology. free. “I found a loophole,” he told a congressional committee. “I made a mistake…I was shocked.”

Shocked? Really?

Once the bank was deregulated, such a crash was inevitable. In the 1950s and 1960s, when banking was boring, the financial sector accounted for only 10-15% of corporate America’s profits. But deregulation has made finance exciting and extremely profitable. In the mid-1980s, the financial industry demanded 30% of corporate profits, and by 2001 – by which time Wall Street had become a gigantic betting parlor in which the house took a large share of the bets – it demanded 40%. That was more than four times the profits made in the entire US manufacturing industry.

When the bubble burst in 2008, the Bush administration decided to protect investment banks. Treasury Secretary Hank Paulson, former CEO of Goldman Sachs, and New York Fed President Timothy Geithner engineered the bailout of investment firm Bear Stearns but allowed Lehman Brothers to go bankrupt. The stock market collapsed. AIG, an insurance giant that had taken out hundreds of billions in loans on the street, was in danger of collapsing. So did Citigroup (from which former Clinton Treasury Secretary Robert Rubin moved after successfully lobbying for the repeal of Glass-Steagall), which had been betting heavily on risky mortgage-related assets.

Paulson asked Congress for $700 billion to bail out the financial sector. He and Fed Chairman Ben Bernanke insisted that a taxpayer bailout of Wall Street was the only way to avoid another Great Depression.

Obama endorsed the Wall Street bailout and appointed a team of Clinton-era economic advisers (led by Geithner, who became Obama’s Treasury Secretary, and Lawrence Summers, who became director of the Economic Council national). These are the same people who, working under Rubin in the 1990s, paved the way for the financial crisis by deregulating Wall Street. Geithner, as president of the New York Fed, had been tasked with overseeing Wall Street in the years leading up to the crisis.

In the end, the Obama administration saved Wall Street, but at a huge cost to taxpayers and the economy. Estimates of the true cost of the bailout range from half a trillion dollars to several trillions. The Federal Reserve also provided huge subsidies to the big banks in the form of virtually free loans. But homeowners, whose homes were suddenly worth less than the mortgages they owed on them, were left hanging. Many have lost their homes.

Obama thus shifted the costs of the speculative frenzy from the bankers onto ordinary Americans, deepening distrust of a political system increasingly seen as rigged in favor of the rich and powerful.

A set of regulations put in place after the financial crisis (called Dodd-Frank) was not as stringent as the banking laws and regulations of the 1930s. It required banks to submit to Fed stress tests and hold a certain minimum amount of cash on their balance sheets to protect against shocks, but it did not prohibit banks from playing with their investors’ money. Why not? Because Wall Street lobbyists, backed by generous campaign donations from the streets, wouldn’t have it.

Which brings us to Friday’s failure of Silicon Valley Bank. You didn’t have to be a rocket scientist to know that when the Fed raised interest rates as much and as quickly as it did, the financial cushions behind some banks that had invested in Treasury would shrink. Why don’t regulators intervene?

Because even Dodd-Frank’s thin protections were undone by Donald Trump, who in 2018 signed a bill that reduced control of many regional banks and removed the requirement for banks whose assets were less than $250 billion to undergo stress tests and reduced the amount of liquidity. they had to stay on their balance sheets to protect against shocks. This has allowed smaller banks – such as Silicon Valley Bank (and Signature Bank) – to invest more of their deposits and make more money for their shareholders (and their CEOs, whose salaries are tied to profits).

Unsurprisingly, Silicon Valley Bank’s own chief executive, Greg Becker, had been a strong supporter of Trump’s pushback. Becker had served on the board of the San Francisco Fed.

Oh, and Becker sold $3.6 million worth of Silicon Valley Bank stock as part of a business plan less than two weeks before the company disclosed major losses that led to its failure. There’s nothing illegal about corporate business plans like the one Becker used, and the timing might just have been coincidental. But it smells bad.

Will the failure of Silicon Valley Bank be as contagious as the failures of 2008, leading to more bank failures as depositors worry about their safety? It’s impossible to know. The speed with which regulators moved over the weekend suggests they are worried. The Wall Street crisis of 2008 started with one or two bank failures, just like the financial crisis of 1929.

Four lessons from this debacle:

  1. The Fed should wait to raise interest rates again until it has conducted a thorough assessment of the implications for smaller banks.
  2. When the Fed raises interest rates quickly, it needs to better monitor the banks that have invested heavily in Treasuries.
  3. Trump’s financial regulatory rollbacks are dangerous. Small banks can have huge problems, triggering potential contagion to other banks. The Dodd-Frank rules must be fully reinstated.
  4. More broadly, even Dodd-Frank is not adequate. To make banking boring again, instead of being one of the most profitable parts of the economy, Glass-Steagall needs to be recreated, separating commercial banking from investment banking. There is no good reason for banks to invest their depositors’ money for profit.

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