Fed criticized for lack of red flags ahead of Silicon Valley bank collapse

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The Federal Reserve is facing harsh criticism for missing what observers said were clear signs that a Silicon Valley bank was at high risk of collapse in the second-biggest bank failure in U.S. history.

The Fed was the main federal oversight agency for the Santa Clara-based bank that went bankrupt last week. The bank was also controlled by the California Department of Financial Protection and Innovation.

Critics point to the many red flags surrounding the Silicon Valley Bank, including its rapid post-pandemic growth, unusually high levels of uninsured deposits, and its many investments in long-term government bonds and mortgage-backed securities that have fallen in value as interest rates have risen. . .

“It is inexplicable how Federal Reserve supervisors failed to see this clear threat to the safety and soundness of banks and financial stability,” said Dennis Kelleher, chief executive of Better Markets, a human rights group.

Wall Street traders and industry analysts “have been screaming about these very issues in public for many, many months since last fall,” Kelleher added.

Now, the fallout from the fall of Silicon Valley Bank, as well as New York’s Signature Bank, which went bankrupt over the weekend, complicates the Fed’s upcoming decisions on how high to raise its benchmark interest rate to combat chronically high inflation.

Many economists say the central bank would likely raise rates aggressively by half a point next week at its meeting, which would mark a step forward in its fight against inflation. The Fed implemented a quarter-point increase in February to about 4.6%, its highest level in 15 years.

The move follows a half-point increase in December and four three-quarter-point increases prior to that.

Last week, many economists suggested that Fed policymakers would raise their forecast next week to 5.6%. Now it’s suddenly unclear how many additional rate hikes the Fed is predicting.

With the collapse of two major banks fueling worries about other regional banks, the Fed may focus more on boosting confidence in the financial system than on its long-term drive to tame inflation.

The government’s latest inflation report, released on Tuesday, shows price increases remain much higher than the Fed’s preference, putting Chairman Jerome Powell in a more difficult position. Core prices, which exclude volatile food and energy prices and are seen as the best indicator of long-term inflation, jumped 0.5% from January to February, the most since September. This is much higher than the Fed’s annual target of 2%.

“Had it not been for the fallout from the bank failure, this might have been a close call, but I think they would be leaning towards half a point (rate hike) at this meeting,” said Katie Bostancic, chief economist at Nationwide.

On Monday, Powell announced that the Fed would review its oversight of Silicon Valley to see how it could better manage its bank regulation. The review will be led by Michael Barr, the Fed’s vice chairman in charge of banking supervision, and will be published on May 1.

“We need to be humble,” Barr said, “and do a thorough and thorough review of how we have controlled and regulated this firm and what we should learn from that experience.”

A Federal Reserve spokesman declined to comment further. A call to the California Department of Financial Protection and Innovation was not immediately answered.

By all accounts, Silicon Valley was an unusual bank. His management took excessive risks, buying billions of dollars worth of mortgage-backed securities and Treasuries when interest rates were low. As the Fed continually raised interest rates to fight inflation, which led to higher Treasury bond rates, the value of existing Silicon Valley bonds steadily declined.

Most banks would try to make other investments to offset this risk. The Fed could also force the bank to raise additional capital.

The bank grew rapidly. Its assets quadrupled in five years to $209 billion, making it the 16th largest bank in the country. And roughly 97% of his deposits were uninsured because they were in excess of the Federal Deposit Insurance Corporation’s $250,000 insurance limit.

This is an unusually high percentage that has made the bank very susceptible to the risk that depositors will quickly withdraw their money at the first sign of trouble – a classic bank failure – which is exactly what happened.

Silicon Valley CEO Greg Becker has lobbied Congress for looser regulation in the past and served on the board of the Federal Reserve Bank of San Francisco until the day of the Silicon Valley crash.

“I am at a loss for words to understand why their regulators found this business model acceptable,” said Aaron Klein, a congressional aide who worked on the Dodd-Frank Banking Regulation Act, which was passed in the wake of the 2008 financial crisis.

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