The Federal Reserve Bank's Collateral Damage
By Joel D. Joseph
The Federal Reserve Bank's target for its interest raising scheme is to reduce inflation. While that has not worked out very well, its collateral damage has destroyed innovative banks, increased big bank concentration and brutally wounded the housing industry. The Fed should subscribe to the Hippocratic Oath which provides that the cure should do no harm. In this case, the harm has been far worse than the cure.
Before the Fed began raising interest rates, Silicon Valley Bank and First Republic Banks were very sound financial institutions. They both served important economic niches, high-tech start-ups and wealthy investors. Because the Fed raised interest rates much too quickly, Silicon Valley Bank's and First Republic's portfolio of government bonds began to lose value rapidly. This weakness caused runs on these banks even though their assets far exceeded their liabilities.
First Republic has now been acquired by J.P. Morgan Chase, the largest bank in the world. Silicon Valley Bank was gobbled up by First Citizens Bank. We are creating more banks that are "too big to fail" so that we may have to bail them out if there is a future financial crisis.
These banks invested the bulk of its deposits in U.S. government bonds. "Based on the current environment, we'd probably be putting money to work in the 1.65%, 1.75% range," said the Silicon Valley Bank's CFO at the beginning of 2022, referring to the yields he wanted to achieve. Nobel-prize winning economist Paul Krugman said, "the bank parked much of that money in boring, extremely safe assets, mainly long-term bonds issued by the U.S. government and government-backed agencies."
The trouble is that when interest rates started to go up, bonds got hit hard. On March 8, 2023, Silicon Valley Bank announced a loss of approximately $1.8 billion from a sale of investments, U.S. treasuries and mortgage-backed securities that it needed to pay depositors who wanted to cash out. These investments were very prudent. U.S. treasury bonds are considered among the safest of investments that banks can make.
The Federal Reserve Banks raised interest rates faster than it has in fifty years. The Fed raised interest rates from a low of 0.25 percent in March of 2022 to 4.75 percent ten months later. Despite Silicon Valley Bank being in sound financial condition prior to March 9, 2023, investors and depositors reacted by initiating withdrawals of $42 billion in deposits from the bank on March 9, 2023 thus causing a run on the bank. An autopsy will show that the Federal Reserve's drastic interest rate increases were the cause of death.
Silicon Valley Bank had $41 billion in cash ready to pay customers. It was just $1 billion shy of having all the cash that it needed.
Within 36 hours, the bank was closed by the California Department of Financial Protection and Innovation which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. As of the close of business on March 9, the bank had a negative cash balance of approximately $958 million. The precipitous withdrawals caused the bank to be temporarily incapable of paying its obligations as they came due.
Silicon Valley Bank's collapse triggered the collapse of First Republic Bank. Panic withdrawals from both banks spread like a row of dominoes. Wealthy depositors in California and New York made electronic withdrawals at warp speed. When Silicon Valley Bank and Signature Bank collapsed in March, the FDIC covered all deposits, not just those of $250,000 or less. This policy should be made permanent. All bank deposits should be covered by FDIC insurance. If all deposits are fully covered it is unlikely that there will be any future runs on banks. If we keep a low ceiling like the quarter million dollar one that we have had for 15 years, it is more likely that there will be more runs banks.
