WASHINGTON — The Federal Reserve faces stinging criticism for missing what observers say were clear signs that Silicon Valley Bank was at high risk of collapsing in the second-largest bank failure in U.S. history.
Critics point to many red flags surrounding the bank, including its rapid growth since the COVID-19 pandemic, its unusually high level of uninsured deposits and its many investments in long-term government bonds and mortgage-backed securities, which tumbled in value as interest rates rose.
"It's inexplicable how the Federal Reserve supervisors could not see this clear threat to the safety and soundness of banks and to financial stability," said Dennis Kelleher, chief executive of Better Markets, an advocacy group.
Wall Street traders and industry analysts "have been publicly screaming about these very issues for many, many months going back to last fall," he added.
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A class-action lawsuit was filed against the parent company of Silicon Valley Bank, its CEO and its chief financial officer, saying the company didn't disclose risks that future interest rate increases would have on its business. The lawsuit was filed in the U.S. district court for the Northern district of California and seeks unspecified damages to be awarded to those who invested in SVB between June 16, 2021, and March 10, 2023.
The Fed was the primary federal supervisor of the bank based in Santa Clara, California, that failed last week. The bank also was overseen by the California Department of Financial Protection and Innovation.
Now the consequences of the fall of Silicon Valley Bank, along with New York-based Signature Bank, which failed over the weekend, are complicating the Fed's upcoming decisions about how high to raise its benchmark interest rate in the fight against high inflation.
Federal Reserve Chair Jerome Powell speaks during a news conference Dec. 14, 2022, at the Federal Reserve Board Building, in Washington.
Many economists said the central bank policymakers at their meeting next week likely would have raised rates by an aggressive half-point and raise their projection for future rates to 5.6%. Its rate stands now at about 4.6%, the highest level in 15 years.
Now it's unclear how many additional rate increases the Fed will forecast.
With the collapse of the two large banks fueling anxiety 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 latest government report on inflation, released Tuesday, shows price increases remain far higher than the Fed prefers, putting Chair Jerome Powell in a tougher spot. Core prices, which exclude volatile food and energy costs and are seen as a better gauge of longer-run inflation, jumped 0.5% from January to February — the most since September.
On Monday, Powell announced the Fed would review its supervision of Silicon Valley to understand how it might have better managed its regulation of the bank. The review will be conducted by Michael Barr, the Fed vice chair who oversees bank oversight, and results will be released May 1.
A Federal Reserve spokesperson declined to comment further.
Elizabeth Smith, a spokeswoman for the California Department of Financial Protection and Innovation, said, “We are actively investigating the situation and conducting a thorough review to ensure the Department is doing everything we can to protect Californians.”
Silicon Valley was an unusual bank. Its management took excessive risks by buying billions of dollars of mortgage-backed securities and Treasury bonds when interest rates were low. As the Fed raised interest rates to fight inflation, leading to higher rates on Treasurys, the value of Silicon Valley's bonds steadily lost value.
Most banks would have sought to make other investments to offset that risk. The Fed also could have forced the bank to raise additional capital.
A pedestrian passes a Silicon Valley Bank branch Monday in San Francisco.
The bank grew rapidly. Its assets quadrupled in five years to $209 billion, making it the 16th-largest bank in the country. And roughly 94% of its deposits were uninsured because they exceeded the Federal Deposit Insurance Corporation's $250,000 insurance cap.
That percentage was the second highest among banks with more than $50 billion in assets, according to ratings agency S&P. Signature had the fourth-highest percentage of uninsured deposits.
Such an unusually high proportion made Silicon Valley Bank highly susceptible to the risk that depositors would quickly withdraw their money at the first sign of trouble — a classic bank run — which is what happened.
The bank failures likely will color an upcoming Fed review of rules that set out how much money large banks must hold in reserve. Barr said last year he wanted to conduct a “holistic” review of those requirements, raising concerns that would lead to rules forcing banks to hold more reserves, which would limit their ability to lend.
Many critics also point to a 2018 law as softening bank regulations in ways that contributed to Silicon Valley's failure. Pushed by the Trump administration with bipartisan support in Congress, the law exempted banks with $100 billion to $250 billion in assets — Silicon Valley's size — from requirements that included regular examinations of how they would fare in tough economic times, known as "stress tests."
Silicon Valley's CEO, Greg Becker, lobbied Congress in support of the rollback in regulations, and he served on the board of the Federal Reserve Bank of San Francisco until the day of the collapse.
How business survival strategies compare during recessions versus COVID-19
How business survival strategies compare during recessions versus COVID-19
Only some companies that survived the COVID-19 crisis can use the same blueprint for the next economic downturn.
To compare business strategies for surviving the recent COVID-19 crisis and a typical recession, altLINE analyzed research from the World Bank, data from the Federal Reserve, and news reports.
A recession is usually defined as two back-to-back fiscal quarters in which the total amount of all goods and services declines. The COVID-19 pandemic began with a deep but brief recession in the U.S. economy, unlike any that preceded it in modern history. The ultimate effect was like flipping a light switch off for a couple of weeks and then turning it back on again.
As local officials announced restrictions on which types of businesses could stay in operation, many businesses feared the worst from the unknown virus. Companies and workers in sectors including travel, hospitality, entertainment, and events were hit especially hard with an abrupt halt to most social and in-person activities.
As uncertainty reigned, the U.S. GDP actually increased 12% in the two years spanning the fourth quarter (Q4) of 2019 through Q4 2021, a huge economic win compared with the 1918 influenza pandemic. During the two years following that influenza outbreak, experts estimate, global economies contracted 6%.
But a recession, much like the impact of COVID-19, is also "a high-pressure exercise in change management," as Harvard Business Review contributing editor Walter Frick observed. And that supreme uncertainty enveloping COVID-19 was felt not only by employers but their employees, too.
Businesses that survived the COVID-19 crisis in 2020 were more productive firms
The firms that survived the introduction of COVID-19 had one statistically significant key factor—their employees were more productive, according to a study from the World Bank.
The authors concluded that the strong correlation between sales per worker annually and the death of firms suggested a market "cleansing" of inefficient companies.
By the summer of 2021, tumultuous pandemic conditions forced at least 3.5% of businesses to close their doors permanently worldwide, according to conservative estimates from the World Bank study. In some developed countries, that estimate varied. Italy is estimated to have lost at least 8% of its businesses by that time. The country was an epicenter of disease early on in the pandemic.
Some countries suffered even more devastating losses on the upper end of World Bank estimates. In Mongolia, estimates suggest some 1 in 5 businesses went under.
In the past, productivity was not necessarily cited as an end-all-be-all factor in surviving typical recessions. Since a recession tends to be accompanied by decreased demand for goods and services, fewer people and work hours are needed to produce enough goods to meet demand.
But in 2020, the federal government rapidly issued increased unemployment assistance and thousands of dollars in stimulus that allowed consumers to continue spending money regardless of whether they remained employed.
Firms pivoted entire business models overnight
Some businesses were prepared to meet the demand—large ones, at least. Amazon had built the largest private logistics network in modern U.S. history, allowing consumers to have nearly anything they wanted delivered to their homes.
Public data shows that businesses that suffered the most under COVID-19 were in the service industry—restaurants, hotels, and live event companies that were forced to close under safer-at-home regulations. Even after rules loosened though, many continued to see steep declines as wary customers stayed away.
Convincing customers to come back wasn't due to lack of trying, though. Event venues shelled out for accreditations like the GBAC-STAR to tout they had adequate public health practices in place for visitors. Like a scene ripped straight from Hollywood, it became commonplace to see hotels using electrostatic sprayers to decontaminate rooms, and plexiglass shields were erected at front desks, cash registers, and restaurant dining rooms across the country.
But these companies, especially small ones, also launched new products, adapting to the changing needs of a country stricken by a pandemic. Hotels rented out rooms as office space for local white-collar workers dismissed from large office buildings and business travel obligations. Restaurants rolled out curbside pickup with online ordering.
Traditionally, any recession can threaten existing business models since consumer demand shifts in affected industries. But the pressure builds more gradually and has often led companies to focus on cutting costs throughout a downturn to survive.
Businesses historically have more time to react to a recession as opposed to a public health crisis
There have been 13 recessions in the U.S. economy since World War II, and no two have looked the same. They do, however, share characteristics, according to leading economic research. And while recession indicators can appear in just one fiscal quarter, conditions typically decline more slowly than in 2020.
A recent study of economic indicators accompanying recessions from the Federal Reserve Bank of St. Louis shows just how steep the dropoff in incomes, payroll employment, production, and retail sales was after COVID-19 compared to past downturns. Employment levels plummeted by 15% as more than 20 million people lost their jobs between February 2020 and April 2020, according to the Bureau of Labor Statistics. The staggering job loss broke the prior record set during the Great Recession (2007-2009), when 6% of jobs were lost.
In a typical recession, businesses often begin taking action to preserve cash as indicators first start to show, whereas the sudden onset of the pandemic caught many businesses by surprise. For example, the retail and hospitality industries were disproportionately affected by social distancing health restrictions. With little time to prepare for the impact, the hard-hit sector shed more than 8 million workers from payrolls in March 2020 and April 2020 alone.
COVID-19 forced companies to invest, whereas typical recessions require spending cuts
The U.S. government may not have adequately prepared for the public health crisis, having had its pandemic infrastructure that was built upon decades of Democratic and Republican administrations gutted by the Trump administration, but the private industry was ready.
Commercially available technologies had arrived at an opportune time by 2020. Video conference calling had been steadily gaining ground in board rooms and businesses across the country, thanks to companies that emerged in the aftermath of recessions such as Skype (launched in 2003) and Zoom (launched in 2011). Internet connectivity has only increased in availability since 2008, and workplaces are more connected than ever with real-time collaborative applications like Slack and Microsoft Teams.
Companies that had been slow to evolve digitally suddenly saw an opportunity to lean into internet-connected services that allowed the public to isolate themselves while still working, eating, shopping, and socializing. Financial, artificial intelligence, and health care-focused tech companies staffed up en masse.
Software and IT infrastructure writ large saw widespread investment as companies pulled back on investing in the construction of buildings, according to a Deloitte analysis of Bureau of Economic Analysis data.
Lobbying strength can sway survivability for industries no matter the crisis
Businesses banded together in the early days of the COVID-19 crisis and the Great Recession to flex their influence over lawmakers with an ultimatum: If you let us die, the jobs die, too.
Bailouts for the automotive manufacturing industry in 2008 and 2009 saved 1.5 million American jobs and the companies that employed them.
On the contrary, the live events industry that crawled out of the COVID-19 wreckage in late 2020 provides a case study of what can happen when those channels with the government aren't already open. The industry had difficulty appealing to lawmakers for more targeted relief.
Prior to the financial crisis of 2008, businesses in the service sector had remained more resilient through recessions compared to manufacturing sector firms, according to a 2010 study from the Federal Reserve Bank of Richmond. Where a downturn in consumer spending might have meant large firms could trim costs to survive in past recessions, COVID-19's impact was prolonged and came with different barriers to doing business than simply reduced propensities to spend.
A coalition of businesses, including Live Nation and SAG-AFTRA, banded together to launch the #SaveLiveEvents campaign, encouraging Americans to lobby representatives for more assistance for events industry workers and small venues.
This story originally appeared on altLINE and was produced and distributed in partnership with Stacker Studio.
