Fed Official: SVB Failure a ‘Textbook Case of Mismanagement’

A trio of banking regulators told the Senate Banking Committee on Tuesday that while the banking system remains safe and sound, it has come under some strain as a result of the failure of Silicon Valley Bank.

It was the first public hearing on the banking crisis that has upended markets and raised new fears about an impending recession.

The comments came in the first congressional investigation into what caused the collapse of Silicon Valley and Signature Banks, as well as the closing of Silvergate, more than two weeks ago, setting off a rush of withdrawals out of smaller, regional institutions into large banks.

Michael Barr, vice chairman for supervision at the Federal Reserve, declared SVB’s failure as a “textbook case of mismanagement.” The bank failed to appropriately cover the exposure of its long-term government bond holdings to rising interest rates and saw an avalanche of withdrawals in a matter of 24 hours. The other two banks had connections to the crypto industry and saw withdrawals as that industry came under pressure.

The bank runs prompted an emergency response from the US government, whereby it assured depositors their money was safe beyond normal Federal Deposit Insurance Corp. limits and made loans and other help available to the banking sector to maintain stability in the financial system. Loans and deposits of SVB were sold at a discount to First Citizens Bank of North Carolina on Sunday.

“We continue to monitor developments across the banking and financial system and coordinate with federal and state regulators,” Nellie Liang, undersecretary for domestic finance at the Treasury Department, said in her prepared remarks. “As Secretary (Janet) Yellen has said, “we have used important tools to act quickly to prevent contagion. And they are tools we would use again if warranted to ensure that Americans’ deposits are safe.”

But some have pointed the finger at the Fed, saying its policy of maintaining extraordinarily low interest rates for so long prior to dramatically changing gears last year was a contributing factor to the instability.

“The swift crash of Signature Bank, the third largest bank failure in US history, following the demise of SVB, which held $160 billion in deposits, along with Silvergate Bank, has investors and depositors questioning if the banking system is as “sound and resilient with strong capital and liquidity” as suggested recently by both Fed Chair Jerome Powell and Secretary of the Treasury Janet Yellen,” Quincy Krosby, chief global strategist and Jeffrey Buchbinder, chief equity strategist, at LPL Financial, said Tuesday morning.

Barr was a key Treasury official in 2018, before President Joe Biden nominated him to the Fed last year, and was critical of moves during the administration of former President Donald Trump to weaken regulation of smaller banks included in the Dodd-Frank legislation that followed in response to the financial crisis of 2007-2009.

Some Democrats have pointed to those changes, which did have support from some in their party, as a reason why SVB and other banks may have engaged in practices that endangered them. That was the main theme of opening remarks from committee Chairman Sherrod Brown, Ohio Democrat.

However, ranking minority member Tim Scott of South Carolina blamed regulators for the failure, while noting that the bank’s management was also lax. Specifically, Scott seized on reports that SVB management actively supported diversity, equity and inclusion initiatives.

He suggested this caused regulators to take their eye off their main regulatory oversight, adding that they became “a bit more permissive” toward SVB and other banks.

Regulators “appear to have been asleep at the wheel,” said Scott, a Republican who is widely believed to be planning a 2024 presidential campaign.

Meanwhile, global megabanks also succumbed to fears about their portfolios. Swiss giant Credit Suisse was sold to rival UBS in a fire sale orchestrated by the Swiss government and Germany’s Deutsche Bank saw its stock crater amid concerns over its bond holdings.

Worries about the health of the banking system and the likelihood of a credit crunch have increased fears that a recession in the US could occur this year. The economy is already slowing under the strain of the Fed’s aggressive raising of interest rates.

“In the wake of recent turmoil in the banking sector, it appears the likelihood of a hard landing has increased as several key leading indicators have begun to turn over,” Jason Pride, chief investment officer of private wealth, and Michael Reynolds, vice president of investment strategy, at Glenmede wrote on Monday.

“Following the collapse of Silicon Valley and Signature Banks, fears have mounted that the flow of credit from regional banks could ultimately slow,” he added. “Even if the Fed winds down its rate hike cycle, tighter financial conditions should continue to seep into the economy in the form of higher interest cost burdens. The odds of recession in the US continue to tick higher, which should prompt a defensive posture from investors.

“Banks report instances of corporate depositors, in particular, moving some or all of their deposits to diversify their exposures and increase their deposit insurance coverage, Federal Deposit Insurance Corp. Chairman Martin Gruenberg said in prepared remarks. “Banks have also reported clients moving their deposits out of the banking system and into government money market funds or US Treasuries.

Gruenberg said much of the outflow has gone to the largest banks, but overall “the vast majority are reporting no material outflows.”

The movement of money and a general “flight to safety” has driven bond yields down sharply over the past couple of weeks. Markets are also pricing in cuts to interest rates by the Fed this year, although Powell said that was not the central bank’s “base case” in comments to reporters last week.