Was Silicon Valley Bank's failure due to "Trump-era deregulation", and/or do Democrats share blame for it?

Question

In CNN's March 13 2023 State of the Union clip Expert advises all depositors to get their money out of collapsed bank after 05:58, CNN's Kaitlan Collins introduces US Senator Elizabeth Warren's tweet:

President Biden called on Congress and regulators to reverse Trump-era deregulation and “strengthen the rules on banks to make it less likely that this kind of bank failure will happen again." Today I’m proposing legislation to do just that.

to the guest "Gary Cohn, the previous director of the National Economic Council under former President Donald Trump".

COLLINS: Obviously, you were in the administration when those those rules were roll(ed) back issue. Is she right? Was it a mistake to roll them back, or do you disagree with her?

Cohn responds to the question by referring to the "rollback" as bipartisan legislation:

COHN: Well, let's start (with) what happened here and what roles got... rolled back.

You know, what we're talking about was some legislation, legislation that worked its way through the congress, that when it went through the Senate needed 60 votes. And in fact, *this piece of legislation got two thirds of the votes in the United States Senate. So it was a very bipartisan piece of legislation.

And what the legislation was, it was a piece of legislation that says "hey, we want, we as a U.S. government, we want many banks in this country. Therefore, we are not going to put every bank under the highest, most stringent rules and regulations that we have in this country."

We will have a lower level of rules and regulations for smaller banks around the country because we want to encourage more banks to be in business.

And I think that has been a good of legislation, and, in fact, I don't think there's anything in this piece of legislation that would have changed the outcome had it not existed in what would happen in Silicon Valley Bank.

Banks still have very high capital levels, and you can't tell me that anything would have changed had had this piece of legislation not going through.

COLLINS: Okay. Good to get your response (that) you disagree with her on that, we wanted you to response to that.

To get clarity, I need answers to a few tightly-related questions:

1. Has Biden or Warren really said that "Trump-era deregulation" (what Cohn refers to as "bipartisan legislation") contribute to Silicon Valley Bank's failure?
2. Is Cohn saying that it didn't?
3. Did it or didn't it?

Answer 1

I was hesitant to answer this because I'm not certain I'm enough of an economist to give you a full answer. However, I think I can explain much of what you asked, and in the end I'm not convinced even an expert economist can give you a definitive answer so I'll do my best and ask for forgiveness and for constructive comments to help me shore up any personal failures once I get into the economics at the end.

The really short answer, while Cohn is slanting things a little bit to cover Republicans I don't disagree with his general conclusions. We're far from certain if deregulation actually mattered here (which is not to say it definitely didn't!)

What regulation was de-regulated?

For starters let's start with discussing what the deregulation everyone is shouting about was. Back after the last banking failure Dodd-Frank act was passed in 2010. It did many things, but the only one really relevant to this discussion was setting up strict oversight and reporting to an oversight board in charge of detecting when a bank was in a precarious position to prevent future collapses. When the act passed in 2010 the act set a requirement that this strict oversight, and all the overhead to the bank it entailed, would apply to any bank with more than $50 billion in assets.

There were arguments from both sides of the political party that this threshold was too low, putting too much overhead on small banks that struggled to meet the costs associated with it. This put a disproportionate burden on small banks, thus helping larger banks to hold their monopolies. Furthermore it's kind of tautological to say that small banks were small! To be precise they tended to be small enough that even if one did theoretically collapse it was likely the impact of the collapse would be small enough for our economy to absorb it without too much long term harm. All this oversight might very well end up being more costly than simply accepting the risk of occasional small banks collapsing and being ready to take steps to shore up our economy if it did happen.

In this regard Cohn was right, the concept of raising the minimum threshold before stricter oversight kicked in was generally bipartisan and the deregulating bill did pass with support from both sides of the aisle. However Democrats also complain that Republicans are responsible for SVB being deregulated and, well they're kind of correct too. To better understand how both could be correct let's dig more into the various categories of banks post de-regulation.

Small Medium and Large banks, setting thresholds.

The deregulation effectively set definitions for small, medium, and large banks.

Banks under $100 billion in assets were small banks and did not need to deal with the strict oversight defined in the original Dodd-Frank act; in other words they doubled the threshold before any kind of additional scrutiny was applied to a bank. Banks with over $250 billion in assets are large banks and still had to deal with all the oversight fun set in the Dodd-Frank act; so deregulation did nothing for them. Banks between 100 and 250 billion in assets are medium-sized banks that only had to meet the oversight standard for 18 months, but after that the Fed could still do periodic stress tests and otherwise collect metrics as it deemed relevant. So in effect medium banks only faced oversight if the Fed went out of its way to make it happen.

As will likely not surprise you SVB, having assets in the $212 billon range at the end of 2022, fell into this medium-sized bank range with limited oversight.

Who supported what?

I should caveat this part by stressing that I'm generalizing the behaviors of the two political parties here. There were discrepancies in view between various folks in the two parties and the bill just wasn't deemed important enough at the time for very clearly defined platforms to be spelled out. This is a broad generalization at best

Both sides of the aisle generally agreed with raising the minimum before scrutiny applied up to $100 billion. However, the creation of a separate 'medium' bank category was more contentious. In general this part was pushed by Republicans and Democrats were far less supportive of it. There were arguments made by some Democrats that both the threshold for being considered a medium bank was too high and the scrutiny applied on these types of banks was too low. In essence, Democrats supported the bill in spite of the lenience on medium banks because they deemed it the best they could get and felt it important to raise the thresholds on small banks.

So it's simultaneously true that the bill as a whole did have bipartisan support, and also sort of true that the deregulation relevant to the SVB bank was something mostly pushed by Republicans with far less support from Democrats.

So Republicans can say it was a bipartisan bill and everyone is equally to blame, and Democrats can say that SVB was deregulated due to Republicans without their support. Both are technically true-ish statements. Making misleading claims, or accusations, with technically true statements is pretty much politics 101. In the end deciding rather either side is actually guilty of 'lying' about who deregulated what is mostly going to come down to rather your favorite animal happens to be a Donkey or an Elephant.

Stressing over fed's stress tests

While medium banks didn't have to met the same oversight requirements of large banks the Fed still had the ability to stress test medium-sized banks after deregulation. The obvious next question is: did they? Well frankly I have no clue, and I don't think anyone outside of the Fed really knows either. I've found no evidence of such tests happening, but such testing would hardly be newsworthy and publicly discussed so lack of evidence does not mean lack of testing.

What I can say is that the Fed themselves apologized for not stopping the SVB collapse and promised to do a thorough review on what happened. Whether this is an admission of actual failure to perform stress tests, or simply a promise to do an analysis of their tests to see if they were insufficient is hard to say. Perhaps we will know more when such a review is complete, but that won't be for a while.

Having said that: just knowing how the government works, they probably did little if any significant testing. There are just too many banks and SVB would most likely not be on the top of the Fed's list. There have been so many examples of generic 'you can test this stuff if you get around it' rules resulting in almost nothing happening throughout government history that my personal presumption would be the Fed likely didn't put the time and effort into serious testing medium sized banks. However I stress I can't prove that. I'd be completely open to any commenters that have evidence to contradict me here.

Would the strict scrutiny of larger banks have helped?

If not for the exemption made for medium sized banks SVB would have had to report more to the Financial Stability Oversight Council (FSOC) whose job was to identify if a bank was at too high a risk and take steps to minimize it if they were. The real question here is whether the FSOC would have judged the SVB to be so unstable as to require steps be taken to mitigate the risk had they possessed all the information they get with larger banks.

Here is where things get harder to answer, partially because I'm not an economist; but economists can't seem to agree here either. It's subjective and I can't give you a definitive yes or no. My personal view is that it's more likely increased oversight wouldn't have helped than that it would have, but no one can really say for sure.

The real question is: at the time the decisions were made, would SVB's choices have been deemed to be high risk by the FSOC, and without the benefit of hindsight that isn't guaranteed. To explain what I mean let's first list out the factors that lead to the SVB's collapse.

1. SVB was always heavily invested and tied to tech - it was the Silicon Valley Bank after all so that sort of makes sense. This means they struggled when tech took heavy losses post Covid. This was made worse because many of these tech companies were startups and venture companies that were impacted the most by the post Covid changes.
2. SVB had invested in a lot of fixed-income securities. At a time when interest rates were at an absurdly low level, and had been for a while, these were very tempting investments. Unfortunately the nature of such funds is that they will see losses if interest rates rise, and we just saw significant raises in an attempt to curb post-Covid inflation.
3. SVB had an unusually large number of depositors with very high deposits above the amount the government insured. The government insurance was intended to be high enough to protect most personal accounts, but it was no where near high enough to protect accounts that contained a startup's entire supply of cash. This meant SVB couldn't fall back on government insurance to protect it once it became insolvent, which in turn increased fear of depositors which lead to the run on the bank.
4. Social media, and the nature of venture capitalists being SVBs primary clientele, significantly increased the fear and escalation that lead to a sudden and unprecedented run on the bank.

Once again Social Media ruins everything

I need a bit of time to better spell out that last problem. The SVB wasn't actually in that bad a position originally. They were already running in the red with significant unrealized losses, but losses can be, and have been, recovered from in the past. They were not in a great position, but so long as they have enough to pay those currently withdrawing money they had time to take steps to try to raise capital and fix things. The SVB already announced that they needed to, and were going to, take steps to raise capital and they may very well have managed that given a bit more time. They could have cut costs, sold some of their assets, made good on some successful investments, or even worked out some less extreme form of government support to tide them over given a bit of time.

Unfortunately they did not have time. Once word got out people got scared, fears lead to the first few withdrawing, which lead to more getting scared, which lead to more withdrawals in a chain reaction that spelled death for the bank. Now this general pattern is nothing new, it happens with all bank runs. What is new is the rate at which it happened! While in 2008 it took several months for mumbling to build up and escalate into an all out run for the SVB it took a mere 2 days!

Two factors contributed to this rapid escalation. One was social media, which allowed word, and thus fear, to spread rapidly and compound on itself. The other was that the primary clientele of the SVB was venture capitalists. Given the risks inherent to venture capitalism they would face higher risk, and fear, at the potential insolvency of their bank and thus were already primed for rapid escalation once social media started amplifying these fears.

In the end the SVB had $42 billion withdrawn in a single day. Let's be clear: no bank, no matter how good their books and profits are, is likely to have 42 billion in liquid assets just sitting around. A bank simply couldn't afford to keep 1/5 of their net worth liquid and uninvested, that's just not how banks are supposed to work! No-one could have survived a run like that.

Yes poor investments and other factors lead to the SVB being in a precarious situation without a doubt, but social media pretty much took away any time SVB may have had to get back in the black. I'd argue the absurd speed at which the fear and run escalated was what killed the SVB more than any of their actual investment mistakes. Though I stress I'm not making light of the other real losses and dangers the SVB faced, perhaps the SVB wouldn't have managed to survive anyways, but their odds fell to 0 as soon as social media started escalating fears of insolvency and a run started.

Back on topic the point of my mini rant here is that this run was caused by a combination of social media and the nature of their clientele. These were factors no one was considering or predicting, absolutely no one thought such a rapid escalation could or would occur and as such there is no way the FSOC would have done anything about it even with more oversight. Sure perhaps the FSOC could have helped prevent decisions that put the SVB in a precarious position, but no one anticipated that position being nearly as lethal as it was.

At least we can all appreciate the irony that tech is what made the SVB, and what ultimately killed it.

Post Covid world and Hindsight

Now let's look at the other issues. Some of these problems make sense in hindsight, but it's uncertain the FSOC would have recognized the risk and acted on them in time to matter even with better oversight. Lets look at each risk in a little more detail.

#3 put the SVB at much higher risk if a run did occur, but it's part of the somewhat unique niche of the SVB focusing on venture capitalists. I find it hard to believe that FSOC would tell the bank to stop accepting rich clients to their bank or demanded they somehow further insure these customers. Nothing would have been done to directly mitigate this risk. Though it may have been considered when determining the overall risk of the SVB to help nudge them into action if the SVB was deemed a potential risk and they were trying to determine rather to step in.

As for issue #1 In retrospect it makes sense that tech stocks, which rose drastically due to Covid forcing more dependence on tech, would have to fall back to pre-Covid levels after Covid no longer was forcing people to be locked in their house dependent on tech to survive. However, at the time most weren't anticipating tech taking the sort of beating it ended up taking. So while the FSOC might have been a little concerned about SVB over reliance in tech on the grounds that diversity of assets is always a good idea that is a far cry from expecting tech to plummet and this reliance to come back and bite SVB quite so hard. In fact Tech is a very wide category, most likely would have thought that SVB was decently diversified because of how many different types of tech they were dependent on.

In short at the time issue #1 may have slightly increased concern due to a bit of overdependence on tech, but no one was going to predict how much this would come back to hurt them.

The interesting issues

(yes I did an edit just to add that punny title. Was it to help separate the most important issue from the rest, or because I just had to make more bad puns? The world may never know....)

Now we get to issue #2, the complicated one. To some degree the lack of supplies, and thus inflation, was anticipated post covid. However, the Fed waited a long time after inflation started before they raised interest rates precisely because common economic doctrine said that the inflation should be short term and fix itself naturally. This didn't end up happening, but it was what was anticipated at the time and would have been what the oversight board expected; rapid interest rate hikes would not have seemed an imminent risk at the time.

That being said it was known interest rates were extremely low and therefore they would have to go up eventually. If you look here you can see interest had been dropping for a long time and some sort of rise was inevitable, it's not like rates could drop much lower. What was not clear was how soon it would be, or how rapid it would be. Normally we would have anticipated a slower more steady rise in interest that would have mitigated the degree of loss SVB took from the interest hikes.

Of all the issues #2 is the one that the FSOC may have reasonable had enough concern to take action on. The SVB was very heavily invested in funds which would suffer if interest rates rose, and eventually interest rates had to rise. In theory one could therefore identify this as a theoretical risk and demanded SVB diversify its assets as a hedge against a theoretical future rapid interest rise even without knowing when it would happen.

Still economists have been failing to anticipate our economy for as long as economists have existed. Something like mitigating against the risk of unusually rapid interest rate is obvious in hindsight, but the real question is rather it would be recognized at the time as so severe a risk as to require the government getting involved.

So, what's the TL/DR here?

In theory the FSOC could have noticed that cause #2 as a legitimate potential risk in the theoretical future that sudden and rapid inflation occurred. Given that and the fact that causes 1 & 3 put the bank at higher risk if something bad did happen they might have, in an abundance of caution, pushed to better mitigate the risk of inflation to the bank.

In reality the SVB had lots of different things all happen to it at once. No one anticipated both tech taking heavy hits and rapid rise in interest rates would occur at the same time; and they definitely weren't prepared for severity and suddenness of an unprecedented two day run removing any chance for SVB to correct for those losses. It's far from guaranteed the SVB's problems would have been detected and fixed prior to a collapse even with heightened oversight.

So in short Republicans are sort-of responsible for partially deregulating SVB, we don't know how much regulation was still in play, or if additional regulation would have actually stopped the collapse. As I already said I personally come down on the side that more regulation wouldn't have saved the SVB, but I can't really tell you for certain what role deregulation played in the collapse; and frankly I'd be skeptical of anyone who says they can unless they provided very conclusive evidence.

None of that will stop both sides of the political party from explaining how the other party is completely guilty for the SVB demise and if everyone just followed their preferred economic policies everything would be perfect. There is enough ambiguity and potential arguments on either side that either political party can slant things to suit their narratives. Why let the tiny detail of not really being able to predict how policies affect our economy get in the way of some good mud-slinging? We never have before!

Answer 2

It's not entirely clear to me what they are talking about, but if it's about the LCR requirement that was relaxed in 2018 for banks under $250 billion, then if you believe BPI's calculation, SVB would have passed with a LCR of around 150%, above the older regulatory limit of 100 percent (Aside: Credit Suisse recently self-reported a 150% LCR as well.)

OTOH, according to some [European] expert, SVB (unlike Credit Suisse) could substantially fudge their CET1 report, because they were not required to account for the "negative mark-to-market on bonds portfolio against their CET1 [Common Equity Tier 1], artificially bolstering their solvency capital". Supposedly had they been subject to the [recently introduced] Basel 4 requirements (rather than just Basel 3) they would not have been able to do that kind of fudging. (According to that expert, Credit Suisse is not funding their CET1 data like SVB did.) Another expert said that "European banks’ unrealised losses are limited to the 4% of assets accounted for as held-to-maturity bonds." I'm not sure if the US ever had this kind of requirement.

It appears that there was something related to the latter in the 2018 changes as well. The AOCI reporting was made optional for banks under $700 billion while previously it was optional under $250 billion. However SVB would not have quite qualified even under the old rules, as they were at about $212 billion in late 2022, as far as I can tell. (Aside, as some research suggested, even the larger banks that were subject to AOCI were able to bend the rules somewhat.)

Answer 3

The collapse of the Silicon Valley Bank may not have been the fault of either Republicans or Democrats. It was foremost the result of a bank-run facilitated by panicking investors and the general current market conditions. Not every fall of a bank must be the fault of politics.

The Silicon Valley Bank was a highly profitable bank in the past. This year it realized some losses and tried to raise capital. This is nothing extra-ordinary. Making a loss from time to time and raising new capital is not forbidden and should not be regulated against. However, customers of the bank panicked when they heard about this and withdraw large amounts of deposits, creating the exact situation they feared by their reaction. What should any regulation achieve against panicking investors? Finance is based on trust, but you cannot dictate that trust. I wouldn't be surprised if other banks are in exact the same situation currently but are simply more lucky.

What the bank did was invest its deposits in long-running bonds. This is risky because it means that losses can occur when rates rise in the mean time and liquidity is needed. This is indeed is now the case. However, that doesn't mean that the general operation model of the bank was unsound. The realized loss of $1.8 billion before the bank run occurred was rather modest (compared to the profits of previous years). The rating agency Moodys downgraded the bank from A3 (medium grade) to Baa1 (slightly worse) shortly before the collapse. While this is not great, it isn't so bad either. There are other banks with the same rating, that are fully operational.

And the Silicon Valley Bank was a bit unlucky to be the first one in this position. A few days later the First Republic Bank which is of similar size got bailed out by other bigger banks with $30 billion of deposits.

The bank had quite a lot of unrealized losses (but so have other banks too), but it's not clear if they would ever have been realized. They pose a certain risk and regulation can try to reduce that risk, but never completely eliminate it.

During the Trump era, the oversight and capital requirements on small to medium sized banks were reduced in the Economic Growth, Regulatory Relief, and Consumer Protection Act in 2018 by Republicans. This will have made the collapse of the bank more likely, but even without it could have happened. Taking the bank run into account it might be one of these cases where no (reasonable) amount of regulation is enough to prevent all banks collapses. The deregulation of the Trump era will however made these cases more likely.

An important question would be how to avoid panic situations on the financial markets in general. Currently it's all about confidence in the banking sector. Interestingly, big banks are currently seen as more stable (also because of a higher degree of regulation) than small banks.

Answer 4

I noticed one point that has not been covered here and that is s.104 of the Economic Growth Act (Link)

For companies that have holdings between 100 billion and 250 billion the FED board/governor has the authority to subject banks to standards set under section 165 of the Financial Stability Act of 2010. This was added to prevent any risks to the stability of banks with medium holdings.

(Remembering that this is different from Stress Testing)

So the FED did have the ability to dictate standards that SVB had to abide by, if it deemed it necessary to do so.

For me the question is, did the FED see any danger signs before the collapse of SVB?

Answer 5

Has Biden or Warren really said that "Trump-era deregulation" contributed to Silicon Valley Bank's failure?

It seems to me that Senator Warren's tweet implies that pretty clearly, but she said it even more directly in a March 13 New York Times op-ed:

No one should be mistaken about what unfolded over the past few days in the U.S. banking system: These recent bank failures are the direct result of leaders in Washington weakening the financial rules. [...]

Had Congress and the Federal Reserve not rolled back the stricter oversight, S.V.B. and Signature would have been subject to stronger liquidity and capital requirements to withstand financial shocks. They would have been required to conduct regular stress tests to expose their vulnerabilities and shore up their businesses. But because those requirements were repealed, when an old-fashioned bank run hit S.V.B‌., the‌ bank couldn’t withstand the pressure — and Signature’s collapse was close behind. [...]

These bank failures were entirely avoidable if Congress and the Fed had done their jobs and kept strong banking regulations in place since 2018.

President Biden made similar comments in a March 13 speech, a little less explicitly:

And finally, we must reduce the risks of this happening again. During the Obama-Biden administration, we put in place tough requirements on banks like Silicon Valley Bank and Signature Bank, including the Dodd-Frank Law, to make sure the crisis we saw in 2008 would not happen again.

Unfortunately, the last administration rolled back some of these requirements. I’m going to ask Congress and the banking regulators to strengthen the rules for banks to make it less likely that this kind of bank failure will happen again and to protect American jobs and small businesses.