Sinema joins the Silicon Valley Bank blame game

The unintended consequences of regulating for "concentration risk"

The blame game over the failure of Silicon Valley Bank is pointing in unproductive directions.

Arizona U.S. Sen. Kyrsten Sinema has been both a victim and a perpetrator in the unproductive blame game.

Ruben Gallego, a likely 2024 opponent, attempted to pin the blame on her for voting to increase the threshold for heightened Dodd-Frank oversight of systemically important financial institutions. In reality, it is highly unlikely that the heightened oversight would have altered the outcome for SVB.

Now, Sinema is blaming the Fed for not preventing SVB’s failure. She took the lead on a letter tossing that dart signed by 11 other senators. The blame gang consisted of seven Republicans, four Democrats, and the newly independent Sinema.

The senatorial blame gang is particularly concerned about the failure to regulate for “concentration risk”. SVB’s customers were overwhelmingly in the tech industry. The theory, also expressed by others, is that having the bulk of customers in the same field means that when the tide goes out for the industry, it might sweep the bank out with it.

SVB was established in 1983. It was founded to serve the tech industry from the beginning. In the ensuing four decades there have been lots of tides come in and out, for the broader economy and the tech industry specifically. SVB survived and even thrived through all of them. And, except for the Fed’s mismanagement of monetary policy, it would have this one as well. 

It is not at all unusual for smaller banks to specialize in products, services, or customers. That’s one of the ways they can successfully compete against the big banks, by serving a niche market better.

That can create a risk, but regulating to eliminate or mitigate that risk is fraught with unintended adverse consequences. 

Turning smaller banks into mini-mes of the big banks by requiring similar diversification of the customer base is a recipe to make the big banks even bigger. Smaller banks have difficulty competing against the economies of scale big banks can bring to serving a broad and diversified consumer base. That’s why they specialize to compete. 

And while regulators can set standards for and measure such things as reserve and capital requirements, they have no particular expertise about what products, services, and customers a bank might profitably pursue. Or what risks inhere with those decisions, for that matter.  

Regulating for “concentration risk” would increase market share for big banks, stifle innovation, and dry up financing particularly for small businesses and startups. 

SVB wasn’t engaged in reckless behavior. Until very recently, it was adequately capitalized with supersafe Treasury bonds and government-insured mortgage-backed securities. When the balance between deposits and withdrawals moved against it, it had to sell its supersafe securities at a substantial discount due to interest rate increases, which started the run on the bank.

In retrospect, SVB should have hedged against the interest rate risk. But, for perspective, it’s worth reviewing the environment the Fed created in which SVB was operating.

In 2020, at its Jackson Hole retreat, the Fed was still fretting about inflation being too low. After inflation began to spike, the Fed dismissed it as a temporary phenomenon, an economic hangover from supply chains being shut down during the pandemic. It was just a year ago that the Fed began increasing interest rates. And initially it was in baby steps, leaving room for the temporary phenomenon theory to be borne out and alleviate the need for serious rate increases. 

So, SVB should have hedged against its interest rate risk. But, until very recently, the prevailing view was that such a risk wasn’t very great.

In reality, all banks are vulnerable to a run and no amount of prudential regulation will eliminate it. It’s inherent in the nature of banking.

In the SVB context, you often hear that one of the problems was that it borrowed short, in the form of demand deposits, and invested long, in Treasury bonds and MBSs. But borrowing short and investing long is what banks do. That’s why we can have such a thing as a 30-year mortgage. No one parks their money at a bank in a 30-year CD. 

There can be reserve and capital requirements. But if enough depositors want their money in a short enough period of time, no bank can handle that on its own.

SVB was brought down by a run on the bank that prudential regulation wouldn’t have foreseen or prevented.

I don’t like saying this, but if the policy goal is to minimize the disruptive threat of bank runs, the best way to achieve it is for the FDIC to guarantee all bank deposits, not just up to $250,000. That way, no one has to fear not getting their money out before a bank shuts down.

To prevent contagion, the FDIC is guaranteeing all deposits at SVB after its collapse. If they had been guaranteed before, SVB would undoubtedly still be standing and in the process of recapitalizing in an orderly manner, rather than attempting to do it in the midst of a run. 

This isn’t an argument against prudential regulation. In fact, if all deposits are guaranteed, it argues for higher reserve and capital requirements, and calculating all capital based upon current value, not its held-to-maturity value. 

But prudential regulation won’t eliminate all risks in banking, nor should we want it to. Guaranteeing all deposits would eliminate the largest systemic threat if prudential regulation fails to foresee or adequately mitigate banking risk. It’s a bad idea whose time has come.

Reach Robb at robtrobb@gmail.com.