Regulators end the week the same way they started – dispelling fears, saving the bank

Financial regulators, politicians and bank executives have spent the week trying to allay fears that the banking crisis will spread to the US financial system.

On Friday, President Joe Biden issued a statement calling on Congress to take action to make it easier for regulators to prosecute top bank executives for their mismanagement.

“It should be easier for regulators to seek compensation from executives, impose civil sanctions and again ban executives from working in the banking sector,” the president said. On Monday, after the collapse of Silicon Valley Bank and the takeover of Signature Bank by New York regulators, Biden assured Americans that their money was safe and said “the management of these banks will be fired.”

Senators on Thursday demanded that Treasury Secretary Janet Yellen respond to future bank failures. Yellen assured them that “our banking system is sound” but also made it clear that deposits of all sizes will only be protected if “failure to protect uninsured depositors creates systemic risk and significant economic and financial consequences.”

Over the weekend, regulators announced additional funding to help banks meet their obligations. The Bank Term Financing Program provides loans to banks for up to one year, offering assets as collateral to “protect deposits and ensure the continued supply of money and credit to the economy.” Yellen approved the use of up to $25 billion in support for the fund. The Federal Reserve said on Thursday that banks had already borrowed $11.9 billion.

When the midsize San Francisco-based First Republic Bank said it was in trouble this week as depositors began to flee, Yellen worked with Jamie Dimon, chairman and CEO of JP Morgan Chase, to devise a plan to stabilize it. On Friday, 11 major banks provided $30 billion in cash inflows. On Thursday, the Swiss National Bank said it would provide billions of liquidity if needed to support Credit Suisse, a Swiss-based global investment bank that has experienced numerous financial problems over the past few months.

No reason to panic

Economists say most Americans still have no reason to panic about the recent bank run because the banking system is more stable than it was during the financial crisis more than a decade ago. But the current crises can still weigh on the economy as the Federal Reserve decides whether to raise rates again to bring down inflation and federal regulators ponder how to move forward with banking policy.

The Federal Deposit Insurance Corporation (FDIC) has historically insured deposits up to $250,000 in the event of a bank failure, and economists say consumers should be careful if their bank deposit exceeds that limit.

Matthew Rognley, associate professor of economics at Northwestern University, said Americans with more than $250,000 should spread that money among multiple banks.

People may also be concerned about the damage caused by the banking crisis to their 401(k), since in most cases they will not be protected, but if you have a bad investment in bank stock, you should not sell at the bottom. market as well, said Galina Hale, professor of economics at the University of California, Santa Cruz.

“So if you’re holding bank stocks, yes, there’s a bit of a downturn in the market because of their anxiety, and there’s not a lot of information about the health of the average bank. For people who own shares in banks, I would advise you to wait and see, ”she said.

While it’s hard for people to watch the value drop, it will bounce back because there is “no fundamental problem in the economy that would justify a sustained drop in the stock market at the moment,” Hale added.

How SVB differs from most banks

Panic about the stability of the banking system and the intervention of the federal government in an attempt to prevent damage to the economy may understandably remind people of the 2008 financial crisis and the subsequent closure of hundreds of banks, but there are many differences between the two. Mind you, Hale and Ronley said.

“A financial crisis is more likely when there is a risk that banks will suffer serious losses. This was certainly true in 2008, when the real estate sector (which accounts for the largest share of financial sector borrowing) crashed and many risky mortgages were issued. I don’t see anything like this this time,” Ronli said in an email.

In this case, Silicon Valley Bank had billions in unrealized losses or a depreciating but not yet sold asset in bonds, and many of its assets were in long-term US government bonds. As customers, most of whom were uninsured, began withdrawing their money from the bank, the bank was forced to sell its portfolio of securities at a loss, resulting in a bank run and actual loss. First Republic, which also catered to wealthy clients, faced similar challenges. But most banks don’t have the same liquidity risk and benefit from what’s called a deposit franchise, which makes it easier for banks to take on interest rate risk. And the big banks have benefited from the fact that savers are looking for a safer place to place their funds.

Ronley said that Silicon Valley Bank and similar banks differ from most banks in that they have more stable deposits.

“Most importantly, if the financial crisis becomes a threat, then interest rates will fall, and Treasury and [mortgage-backed securities] will rise in price … So in the current conditions, the financial crisis is to some extent a self-eliminating problem, ”he added.

Politicians are calling for increased regulation of the banking industry in the wake of recent bank failures, especially after backtracking on some of the 2010 banking reforms that they say could have helped avert the current crisis. But consumers need to be somewhat confident that the regulatory environment is still much better than it was in 2008, Hale said.

“We did not have the regulation that now requires banks, especially large ones, to have large capital. We have rules that require big banks to have a lot of liquidity, so even raiding a big bank – they have to be able to survive. I don’t see a repeat of the Lehman crisis and the like,” she said.

But this does not mean that there are no risks for the economy now. Hale said the downside to federal government intervention and coverage of all contributors is the risk that people will assume this intervention will happen in the future.

“This can create moral hazard… Let’s say I run a small business and I have over $250,000 in bank deposits and I’m not going to worry too much about that insurance limit because I’m going to say, ‘Well, in the past the government has given money everyone, not just insured deposits, so I’m not going to waste time and complicate them. I’m just going to deposit half a million dollars. But in this picture, that might not happen, right?” She said.

Ronli said he remains concerned about another important factor in the health of the economy – the Federal Reserve’s decisions on how much to raise interest rates. Since March 2022, the Fed has continued to raise the federal funds rate to bring down inflation, and indicated in its latest announcement of its decision to raise rates that it will continue to do so in the near future. The banking crisis has called into question whether the Fed will continue to raise rates as high as before, or whether they will raise rates at all at next week’s meeting.

“Something that worries me is that this will add uncertainty to the Fed’s anti-inflationary policy,” Ronley said. “A week and a half ago, the Fed planned to quickly raise rates, and the most likely outcome was a moderate slowdown (possibly a slight recession) in the economy in order to reduce inflation.

“Now the Fed will be more cautious about raising rates – at least in the short term – due to concerns about the financial sector. I wonder if the Fed will raise rates sufficiently now and then reverse course sharply in a few months if it becomes clear that inflation is not slowing enough yet.”

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