After bankruptcies, there is always the blame game. For the collapse of Silicon Valley Bank, and two other banks, everything points to a process of banking deregulation that began with Donald Trump in 2018. The Federal Reserve also excluded regional banks from portfolio monitoring. And, of course, Silicon Valley Bank took more risks than it should have, its bond portfolio barely covered by financial derivatives.
Eight years ago, Silicon Valley Bank (SVB) Director Greg Becker appeared before the US Congress and before the powerful senators of the House Banking Committee said: “The Dodd-Frank Act is not for us“. The bankrupt entity’s banker was referring to all the legal scaffolding, which the Obama Administration had put in place to protect the real economy from future banking crises. It was the political response to the Lehman Brothers crisis, which was about to destroy the world financial system..
A decade after the 2008 financial crisis, It fell to Donald Trump to dismantle all the regulations that forced banks to be cautious with their capital and to reinforce their solvency. Trump signed the Economic Growth Act and with it the deregulation of the US banking sector.
The top executive of the SVB was heavily involved in parliamentary work. He even went to testify to the famous Banking Committee. “The evidence is clear, the Dodd-Frank Act framework for SVB and banks of our size is not adequate”, point out the minutes collected by Bloomberg. The banker assured that “the costs of complying with regulations were too high for the sector and for customers”.
The tech banker was advocating for selective deregulation. The SVB and regional banks were not like the financial giants on Wall Street. Smaller banks don’t have to meet capital ratios, pass solvency tests or put in man hours to comply with regulations. Becker was no exception, the entire regional banking industry knocked on the door of the Oval Office to achieve its goal.
Trump complied with the bankers’ wishes. At the law’s solemn signing, he said, “One size doesn’t fit all, these Dodd-Frank rules just don’t work.” “They shouldn’t be regulated in the same way as large and complex financial institutions, and that’s what happened and they went bankrupt one by one,” he explained. More than a dozen Democratic senators joined Republicans in supporting the measure. In fact, Barney Frank, one of the promoters of the Dodd-Frank Act, advocated for relaxing the regulations. Today he is on the Board of Directors of Signature Bank, one of the failed banks.
The collapse in a few days of Silvergate, Silicon Bank and Signature Bank is partially explained by the lifting of capital requirements and demands. “We’ve known since 2008 that stricter regulations are needed to prevent exactly this type of crisis.“, says Democratic Representative Ro Khanna, who represents a district in California that includes parts of Silicon Valley. “Congress must unite to reverse the deregulation policies that were implemented under Trump to avoid future instability.”
With banks down, accusations of responsibility point to Donald Trump. Trump spokesman Steven Cheung said in a statement that Democratic critics were trying to blame the former president “for your failures with desperate lies” on various topics. “This is nothing more than a sad attempt to deceive the public to evade responsibility”, defends the former president.
Within the Fed, there are critics pointing in this direction of lack of oversight. The Fed’s vice president for supervision, Michael Barr, said last week that the regulator has been dealing with smaller creditors with “a very light approach”. At last Monday’s extraordinary meeting, the Fed decided to open an investigation to find out whether the SVB correctly complied with regulatory requirements and understand whether the supervisory system failed. Fed Chairman Jerome Powell said in the statement that “[la quiebra de] Silicon Valley Bank demands a thorough, transparent and immediate review” to understand its causes.
Fewer tests for regional banks
“We need to be humble and do a careful and thorough review of how we oversee and regulate this company and what we need to learn from this experience,” said Vice President Michael Barr, who will lead the process. Current US President Joe Biden has stated that he will ask Congress and banking authorities to “enforce banking regulations”.
Since 2019, banks with less than 700 billion assets have been released from subjecting their bond portfolios to stress tests, denounce executives of large American banks. This allowed regional banks to take on more risk in asset management as they were not influenced by the volatility of capital levels.
The Dodd-Frank Act meant that regulators required all banks to hold a number of high-quality liquid assets – there is no higher-quality asset than US debt – large enough to satisfy a stressed deposit outflow for 30 days. In practice, it means having more than one liquidity coverage ratio above 100%. The SVB downfall has been a major liquidity issue as in late 2022 customers started withdrawing deposits
As detailed by Bloomberg, internal bank documents recommended at the end of 2020 that the bank’s balance sheet should be more exposed to short-term bonds. This measure was intended to protect the bank’s balance sheet against fluctuations in the valuation of assets. Management objected and the entity continued to invest cash in riskier assets. Until 2021, the strategy worked. The results reached a record level, but when the bond market turned with the biggest interest rate adjustment in history, 16 billion of capital losses appeared in the portfolios.
“I have no doubt that if this bank were subject to much tighter regulation, it would not be allowed to buy long-term Treasuries and mortgage-backed securities,” said Brad Sherman, a Democratic congressman also from California. “They would have been pressured to buy short-term instruments and we wouldn’t be having that conversation.”
The politician’s explanations point to the fact that the bank would have much more liquidity if the securities were short-term. Losses would not have skyrocketed when selling assets. The big losses weren’t unique to SVB: In total, US banks posted $620 billion, according to documents filed with the FDIC.
The big banks quickly caught on to the game. Long-term bonds were transferred to held-to-maturity portfolios. That is, the debt on the balance sheet ceased to count as capital and the first source of liquidity, it remained in the bank until the end of the life of the loan. For the financial entity, it implies that price volatility does not affect the price, although it ceases to count as an asset.
In turn, SVB’s bond portfolio increased to 57% of its total assets. No other competitor among the top 74 US banks had more than 42%, according to the agency.
It has not only been a liquidity issue, but also a risk management issue. Alfonso Peccatiello of The Macro Compass points out that the average bond portfolio of US banks is 24% and for large banks it is over 30%. For the specialist, the most important thing is not the percentage, but whether the portfolio is protected. “The SVB didn’t have the bond portfolio covered,” he explains. While in 2021 the bank had 10,000 million dollars in financial swaps, at the end of 2022 only 500 million remained.
The most curious thing about the entire regulatory labyrinth is that, at the end of 2022, the SVB presented its first Resolution Plan, the emergency plan in case of liquidity problems, before the Federal Deposit Insurance Corporation, thanks to the Dodd-Frank Act. .