Robert Reich's Explanation Of The Banking Debacle; Silicon Valley Bank, etc.

Click here for Robert Reich's article, "The real story behind the Silicon Valley Bank debacle.

The surface story of the Silicon Valley Bank debacle is straightforward. During the pandemic, startups and technology companies enjoyed heady profits, some of which they deposited in the Silicon Valley Bank. Flush with their cash,T the bank did what banks do: It kept a fraction on hand and invested the rest — putting a large share into long-dated Treasury bonds that promised good returns when interest rates were low.

But then, starting a little more than a year ago, the Fed raised interest rates from near zero to over 4.5 percent. As a result, two things happened. The value of the Silicon Valley Bank’s holdings of Treasury bonds plummeted because newer bonds paid more interest. And, as interest rates rose, the gusher of venture capital funding to startup and tech companies slowed, because venture funds had to pay more to borrow money. As a result, these startup and tech companies had to withdraw more of their money from the bank to meet their payrolls and other expenses.

But the bank didn’t have enough money on hand. 

The Roosevelt administration in the 1930s brought in banking regulations that ushered in an era of financial stability that lasted until the 1980s:

when Wall Street financiers, seeing the potential for big money, pushed to dismantle these laws and regulations — culminating in 1999, when Bill Clinton and Congress repealed what remained of Glass-Steagall.

Then, of course, came the 2008 financial crisis, the worst collapse since 1929. It was the direct result of financial deregulation. Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006, called it “a once-in-a-century credit tsunami,” but pressed by critics, Greenspan acknowledged that the crisis had forced him to rethink his free market ideology. “I have found a flaw,” he told a congressional committee. “I made a mistake … I was shocked.”

Shocked? Really?

The banking industry became a giant casino, with rapacious bankers reaping enormous profits, until the house of cards came crashing down in 2008, the worst financial crisis since 1929.

In the end, the Obama administration rescued Wall Street, but at enormous cost to taxpayers and the economy. Estimates of the true cost of the bailout vary from half a trillion dollars to several trillion. The Federal Reserve also provided huge subsidies to the big banks in the form of virtually free loans. But homeowners, whose homes were suddenly worth less than the mortgages they owed on them, were left hanging in the wind. Many lost their homes.

Obama thereby shifted the costs of the bankers’ speculative binge onto ordinary Americans, deepening mistrust of a political system increasingly viewed as rigged in favor of the rich and powerful.

Regulations were put into place, but they didn't go far enough and then were further weakened:

A package of regulations put in place after the financial crisis (called Dodd-Frank) was not nearly as strict as the banking laws and regulations of the 1930s. It required that the banks submit to stress tests by the Fed and hold a certain minimum amount of cash on their balance sheets to protect against shocks, but it didn’t prohibit banks from gambling with their investors’ money. Why not? Because Wall Street lobbyists, backed with generous campaign donations from the Street, wouldn’t have it.

Which brings us to Friday’s failure of the Silicon Valley Bank. You didn’t have to be a rocket scientist to know that when the Fed raised interest rates as much and as fast as it did, the financial cushions behind some banks that had invested in Treasury bonds would shrink. Why didn’t regulators move in?

Because even the milquetoast protections of Dodd-Frank were rolled back by Donald Trump, who in 2018 signed a bill that reduced scrutiny over many regional banks and removed the requirement that banks with assets under $250 billion submit to stress testing and reduced the amount of cash they had to keep on their balance sheets to protect against shock. This freed smaller banks — such as Silicon Valley Bank (and Signature Bank) — to invest more of their deposits and make more money for their shareholders (and for their CEOs, whose pay is linked to profits).

Reich lists what he calls Four lessons from this debacle":

1. The Fed should hold off raising interest rates again until it has done a thorough appraisal of the consequences for smaller banks.

2. When the Fed rapidly raises interest rates, it must better monitor banks that have invested heavily in Treasury bonds.

3. The Trump regulatory rollbacks of financial regulations are dangerous. Small banks can get into huge trouble, setting off potential contagion to other banks. The Dodd-Frank rules must be fully reinstated.

4. More broadly, not even Dodd-Frank is adequate. To make banking boring again, instead of one of the most profitable parts of the economy, Glass-Steagall must be reenacted, separating commercial from investment banking. There’s no good reason banks should be investing their depositors’ money for profit.