Within three days, the Federal Deposit Insurance Corporation and state regulators in California and New York took control of Silicon Valley Bank and Signature Bank and guaranteed all of their deposits, beyond the usual federal insurance limit of $250,000.
The Federal Reserve also announced a new lending facility, backed by the US Treasury Department, which other banks can tap into to help meet depositor demands.
The measures aim to prevent contagion throughout the US banking sector after the defunct Santa Clara-based company SVBwhose clients were mainly venture capital funds and tech start-ups, suffered massive withdrawals of deposits last week.
Here’s how the Fed’s intervention works and how it differs from bailouts during the 2008 financial crisis.
How do Fed loan facilities work?
Lenders will be able to draw on Fed lending facilities for up to one year by pledging collateral such as government bonds, which will be valued at face value. These credit lines have been the tool of choice since the 2008 crisis and were widely used when central banks intervened to stabilize markets at the onset of Covid-19.
Pandemic-era interventions expanded the reach and breadth of the Fed’s reach in unprecedented ways, ultimately dragging the central bank into the corporate credit and municipal bond markets and creating a lifeline directly to help small and medium-sized businesses.
In testament to their effectiveness, only a fraction of the multi-trillion dollar support available through these lending facilities has been deployed, as the mere promise of Fed support has quelled the panic.
On Sunday, the Fed sought to have a similar effect, going so far as to say it was “ready for any liquidity pressure that may arise.”
What problems were regulators trying to solve?
Many banks have large depositors whose balances exceed the $250,000 limit above which deposits are not covered by the FDIC insurance mechanism. If they flee, more lenders will face the same pressure to sell assets at a loss.
The extended deposit guarantee aims to prevent further bank runs, convincing customers to stay put because they will be protected even if another bank fails.
The Fed’s offer to lend against high-quality bonds at par is intended to help other banks meet withdrawals without selling securities at a loss. Depositors at other banks can now be more sure to avoid being caught up in a similar panic.
It also addresses a specific problem with SVB and other large institutions: many of them have billions of dollars tied up in securities that can currently only be sold for less than the bank paid. for them. If held to maturity, they would be worth parity. Fed lending reduces the risk that banks’ paper losses, estimated at more than $600 billion at the end of 2022, crystallize into real losses.
More broadly, the specter of savers losing money on their deposits at a major US bank would have shaken confidence in the financial system and increased the risk of widespread flight.
Sunday’s show of force was aimed at stopping this destructive cycle in its tracks.
Why is this different from taxpayer-funded bailouts in 2008?
FDIC and Treasury officials were keen to stress that SVB and Signature assets will be used to cover initial government expenses to allow depositors to access their money.
That may be enough to fill the hole, because SVB’s losses were paper losses on government bonds, not bad debts or complex securities, as happened during the Great Financial Crisis. SVB also had a brokerage and investment banking arm, and the sale of these divisions could also generate funds to repay federal aid.
If that still doesn’t cover the hole, US officials said last night: ‘Any losses incurred by the deposit insurance fund to support uninsured depositors will be recovered by a special levy on the banks.’
The other difference is that the government has said that investors who hold the shares and bonds of SVB and Signature will lose their money unless there are excess funds after depositors are reimbursed. With the exception of Lehman Brothers, this generally did not happen in 2008, due to fears that losses on bank stocks and bonds would spread contagion.
“People say the whole banking system is in jeopardy. I don’t see it at all,” said Lloyd Blankfein, who ran Goldman Sachs in 2008. “The bigger banks are much more regulated and have been through rigorous stress testing.
Why do the shares of other banks continue to sink?
The sharp moves in some banks’ shares suggest investors aren’t entirely convinced that Sunday’s bailout will end the fallout from SVB’s failure. Beyond that, even the strongest banks are set to face higher costs and tougher regulation, even if Sunday’s bailout succeeds in easing the crisis of confidence that had threatened to escalate in recent days.
Whether offering higher interest rates to depositors or tapping into the wholesale money markets, analysts expect banks to take on little risk as they shore up their funding position, which means lower interest margins.
Regulators are also likely to revise their assumptions about the systemic importance of mid-sized financial institutions, further squeezing profits from a sector that had successfully argued it should be spared the stringent oversight inflicted on the biggest banks. .
What future problems does this intervention create?
Pressure will mount on the FDIC to insure all depositors at all U.S. banks, regardless of account size, lest investors and depositors flee those who are unprotected.
This would extend protection that has historically been focused on retail customers to businesses and raises the possibility that the ultimate cost will fall on the taxpayer.
“This bailout of taxpayers’ money today signals to businesses in the future that the Fed will bail them out tomorrow,” said Aaron Klein of the Brookings Institution.
The Emergency Lending Facility’s decision to accept securities at par also reduces pressure on banks to be prudent in their investments and liquidity management, which runs counter to decades of efforts to make banks safer.
If bank stock prices continue to fall and take the market with them, the Fed could feel pressure to stop raising interest rates at a time when inflation is still well above the 2% target rate.
“What’s happening is sheer panic,” said veteran banking analyst and head of Whalen Global Advisors Christopher Whalen. “If we get more bank failures, I think we could see Fed rates go down.”
Additional reporting by Joshua Franklin and Stephen Gandel in New York