Fed Admits Mistake In Scathing Report
Please consider a 100+ page Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley released by Michael Barr, emphasis mine.
Silicon Valley Bank (SVB) failed because of a textbook case of mismanagement by the bank. Its senior leadership failed to manage basic interest rate and liquidity risk. Its board of directors failed to oversee senior leadership and hold them accountable. And Federal Reserve supervisors failed to take forceful enough action..
Our banking system is sound and resilient, with strong capital and liquidity. And in some respects, SVB was an outlier because of the extent of its highly concentrated business model, interest rate risk, and high level of reliance on uninsured deposits; however, SVB’s failure demonstrates that there are weaknesses in regulation and supervision that must be addressed. Regulatory standards for SVB were too low, the supervision of SVB did not work with sufficient force and urgency, and contagion from the firm’s failure posed systemic consequences not contemplated by the Federal Reserve’s tailoring framework.
Our experience following SVB’s failure demonstrated that it is appropriate to have stronger standards apply to a broader set of firms. As a result, we plan to revisit the tailoring framework, including to re-evaluate a range of rules for banks with $100 billion or more in assets.
We should also consider applying standardized liquidity requirements to a broader set of firms. Any adjustments to our liquidity rules would, of course, go through normal notice and comment rulemaking and have appropriate transition rules, and thus would not be effective for several years.
Liquidity Rules
The Fed admits it needs new liquidity rules now. But don’t worry. it will wait several years to implement them.
There’s no time like the future to do what needs to be done today.
Capital Rules
With respect to capital, we are going to evaluate how to improve our capital requirements in light of lessons learned from SVB. For instance, we should require a broader set of firms to take into account unrealized gains or losses on available-for-sale securities, so that a firm’s capital requirements are better aligned with its financial positions and risk.
Unrealized Losses
By the time unrealized losses mount, it’s too damn late.
The Fed should act to prevent unrealized losses and the easy way is to require 100 percent reserves matched by duration.
Consensus-Driven Silliness
Overall, the supervisory approach at Silicon Valley Bank was too deliberative and focused on the continued accumulation of supporting evidence in a consensus-driven environment.
Consensus-driven groupthink sums up the entire state of affairs at the Fed. The groupthink consensus said the inflation was too low. Then the Fed said higher inflation was transitory.
Then even when it was plain to the entire world that inflation was soaring, the groupthink consensus said to keep QE going to the bitter end so ad to not upset the market.
Supervisors Ignored 31 Open Findings
SVBFG had 31 open supervisory findings when it failed in March 2023, about triple the number observed at peer firms. The supervisory findings at SVBFG included core areas, such as governance and risk management, liquidity, interest rate risk management, and technology.
That’s OK because the groupthink consensus said it was OK.
Regarding Liquidity, SVBFG was rated “Conditionally Meets Expectations (CME),”a satisfactory rating.
Why CME is “satisfactory” is a mystery to me.
Regarding Capital, SVBFG was rated “Broadly Meets Expectations (BME),” a satisfactory rating that is the highest rating. What a hoot.
Regarding Governance and Controls SVBFG was rated “Deficient-1,” a rating that is less than satisfactory.
Incomprehensible Rules
SVBFG’s rapid growth led it to move across categories of the Federal Reserve’s regulatory framework (see the “Federal Reserve Regulation” section). Under the current framework, the application of rules to a particular firm depends on a range of factors related to a firm’s size and complexity. As seen in the visual produced by the Federal Reserve Board,24 the framework is quite complicated. SVBFG and staff supervising SVBFG spent considerable effort seeking to understand the rules and when they apply, including the implications of different evaluation criteria, historical and prospective transition periods, cliff effects, and complicated definitions. SVBFG regularly engaged consultants to help prepare for the transition.
The Fed Failed but Wants More Power
The Wall Street Journal comments The Fed Failed but Wants More Power
An iron law of the modern administrative state is that the solution to regulatory failure is always to give regulators more power. That’s the key to understanding Federal Reserve Vice Chair for Supervision Michael Barr’s autopsy, released Friday, of Silicon Valley Bank’s (SVB) failure.
The report offers a token mea culpa for not having responded fast enough to troubles at the bank. But that’s mainly a deflection from the report’s main purpose, which is to protect the Fed and bolster the Biden Administration’s financial regulatory agenda.
Fed Uncertainty Principle
Long time Mish readers will note the Fed Uncertainty Principle in action notably corollary numbers two, three, and four.
The Observer Affects The Observed
The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg’s Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.
The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.
Fed Uncertainty Principle: The fed, by its very existence, has completely distorted the market via self-reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed’s actions. There would not be a Fed in a free market, and by implication, there would not be observer/participant feedback loops either.
Corollary Number One: The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn’t know (much more than it wants to admit), particularly in times of economic stress.
Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.
Corollary Number Three: Don’t expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.
Corollary Number Four: The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it’s easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
I wrote The Fed Uncertainty Principle on April 3, 2008, before the collapse of Lehman and Bear Stearns.
Corollary number two is now in full swing.
Fed Policy: It’s Not Fractional Reserve Banking, It’s ZERO Reserve Banking
Please read and/or re-read Fed Policy: It’s Not Fractional Reserve Banking, It’s ZERO Reserve Banking
If you think we have fractional reserve banking, we don’t. We have zero reserve banking.
One simple regulatory rule would have saved SVB, that being a 100% reserve requirement on deposits instead of a 0% reserve requirement on deposits.
Money that is supposedly 100% payable on demand was in fact NOT payable on demand. It’s like leasing your car to two people simultaneously, banking on the notion one will not show up.
The Impact of Fraudulent Practices
A 100% reserve requirement would have stopped the run and thus bank failures due to greed.
Moreover, given that money is lent into existence (rather than deposits funding loans), a mandatory requirement to park money at the Fed or in very short term treasuries would not have impeded bank lending at all.
An Invite You Cannot Refuse
In case you missed it, please note JPMorgan Takes Over First Republic Bank, Big Get Bigger
“Our government invited us and others to step up, and we did,” JPMorgan Chief Executive Jamie Dimon said Monday.
Regulators seized First Republic Bank and offered it to JPMorgan with sweeteners. JPMorgan accepted the invite.
This post originated at MishTalk.Com
Please Subscribe!
Like these reports? I hope so, and if you do, please Subscribe to MishTalk Email Alerts.
Subscribers get an email alert of each post as they happen. Read the ones you like and you can unsubscribe at any time.
If you have subscribed and do not get email alerts, please check your spam folder.
Mish
