The March 10 collapse of Silicon Valley Bank (SVB) is worrying, but in itself should not cause a systemic financial crisis. It does increase a true systemic risk, by loading another straw of doubt on the back of the camel of financial confidence.
People who deal with banks know that SVB was an outlier. In catering to tech companies, it handled huge deposits from tightly connected customers. With concentrated and “herd-like” depositors, it should have held assets that could be liquidated quickly without losses, to cover withdrawals. Instead it locked itself into longer-term government bonds during a period of rock-bottom interest rates. The bonds were safe from default but would lose value if rates rose and, being of longer maturity, would have to be sold at the reduced prices rather than maturing at par. This error should have been avoidable, and it seems that the bank lacked a Chief Risk Officer at the time the Fed started to raise interest rates in 2022. With the news that the bank had taken a large loss on sale of bonds, all this mismanagement came home to roost, and set off the bank run of March 8th to 10th.
Bank failures are caused above all by a lack of confidence. Once confidence is lost, for whatever reason, cash flows and reserve positions matter less than depositors’ fear that others’ withdrawals will close the bank before you get your own money out. In SVB’s case, mismanagement set the table. But the announcement of a loss on sale of securities turned overhanging doubt into living fear. Signature Bank closed over the weekend and First Republic was possibly at risk Monday – their weaknesses were also known and the jolt to confidence from the SVB failure triggered their losses. Every crisis raises questions that sap general confidence. Hence the rapid FDIC response, with the agency quickly assuring all depositors of SVB and Signature, insured or not, of access to their funds.
Confidence once jolted is not easily restored, and deficits in confidence are like the smell of rotten eggs. Even if bank run contagion is contained, the odor pervades the air and affects everyone’s outlook on everything.
This question of general confidence is especially worrisome for reasons that run far beyond the failure of SVB and perhaps a few more banks. The federal debt ceiling must be raised in order for the US to pay its bills, and if legislation is not passed by June, the nation will be in default on its bonds.
There are at least three levels of risk here. The obvious risk is that Congress will not act in time. A problem here is that we have been through Congressional delays on budget bills and debt ceiling raises a number of times, and have come to expect them to cut a deal after brief government shutdowns. But as partisan division deepens, the posturing ratchets up and the eventual deal cannot be taken for granted. The process of electing a Speaker of the House in January should do away with any attitude that “we’ve seen this dance before.”
The second level of risk is systemic. Today’s failure of some regional banks will reduce overall confidence in the system. Even if, as seems likely, contagion is contained, we now see that nightmares came true. The emerging suspicions turn questions about any given bank into sysemic doubt, and doubts into fear. Fear can lead all the more easily to further crises and runs. In the real economy, risk-taking, necessary to some degree for any business, will be inhibited. Growth will be stunted and confidence sapped further. The path grows shorter, from financial worry to crash as self-fulfilling prophecy, while the economy sags further and adds to the fear.
The overall drop in confidence sets us up very badly for the possibility of a federal default. It raises a third, deep, type of risk. As Treasury Secretary Janet Yellen testified on March 10, “a default on our debt would trigger and economic and financial catastrophe.” While we have had government shutdowns before, there has not yet been a default.
What few understand is that U.S. Treasury bonds are treated as a benchmark of “zero risk” for all financial dealings worldwide. One default, even if remedied quickly, undoes the magic of that label. So system-wide pricing of financial risk loses its most basic measurement tool, which could create immense chaos in worldwide markets. Further, a defaulting US government will have difficulty issuing new bonds, and its ability to cover our fiscal deficits comes into question, in a vicious cycle. Given the amount of federal funding in the economy, an outright depression becomes an actual thought. Ramifications beyond that are hard even to imagine, but could include economic collapse and social chaos.
All these still remain only possibilities. But if they start to look at all plausible, it takes decisive, swift, and credible measures to make the fears recede. How confident are we that the U.S. Congress will do the right thing? Already the politicians, ignorant of SVB’s outlying nature, are looking to blame the Fed for its rising rates, “wokeness,” or the Trump loosening of regulations. At bottom, really, there is a post-Covid economic environment and a poorly run bank. That alone raises legitimate concerns. Political games only add to them.
If our leaders lack character, the populace must somehow force them to face the most urgent goal, the one they are actually responsible for. The only way that can happen is for the public to scream from the rooftops that the urgent and overriding priority is to raise the debt ceiling. No quibbling over spending cuts, no posturing over social needs, no blame game to pin SVB on the other side – take up other problems later. If the public can figure out how to say this with a single voice, we might avert default, keep our economic reset on track, and even show a quiet strength. If not, we may find trouble like few of us have ever seen.
Our nation is founded on a creed of personal rights and self-government; we depend on ourselves to meet needs like economic well being and stability. We need to do it well, to show free people as competent, which is needed to validate government by the people. If we cannot maintain an economy, our creed as a governing philosophy looks fanciful if not delusionary. But if we can force our politicians to keep our nation viable, we show the true power of a free society.
Common Conviction 