Tuesday, March 14, 2023

Five Observations on SVB

1. The collapse of Silicon Valley Bank seems closely related to the fact that we recently experienced the largest drawdown in bonds in history. That is, the bank made an imprudent bet on interest rates and was very, very unlucky. 

2. Contrary to the claims of some talking heads, the relaxation of Dodd-Frank in 2018 appears not to be a big part of the story. The "severely adverse scenario" in the regulators' stress test did not include a major bond drawdown.  Instead, it described a recession accompanied by falling interest rates. That is, the regulators would not likely have caught the imprudent bet the bank was making.

3. I am not particularly concerned about the moral hazard associated with insuring all bank deposits (though the expansion of deposit insurance should be done explicitly, rather than through the implicit and ad hoc process now occurring). It is not realistic to expect bank depositors to monitor the health of their banks. A sophisticated depositor with a large balance would instead spread his holdings in $250,000 chunks among many banks. Those left with large holdings in a single bank are, by revealed preference, unsophisticated.

4. People say we need better regulation. Of course, but that is easier said than done. Don't expect supervision to get much better, though we should try.

5. The simplest way to avoid these problems is to push banks toward higher levels of capital. Maybe that can be accomplished by making deposit insurance fees depend more strongly on the bank's capital/asset ratio. Or something along those lines.