The Federal Reserve is criticized for its lack of forward focus

Enkel
Enkel

The Federal Reserve is facing stinging criticism for missing what observers say were clear signs that the Silicon Valley bank was at high risk of collapse in the second-largest bank failure in US history.

Critics point to many hallmarks of the bank, including its rapid growth since the pandemic, its unusually high level of uninsured deposits and its heavy investments in long-term government bonds and securities, which fell to value as interest rates rose.

“It is inexplicable how Federal Reserve supervisors could not see this clear threat to the safety and soundness of banks and to financial stability,” said Dennis Kelleher, chief executive of the firm Better Markets, a watchdog group.

Wall Street traders and industry analysts “have been raising their voices publicly about these issues for many, many months since last fall,” Mr. Kelleher added.

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The Federal Reserve was the primary federal bank supervisor based in Santa Clara, California. The bank was also overseen by the California Department of Financial Protection and Innovation.

Now the fallout from the Silicon Valley bank’s failure, along with New York-based Signature Bank, which failed over the weekend, is complicating the Federal Reserve’s future decisions about how high to raise its interest rate in the fight against chronically high inflation.

Many economists say the central bank is likely to raise interest rates by half a point next week, which would constitute a step in its fight against inflation. Its rate currently stands at around 4.6%, the highest level in 15 years.

With the collapse of two major banks fueling anxiety for other regional banks, the Federal Reserve may focus more on boosting confidence in the financial system than on its long-term effort to tame inflation.

The government’s latest inflation report, released on Tuesday, shows that price growth remains much higher than the Federal Reserve prefers, putting Chairman Jerome Powell in a more difficult position. Core prices, which exclude volatile food and energy costs and are seen as a better gauge of longer-term inflation, rose 0.5% from January to February – the highest since September. This is well above the Federal Reserve’s annual target of 2%.

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By all accounts, Silicon Valley was an unusual bank. Its leaders took excessive risks by buying billions of dollars in securities and Treasury bills when interest rates were low. As the Federal Reserve repeatedly raised interest rates to fight inflation, the value of Silicon Valley’s bonds steadily lost value.

Most banks would have sought to make other investments to offset this risk. The Federal Reserve could also have forced the bank to raise additional capital.

The bank had grown rapidly. Its assets quadrupled in five years to $209 billion, making it the 16th largest bank in the country. And approximately 94% of its deposits were uninsured because they exceeded the Federal Deposit Insurance Corporation’s $250,000 insurance limit.

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That percentage was the second highest among banks with more than $50 billion in assets, according to ratings agency S&P. The underwriting had the fourth highest percentage of uninsured deposits.

Bank failures are likely to prompt an upcoming review of Federal Reserve rules that determine how much money large banks must hold in reserves.

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