Opinion: SVB’s collapse doesn’t have to be the first in a chain of many

Editor’s note: Lanhee J. Chen is a regular contributor to CNN Opinion and a David and Diane Steffy Fellow in American Public Policy Studies at the Hoover Institution. He was a candidate for the position of Comptroller of the State of California in 2022. He has held leadership positions in the Republican and Democratic presidential administrations and has served as an adviser to four presidential campaigns, including as director of policy for the Mitt Romney-Paul Ryan’s 2012 campaign. The opinions expressed in this commentary are his own. See more reviews on CNN.

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When Silicon Valley Bank collapsed this month, analysts and policymakers quickly began thinking about how to prevent similar failures from happening again in the future. While there are changes lawmakers should consider, when it comes to financial regulation, history shows us that politicians generally react to the last crisis and step back from the next.

The savings and loan crisis of the 1980s led to the passage of the Financial Institutions Reform, Recovery and Enforcement Act 1989, which closed down insolvent financial institutions, created new regulation and put in place restrictions on how savings and loan (or savings) institutions could invest. deposited funds.

The 2007-2008 financial crisis led to the passage of the sweeping Dodd-Frank Act in 2010, which revamped federal regulation of the financial services industry and placed restrictions on how banks do business. Amid criticism that Dodd-Frank had gone too far in regulating banks, a bipartisan coalition in Congress was passed, then then-President Donald Trump signed legislation in 2018, some backtracking Dodd-Frank requirements for small and medium financial institutions.

Democrats have largely blamed this regulatory rollback for SVB’s demise. Many Republicans, for their part, have focused their lens on whether bank management has spent too much time pursuing “woke” policies on diversity and sustainability rather than ensuring depositors were protected.

The fact that there is so little overlap between Republican and Democratic critics in the wake of the SVB’s collapse illuminates the difficult road ahead in finding bipartisan policy solutions to avoid a similar failure in the future. If the two parties cannot even agree on the root cause of the bank’s failure, it is unlikely that there will be consensus on the policies needed to shore up the financial system in the future.

But they should. While Democrats generally favor more aggressive oversight of the financial system, and Republicans broadly argue that the current regulatory regime is sufficient, the right answer for the future lies somewhere in between.

In the wake of SVB’s failure, some regulatory interventions have been finalized and could form the basis of policy discussions in the weeks and months to come as Congress considers how to respond to the current banking crisis. .

First, SVB’s demise came when a lack of cash (or a lack of available cash) prevented it from paying depositors when they came to collect their money. The bank had invested a disproportionate amount of assets in long-term debt that had been purchased at a time when interest rates were much lower than they are today. When the bank attempted to liquidate this debt in recent weeks, it was forced to do so at a significant loss. The SVB failed to hedge against risk by diversifying its investments.

When depositors attempted to withdraw $42 billion in cash from the bank in a single day, SVB’s lack of liquidity caused panic among those who had deposits in the bank and raised concerns about the health of the bank. American banking system in general.

Just as individual investors are often urged to diversify their investment strategies to minimize risk, politicians could also look to requirements that banks ensure they have appropriate diversification in how they invest their assets. .

In addition, some Republicans and many Democrats are also calling for expanded deposit insurance so that bank deposits above the current federal cap of $250,000 are also insured. Democratic Sen. Elizabeth Warren of Massachusetts, a strong supporter of increased regulation of the financial sector, called for an increase in deposit insurance that would be paid for by banks. Democratic Rep. Ro Khanna of California is expected to soon introduce legislation that raises or removes the insurance cap entirely, so deposits of all amounts will be protected.

Some Republicans joined them in addressing the insurance cap. Republican Senator JD Vance of Ohio, for example, argued that lifting the cap (for example, ensuring the cap keeps up with inflation) would level the playing field between big banks and small banks. local and regional. Republican Senator Mitt Romney of Utah has suggested that large depositors could be insured up to the full amount of their deposits in exchange for a small fee.

If Congress decides to increase or eliminate the deposit insurance limit entirely, it should do so with caution. Depending on how the policy is constructed, such changes could disproportionately benefit wealthier institutional depositors or encourage bad behavior by banks if they know an indefinite bailout awaits at the other end of the decisions. risky investments.

Finally, some changes will no doubt come from the Federal Reserve rather than Congress. This is probably a good thing, because these decision makers are isolated from the political forces that directly affect legislators.

The Federal Reserve, for example, will likely review the extent of banks’ capital and liquidity requirements based on their total assets. A bank’s capital is the difference between its assets and its liabilities or, in other words, the resources a bank has to ultimately absorb losses. Liquidity, by comparison, is a measure of the cash and assets a bank has immediately available to pay its obligations (such as cash that depositors might demand).

The U.S. central bank could also examine the content of the “stress tests” created by the Dodd-Frank Act and designed to regularly assess the health of major financial institutions across the country. For nearly a decade, the tests have been compared to a low interest rate environment, which does not reflect recent conditions.

But at the end of the day, the Federal Reserve isn’t blameless in SVB’s collapse because it created a fertile environment for the bank to fail by keeping interest rates as low as they have been too. long as they have been. Lawmakers should do their part to make sure people understand that monetary policy has far-reaching impacts.

While the best way to prevent the next SVB is likely to be seen by policymakers through tinted partisan glasses, there are ways Democrats and Republicans can work together. But the window to do so is narrow and closing. Next year around this time we will be in the throes of presidential primaries, and neither party will be particularly interested in a compromise, even if that is what our financial system needs.