San Francisco Federal Reserve President Mary Daly could offer Republicans and Democrats a rare point of unity as lawmakers trade blame for the collapse of Silicon Valley Bank earlier this month.
That’s because Daly’s failure to act on clear signs of weakness at the bank under her supervision has drawn ire from both sides of the aisle.
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Critics agree that the San Francisco Federal Reserve should have spotted warnings about Silicon Valley Bank’s balance sheets long before the bank shuttered and sparked unease about the banking industry.
But they disagree on why the system failed at one of its most basic responsibilities.
“The Fed screwed up. People are mad because they made a major error with profound consequences,” Aaron Klein, senior fellow in economic studies at the Brookings Institution, told the Washington Examiner. “But it’s not just the San Francisco Fed. It’s the entire system.”
Both the San Francisco Fed and the Federal Reserve had responsibility for overseeing SVB.
The San Francisco Fed has come under particularly harsh criticism, however, because it failed to exercise its legal discretion to perform stronger oversight of the bank. Greg Becker, SVB’s chief, sat on the board of the San Francisco Fed until his bank collapsed.
“The SF Fed had all of the resources and information necessary to properly supervise SVB, yet it spectacularly failed to do so,” Sen. Ted Cruz (R-TX) wrote in a letter to the institution last week. “Instead of fulfilling its statutory mandate to supervise SVB, the SF Fed has been distracted with engaging in politically-charged research and advocacy on environmental, social, and governance (‘ESG’) and diversity, equity, and inclusion (‘DEI’) topics, like global warming and racial justice.”
Indeed, Daly, the San Francisco Fed president, has come under fire in recent days from conservatives for her high-profile embrace of liberal pieties such as climate change and racial equity.
For their part, Democrats have blamed a 2018 law that exempted some banks, SVB included, from the most strenuous regulations applied to banking giants.
But experts say the real reasons she and the Federal Reserve’s board of governors missed the signs of trouble are far more complicated — and not yet entirely clear.
Under the 2018 law, San Francisco Fed officials had the option to perform stricter oversight of banks with $100 billion or more of assets; they chose not to do so in SVB’s case.
Klein compared the stricter oversight the San Francisco Fed could have performed, if it wanted, to an “advanced test,” while the oversight SVB did receive was more like a “basic test” in school.
“That law also gave the Fed the discretion to apply the advanced test to banks whose failure would be systemic, which highlights another flaw of the Fed’s judgment, in that by choosing not to give the Silicon Valley Bank the advanced test, they were saying the failure of Silicon Valley Bank would not be systemic,” he said. “Then they reversed course when Silicon Valley Bank failed.”
“Silicon Valley Bank failed the basic test,” Klein added. “Whether the advanced test would have caught it or not, we can debate also.”
Sen. Elizabeth Warren (D-MA) signaled potential scrutiny may lie ahead for Daly when she said on Sunday that she had lost confidence in Daly specifically.
“The Fed should have acted,” Warren said on CBS’s Face the Nation.
Fed officials reportedly did raise several concerns with SVB in 2019 and 2021, mostly related to the bank’s processes for determining risk management. What the Fed did to ensure its concerns got addressed, and whether regulators warned of the particular factors that brought down the bank or just of procedural weaknesses, remains to be seen.
Speaking to reporters on a conference call less than a week before the SVB collapse, Daly said she was “hearing some very encouraging news” from people in her district about inflation and the direction of the economy.
She, like many other top officials at the Fed, has repeatedly acted as a cheerleader for the higher interest rates that helped bring down SVB.
SVB was the largest bank in her district, and its client base consisted largely of depositors reliant on a technology industry that had publicly struggled for months. Layoffs and falling revenues in the tech sector had splashed across headlines for months before SVB’s collapse.
SVB’s deposits were almost all uninsured — meaning most were above the $250,000 level that the Federal Deposit Insurance Corporation guarantees to repay in the event of a bank disaster — which regulators should have seen as a warning sign amid the economic uncertainty. Uninsured depositors are more likely to flee their bank if they sense turbulence ahead, heightening the risk of a bank run.
Silicon Valley Bank had uninsured deposits around 90%; Bank of America and Goldman Sachs, two far larger and more stable banks, both had uninsured deposits around 33%.
First Republic, another regional bank seen as facing the same kinds of risks as SVB, had fewer uninsured deposits at 68%, according to a Business Insider analysis.
And the Fed appeared to miss the extent of unrealized losses SVB was carrying on its books due to its heavy investment in securities that lost value once interest rates started to rise. While those investments appeared on paper to give SVB more value, they cost the bank dearly when bank executives went to sell the investments in a desperate effort to have more cash in hand.
Critics say San Francisco Fed officials should have weighed the risks posed by rising interest rates at the largest bank under its jurisdiction.
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The Fed has said it will conduct a review of how its own process broke down with regard to SVB.
Cruz, the top Republican on the Senate Commerce Committee, has also demanded answers from the San Francisco Fed, including whether SVB conducted regular stress tests and whether the Fed officials enforced liquidity requirements on the bank.
