Former FDIC Chair on Bank Collapses, the Federal Reserve and “Potential Fragility” in the Financial System


March 16, 2023

Sheila Bair served as the chair of the Federal Deposit Insurance Corporation (FDIC) from 2006 to 2011. Bair spoke to FRONTLINE producer James Jacoby on March 13th, 2023, for the documentary Age of Easy Money, just days after news broke about the collapse of Silicon Valley Bank — the biggest bank failure in the U.S. since the 2008 financial crisis.

In the interview below, Bair talked to FRONTLINE about federal regulators’ determination that the two bank collapses qualified as “systemic risk exceptions,” which led to the government’s decision to step in to guarantee uninsured deposits at the banks. Bair described the actions taken by the Federal Reserve, Department of the Treasury and Federal Deposit Insurance Corporation as a “bailout,” a label that the White House has disputed. She also spoke about the role she thinks the Federal Reserve’s monetary policy played in the current climate of economic uncertainty.

Bair is a founding chair of the Systemic Risk Council, a non-partisan organization of former government officials and financial and legal experts that advocates for financial stability, and a founding director of The Volcker Alliance, a nonprofit which was established by former Federal Reserve Board Chair Paul Volcker to promote higher standards in government.

This interview has been edited for clarity and length.

How surprised are you by what’s been happening?

Well, I’m very surprised the regulators would make a systemic risk determination for a $200 billion institution that’s like, what 0.9% of a $23 trillion banking industry? They decided to just bail out all the uninsured depositors, which are very wealthy Silicon Valley venture capital types and the companies that they fund. That did surprise me. And if they felt that there was widespread run risk — that throughout the system we were going to have runs on uninsured deposits — then I can see how that might justify a systemic risk determination, which is an extraordinary determination. It requires a two-thirds vote by the FDIC, by the Fed (Federal Reserve). The secretary of the Treasury has to approve; the president has to approve.

So if they thought there were going to be widespread bank runs, then I could understand intervening, but then wouldn’t you think that they would want to provide a guarantee for all uninsured deposits, because now you’ve got a couple banks that they’ve said, “We’re going to bail out those uninsured.” So what about everybody else? There are other banks that are having pressure. And I do worry about community banks, in particular, when for these larger institutions, $100 billion, $200 billion, that’s not huge. But if you’re a $1 billion community bank, it’s a big difference. And what happens to them if the market starts assuming anybody, say, over $100 billion is going to have their uninsured deposits protected? Then that money is going to start going out of the community banks into those institutions that are viewed as having favored status. So these one-off bailouts that are particularly just for a couple of institutions create a lot of distortions and competitive disadvantages for others, which is why I really don’t like them.

How extraordinary are the measures that they’ve taken?

So it’s extraordinary that they’re singling out just a couple of midsized institutions to basically bail out all their uninsured depositors. That is extraordinary. I have never seen that before. And the systemic risk exception itself, which is the legal mechanism they’re using, is very extraordinary to trigger. It is meant to be used very rarely when things are really dire. And again, liquidity fears at a couple of midsize institutions — it’s surprising to me they would say that’s systemic. …

What happened here, with Silicon Valley Bank?

It’s a larger question. We’re seeing a potential fragility in the system related to monetary policy. When interest rates go up, the value of financial assets go down. That’s just the way it works. We’re all seeing that, especially with bonds. The old bonds, they have lower yields. The new bonds have higher yields. Those old bonds lose market value. Banks own a lot of those securities. Even if they’re government securities — which is the case here, they’re very safe from a credit quality perspective — they have lost a lot of market value, because you can get new bonds that have a much higher yield. So this just underscores the larger issue of having 14 years of very easy money and then trying to rapidly, within a year, a 6,000% increase in short term rates to try to contain inflation, which got ahead of the Fed.

But you can’t do this overnight. There’s only so much the system can absorb. There’s only so much the economy can absorb. There’s only so much the financial system can absorb.

And it’s important for people to understand the last crises we’ve had — look over the last 60 years, the S&L crisis, the banking crisis, the subprime crisis — those were all catalyzed by rising interest rates. Not to say that banks didn’t do a lot of stupid things and that’s not to excuse them for doing stupid things. But some of that was facilitated by easy money. And then when monetary conditions got tight, the system couldn’t absorb it. We may be seeing that dynamic going on now. I hope not.

But there’s been a lot of talk about how safe the system is now, and Dodd-Frank fixed everything and no more bailouts. We’re seeing now that we didn’t end bailouts, obviously. But it’s going to make me wonder: if they think just a couple of these small institutions have to be bailed out, how resilient is the system, really?

If we can’t impose losses on uninsured depositors at two institutions without worrying about a broader fallout in the system, that is not a stable system. That is not a resilient system. …

If we can go back to one thing you said, which is that there’s only so much the system can absorb?

There’s only so much the system can absorb in terms of undoing all the damage that was caused by this 14 years of easy money. It can absorb these dramatic increases in interest rates only so quickly. This is making credit conditions much tighter. Those who borrow to sustain themselves, it’s making it a lot more expensive for them to borrow to continue to fund themselves.

And it’s dramatically impacting the value of the old bonds, the old securities that banks hold, again, because they yield a much lower rate than the new bonds, so the market value is a lot less. If you can hold those to maturity, that’s not a problem, you can just redeem them at their par value. But sometimes you can’t. If you have a deposit run, if you have a lot of deposit withdrawals, you have to sell them and then you have to sell them at a loss. And another problem in our system is because banks do not have to recognize these market losses on their securities. If they keep them in something called hold-to-maturity, then the capital level is not adequately reflective of how much loss absorption they need. If in fact they can’t hold them to maturity and they do have to sell them in an emergency situation, they don’t have the capital to absorb the loss. And that’s exactly what happened with these two banks that just got their bailout.

Are you saying that the banks have lots of losses — unrealized losses — on their …

According to the FDIC, there’s about $620 billion, yes, of unrealized market losses. Now, again, if they can hold those to maturity they won’t have a loss. … And you know, the big banks here have better rules around when they have to mark to market their securities. But even they don’t have to mark them if they’re in what’s called a hold-to-maturity portfolio. …

When the president comes out and assures the country that the American banking system is safe and sound at the moment, what do you think?

I think I don’t honestly know. I think another negative about making the systemic risk determination for these two relatively small banks, frankly, is that it makes people like me wonder what is going on? Is our system really safe? …

Sheila, you’re the former head of the FDIC, and if you’re saying that you’re not even sure about the safety and soundness of the banking system, I’ve got to say that’s concerning.

I think there are a couple things they could do immediately. They could stress test the banks in a high interest rate scenario to make sure they can absorb market losses in the securities they had that they’ve not yet marked. If they’re really worried about uninsured deposit runs, then I think some type of program along the lines of what we had during the great financial crisis, where we temporarily guaranteed transaction accounts — those are accounts that are used for payroll and operating expenses — they could do something like that, and those uninsured deposits then would be stable. So there are a couple of things I think they could do in the near term.

But I do think we need to have a lot more candor from regulators about what exactly are they worried about to invoke this extraordinary procedure for a couple of relatively small banks. The communication has not been good. And until they do that, I think a lot of people are going to be scratching their heads and worrying and then it feeds on itself. Financial instability can be created just because people get scared. They get worried. They start taking their money out of the banks. …

We’ve heard [Federal Reserve Chair] Jerome Powell saying that the fight against inflation is far from over, signaling that there’ll be more rate hikes in the future. What should the Fed do?

Last December, I wrote an op-ed and I suggested that the Fed should hit pause. Rates have gone up. They started at .08% early in 2022, the first quarter of 2022. And they started to raise the short term rates. They’re about 4.5% now. That’s over 6,000% increase. Four and a half percent by itself doesn’t sound high by historical standards. But if you look at where we started — and for how many years rates were zero to negative — you can only do this so fast. And you know, I’m an inflation hawk. Esther George, who used to be the head of the Kansas City Fed, she’s an inflation hawk. But a lot of us have said, “Hold on, stop, you’re going too fast. You’ve got to make sure the economy and the financial system can absorb this.” …

So we’ll see how this plays out, but maybe Silicon Valley Bank’s troubles will serve as a wake up call to the Fed that there are some fragilities here, hopefully just a pocket, maybe just a couple, but there are some fragilities here, they need to stop and assess before they keep tightening. Because again, I think the worst situation we get into is that really aggressive rate hikes cause a financial crisis, and they take rates back to zero again to bail out the financial sector. And then we’re just right back in it. After all this pain they’ve imposed on the real economy, the housing market, the labor market, it’ll be all for naught. So if I were the Fed, that’s what I would be worried about the most and working very, very hard to avoid.

So you’re in favor of the Fed pausing rate hikes?

I do think they should pause. I don’t think they should raise another 50 basis points. If they want to keep tightening instead of raising short term rates, they could sell some of their mortgage-backed securities. …

I really think they need to just hold off for a bit and have a full assessment of what’s going on in the economy and the financial system.

You are an inflation hawk, and inflation is still running way above their 2% target. So they seem to be in a bind here.

There are no good options here. And I think it would be far better to tolerate a little more inflation than it would be to just keep going full steam ahead and bring out a financial crisis and a deep recession. And financial crises, if it was just a matter of credit costs going up, the slowdown might be mild. But if you hit the financial sector, if there’s a financial crisis, that’s when you have these really profound, deep recessions when credit availability just stops. So they need to make sure that doesn’t happen. …

Do you see the failure of these banks and then the extraordinary measures the Fed has taken as a signal of the tide coming out on an era of easy money?

Yes, definitely. Definitely. When money’s easy and it’s cheap to borrow, leverage is great going up and it’s terrible going down. Absolutely. This is nothing new. These are lessons we should have learned. We keep repeating these cycles and seem to forget with every generation, but this is nothing new. Credit conditions get tight, the tide goes out and you see who’s swimming naked. I think Warren Buffett was the one that coined that phrase, but it’s a good one. …

If you can explain, what is the Fed doing right now? What emergency measures have been enacted here?

So they’ve announced a new lending facility. … You can borrow from it for up to a year with government-backed securities or mortgage-backed securities, so government-backed bonds and MBS, you can pledge those without a discount, without a haircut. Usually when the Fed takes collateral, they will impose some haircut, so they’ll only lend you 90% or 80% of what your collateral is. But this will be without a haircut, so they’ll provide 100% advances, and it’s a pretty good interest rate, and the loan can last for up to a year.

This will be a way for these banks that have a lot of securities that have lost value, that they have a mark, to put them at the Fed, actually get cash for them, and let them sit at the Fed and get the cash that they might need for deposit redemptions or whatever. So, it’s another bailout. Yeah, I mean, you know, define bailout. But it’s another special intervention to help banks. … I think if they’re really worried about uninsured deposit withdrawals, this will help a little bit. It won’t solve the problem, but it will help some.

There’s some controversy using the word bailout. But you’re saying it’s a bailout?

I think it’s a bailout when you get a special break. Banks are in the safety net, so they have special breaks already. They have deposit insurance, they have access to the Fed’s liquidity facilities, the Fed keeps creating new ones. … I think when they get even more breaks on top of those that are already provided for and recognized in law, yeah, I call it a bailout. Call it an intervention if you want, if it’s less pejorative, but these are special things they get that other sectors of the economy don’t get.

And we should be trying to regulate the system and oversee this system in a way that tells banks, “This is all you get. You need to manage your risk. You need to manage your interest rate risk. You need to look at the stability of your deposit base. You need to mark losses down from your capital to make sure your capital adequately reflects your true resiliency.” That’s the kind of thing we should be communicating to banks because these government safety nets create a lot of moral hazard. …

Reflecting on this era, this age of easy money, is this part of the reckoning with what’s happened over the past 14 years?

… If we hadn’t been driving our economy for 14 years with easy money and then trying to really quickly undo that, no, we wouldn’t be having these problems now. Absolutely not.

Again, that doesn’t excuse the bank management for not hedging their interest rate risk. They mismanaged too. Recognizing that government policies are partly responsible, I think it’s also important to recognize that bank managers also have responsibility for their institutions. Whatever the monetary policy environment is that’s been created, whatever those risks are, it’s their job to manage around them. But yeah, I mean, these risks were created by monetary policy. There’s no doubt about it. …

You hear about these bank failures. You hear about these extraordinary measures. For people watching this, what do they need to understand about the context here in terms of the dangers in the system? As a former top banking regulator, how concerned are you about this spiraling into something like a financial crisis?

At this point, I still think these risks can be managed. I think that Silicon Valley Bank in particular was unusual, in that it had a lot of uninsured deposits. And it was a very concentrated group of depositors … Silicon Valley folks. And word spread very fast precipitating a bank run and that had a cascading effect on some other banks that had somewhat similar vulnerabilities though not as severe.

I would say, if you have your money in a traditional community bank or regional bank, one where you banked for a long time, that has lots of households and businesses that do business with them, have done business with them for a long time, most of their deposits were insured or with institutions that have loyalty and multiple relationships with them — that’s the vast majority of the regional banks and community banks in this country. Stay where you are, right? Don’t get scared. If you’re a household, make sure you’re under the insured deposit limits. That’s important, but if you are, the FDIC has a perfect record. … And again, I think most banks are okay. What we need to guard against is just contagion: otherwise healthy banks starting to lose deposits just because everybody gets scared.

What should the Fed do now?

So, for a long time, I’ve advocated that the Fed should be raising rates. Back in 2010, I thought they should start normalizing rates and not try to keep generating inflation through loose money. So that’s my history. But even I believe now, they need to hit pause. They’ve gone too far too fast. They need to hit pause and assess the impact on the financial system and the economy.

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