1 00:00:10,200 --> 00:00:14,200 Speaker 1: Hello, and welcome to another episode of the Odd Lots podcast. 2 00:00:14,280 --> 00:00:19,040 Speaker 1: I'm Joe Wisenthal and I'm Tracy Allow. So Tracy, we obviously, 3 00:00:19,280 --> 00:00:23,000 Speaker 1: I think have a sense of why Silicon Valley Bank failed. 4 00:00:23,040 --> 00:00:25,680 Speaker 1: We just published a really good episode with Dan Davis, 5 00:00:25,840 --> 00:00:28,520 Speaker 1: like sort of like talking about where things went wrong 6 00:00:28,840 --> 00:00:32,200 Speaker 1: on the sort of deposit side and failing to balance 7 00:00:32,280 --> 00:00:35,800 Speaker 1: assets and liabilities and the issues of strengths and weaknesses 8 00:00:35,800 --> 00:00:38,519 Speaker 1: of the business model. But then the other question, there 9 00:00:38,520 --> 00:00:42,320 Speaker 1: are many, many more questions beyond just like why they failed. Yes, 10 00:00:42,440 --> 00:00:44,920 Speaker 1: I mean some of the big ones that are emerging 11 00:00:45,120 --> 00:00:49,440 Speaker 1: are where were the regulators right it? You know, people 12 00:00:49,520 --> 00:00:54,040 Speaker 1: were already analyzing spb's balance sheet, you know, certainly the 13 00:00:54,080 --> 00:00:57,279 Speaker 1: week before it collapsed and for some time before that, 14 00:00:57,320 --> 00:01:00,600 Speaker 1: and you could see these vulnerabilities when it comes to 15 00:01:00,680 --> 00:01:03,640 Speaker 1: duration exposure. And again that's something we talked about with 16 00:01:03,680 --> 00:01:06,960 Speaker 1: Dan Davies. And then the other thing I guess just 17 00:01:07,400 --> 00:01:12,200 Speaker 1: in general is it's not like bank failures are that 18 00:01:12,720 --> 00:01:15,960 Speaker 1: unusual over the course of history. So this is the 19 00:01:16,000 --> 00:01:18,840 Speaker 1: first big one, I guess since the two thousand and 20 00:01:18,840 --> 00:01:22,119 Speaker 1: eight financial crisis. And so it's obviously garnering a lot 21 00:01:22,120 --> 00:01:26,840 Speaker 1: of attention, But we do have bank failures throughout history 22 00:01:27,000 --> 00:01:29,319 Speaker 1: from time to time, and it kind of begs the 23 00:01:29,400 --> 00:01:32,640 Speaker 1: question of, well, if we're going to keep having them 24 00:01:33,120 --> 00:01:36,319 Speaker 1: in different ways, and if the government or the Federal 25 00:01:36,360 --> 00:01:39,320 Speaker 1: Reserve are going to keep coming in and rescuing them 26 00:01:39,400 --> 00:01:43,120 Speaker 1: in various ways, should we maybe do something to the 27 00:01:43,240 --> 00:01:47,040 Speaker 1: system to make it different. What were the failures and 28 00:01:47,120 --> 00:01:49,240 Speaker 1: can we at least you know, we're always going to 29 00:01:49,280 --> 00:01:52,680 Speaker 1: be fighting the last War cliche obviously, but what does 30 00:01:52,720 --> 00:01:55,400 Speaker 1: it tell us about weaknesses in the system? And there 31 00:01:55,440 --> 00:01:56,920 Speaker 1: may be things that we could do, And of course 32 00:01:56,960 --> 00:01:59,240 Speaker 1: there's things that people are talking about on the sort 33 00:01:59,280 --> 00:02:03,680 Speaker 1: of written law side, which is like, Okay, maybe we 34 00:02:03,720 --> 00:02:08,560 Speaker 1: need more banks to have greater liquidity, ability to meet withdrawals, etc. 35 00:02:08,840 --> 00:02:12,040 Speaker 1: I think some of the smaller, more regional banks don't 36 00:02:12,080 --> 00:02:15,000 Speaker 1: have a stringent requirements on that front as the really 37 00:02:15,080 --> 00:02:18,120 Speaker 1: large banks. And then people are talking about supervision, and 38 00:02:18,600 --> 00:02:22,120 Speaker 1: I don't think supervision gets as much attention as the 39 00:02:22,160 --> 00:02:25,080 Speaker 1: sort of written laws, but it's essentially, well, why did 40 00:02:25,200 --> 00:02:29,240 Speaker 1: the supervisors the bank regulators allow the bank to create 41 00:02:29,280 --> 00:02:31,960 Speaker 1: this confluence of risks, this big like sort of very 42 00:02:32,000 --> 00:02:36,280 Speaker 1: specific mismatch between the nature of its assets, the nature 43 00:02:36,320 --> 00:02:40,880 Speaker 1: of its deposit base that allowed it to unravel really quickly. Absolutely, 44 00:02:40,919 --> 00:02:44,359 Speaker 1: and then of course, with the FED announcing this new facility, 45 00:02:44,720 --> 00:02:47,560 Speaker 1: which is quite a dramatic one, you have a question of, Okay, 46 00:02:47,639 --> 00:02:51,040 Speaker 1: if we're just going to guarantee all the US bank 47 00:02:51,120 --> 00:02:55,040 Speaker 1: deposits out there, then should we maybe make a more 48 00:02:55,160 --> 00:02:59,880 Speaker 1: fundamental change to the banking industry itself? Right? And actually, 49 00:03:00,320 --> 00:03:03,560 Speaker 1: Matt Klein over at the Overshoot, I think he tweeted this, 50 00:03:03,760 --> 00:03:06,480 Speaker 1: but he had that great first line in his most 51 00:03:06,480 --> 00:03:11,919 Speaker 1: recent newsletter about how basically banks are these private investment 52 00:03:12,000 --> 00:03:16,560 Speaker 1: funds that are grafted on top of critical infrastructure, and 53 00:03:16,600 --> 00:03:20,639 Speaker 1: that structure is designed to extract subsidies from the rest 54 00:03:20,680 --> 00:03:25,799 Speaker 1: of society by basically threatening people with banking crises whenever 55 00:03:25,840 --> 00:03:27,960 Speaker 1: one of them is allowed to fail. And we saw 56 00:03:28,000 --> 00:03:31,520 Speaker 1: that last week, right, We saw especially a bunch of 57 00:03:31,600 --> 00:03:34,440 Speaker 1: vcs coming out and saying, if you don't rescue all 58 00:03:34,440 --> 00:03:38,160 Speaker 1: the SVB depositors right now, this is going to happen 59 00:03:38,160 --> 00:03:40,360 Speaker 1: to all the banks. And so you kick off that, 60 00:03:40,480 --> 00:03:45,720 Speaker 1: you know, privatization of profits versus publicization of loss's argument 61 00:03:45,880 --> 00:03:48,520 Speaker 1: over and over and over again. Well, that's been like 62 00:03:48,720 --> 00:03:52,840 Speaker 1: really clear in this particular episode, like there's something about 63 00:03:52,840 --> 00:03:56,080 Speaker 1: this story really raises some like uncomfortable days because it's 64 00:03:56,080 --> 00:04:00,400 Speaker 1: not coming in like a wholesale financial collapse that's related 65 00:04:00,440 --> 00:04:02,760 Speaker 1: to the collapse of the economy like in two thousand 66 00:04:02,760 --> 00:04:04,480 Speaker 1: and eight or two thousand nine. It's like it's this 67 00:04:04,640 --> 00:04:08,320 Speaker 1: very specific industry that sort of got it in trouble. Anyway, 68 00:04:08,680 --> 00:04:11,520 Speaker 1: we could go on and on, but I'm excited. We 69 00:04:11,600 --> 00:04:14,160 Speaker 1: do have the perfect guest for us to talk about 70 00:04:14,440 --> 00:04:18,039 Speaker 1: the role of regulator, the role of regulatory failure, the 71 00:04:18,120 --> 00:04:20,159 Speaker 1: role of the FED in all of this in the 72 00:04:20,240 --> 00:04:22,200 Speaker 1: history of banking, and how we got here. We're gonna 73 00:04:22,200 --> 00:04:25,200 Speaker 1: be speaking to a Levmanon Here's a professor at Columbia 74 00:04:25,279 --> 00:04:27,880 Speaker 1: Law School written a lot about the FED and regulation. 75 00:04:28,000 --> 00:04:30,360 Speaker 1: So Lev, thank you so much for joining us, Thank 76 00:04:30,400 --> 00:04:32,359 Speaker 1: you so much for having me. So just you know, 77 00:04:32,880 --> 00:04:36,680 Speaker 1: very top line view. You know, what would you say 78 00:04:36,800 --> 00:04:47,160 Speaker 1: was the main regulatory failure with SIV with SVB, So yeah, yeah, 79 00:04:47,200 --> 00:04:50,640 Speaker 1: we can distinguish between maybe regulation bright line rules yeah, 80 00:04:50,680 --> 00:04:53,840 Speaker 1: put down in advance, and sort of supervision, yes, which 81 00:04:53,920 --> 00:04:58,400 Speaker 1: is discretionary safety and soundness oversight by by examiners and 82 00:04:59,480 --> 00:05:03,720 Speaker 1: federal federal regulators, federal officials, and both the sort of 83 00:05:03,720 --> 00:05:06,680 Speaker 1: bright line rules and the sort of supervision failed here. Yeah, 84 00:05:06,720 --> 00:05:08,880 Speaker 1: there was an overreliance on the bright line rules and 85 00:05:08,920 --> 00:05:11,600 Speaker 1: a failure to do the discretionary oversight, the safety and 86 00:05:11,640 --> 00:05:14,760 Speaker 1: soundness oversight effectively. So on the bright line rules side, 87 00:05:15,839 --> 00:05:19,480 Speaker 1: SVB figured out a way to take additional risk without 88 00:05:19,520 --> 00:05:24,839 Speaker 1: holding additional capital. Because of what's called the risk capital rules, 89 00:05:25,040 --> 00:05:28,000 Speaker 1: treasury securities are risk weighted zero. That means that a 90 00:05:28,040 --> 00:05:32,599 Speaker 1: bank has to hold zero equity against their treasury positions. 91 00:05:32,800 --> 00:05:36,240 Speaker 1: And so SEP was able to go and buy a 92 00:05:36,279 --> 00:05:38,320 Speaker 1: lot of long dated treasuries and actually build up quite 93 00:05:38,320 --> 00:05:40,440 Speaker 1: a bit of interest rate risk without that being reflected 94 00:05:40,560 --> 00:05:43,440 Speaker 1: in the capital that was required of them under the 95 00:05:43,760 --> 00:05:46,880 Speaker 1: under the bright line rules, under the under the regulatory framework. 96 00:05:46,960 --> 00:05:50,760 Speaker 1: Now we have a whole supervisory framework that's designed to 97 00:05:50,880 --> 00:05:54,520 Speaker 1: deal with these sorts of holes in the rules. Everybody 98 00:05:54,560 --> 00:05:58,080 Speaker 1: knows that the rules are insufficiently precise, and in fact, 99 00:05:58,320 --> 00:06:00,720 Speaker 1: we didn't even have the rules until the nineteen eighties 100 00:06:00,880 --> 00:06:04,200 Speaker 1: in meaningful sense. We used to just do discretionary safety 101 00:06:04,200 --> 00:06:06,240 Speaker 1: and soundness oversight. And so the real question here in 102 00:06:06,279 --> 00:06:09,000 Speaker 1: some sense is how come the supervisors didn't pick up 103 00:06:09,000 --> 00:06:11,880 Speaker 1: on the fact that SVB had gamed the rules to 104 00:06:12,440 --> 00:06:15,120 Speaker 1: take on a lot of interest rate risk without holding 105 00:06:15,120 --> 00:06:18,040 Speaker 1: an adequate amount of capital against it. It's a pretty 106 00:06:18,080 --> 00:06:22,200 Speaker 1: obvious maneuver. It's not nearly as complex as some of 107 00:06:22,240 --> 00:06:27,039 Speaker 1: the maneuvers the gaming and it's not novel. It's not novel. Yeah, 108 00:06:27,080 --> 00:06:29,520 Speaker 1: this is an old move. It's not like they camp 109 00:06:29,520 --> 00:06:35,279 Speaker 1: with something new. You would think any seasoned supervisor looking 110 00:06:35,320 --> 00:06:38,480 Speaker 1: at the balance sheet could pick up on this pretty quickly. 111 00:06:38,839 --> 00:06:41,960 Speaker 1: So so what happened, I think is exactly the right 112 00:06:42,040 --> 00:06:46,280 Speaker 1: question to be asking, and I think the answer requires 113 00:06:46,960 --> 00:06:50,720 Speaker 1: maybe And this might just be my approach to these 114 00:06:50,760 --> 00:06:55,200 Speaker 1: issues twenty thirty years worth of history to understand, because basically, 115 00:06:55,720 --> 00:07:00,840 Speaker 1: I think contemporary supervision is broken in some sense and 116 00:07:00,960 --> 00:07:04,680 Speaker 1: this is a manifestation of that. Okay, um, well, I'm 117 00:07:04,839 --> 00:07:07,839 Speaker 1: I'm just gonna go ahead and buy and say, please, 118 00:07:07,960 --> 00:07:10,440 Speaker 1: please give us the you know, thirty or forty years 119 00:07:10,480 --> 00:07:13,200 Speaker 1: of banking history building up to those. Yeah, So let me. 120 00:07:13,360 --> 00:07:15,120 Speaker 1: I'll say why I think it's broken, and then I'll 121 00:07:15,160 --> 00:07:17,000 Speaker 1: tell you how we got sure, how it got so broken. 122 00:07:17,520 --> 00:07:22,800 Speaker 1: So it's broken because outside of the stress testing framework, 123 00:07:22,840 --> 00:07:27,040 Speaker 1: which I think we should definitely talk more about. Supervisors 124 00:07:27,680 --> 00:07:34,000 Speaker 1: primarily now focus on process and procedures. Our insight into 125 00:07:34,000 --> 00:07:37,400 Speaker 1: what actually goes on in supervision is very limited, and 126 00:07:37,640 --> 00:07:44,080 Speaker 1: that's because supervisory materials are all confidential and can't be 127 00:07:44,120 --> 00:07:47,840 Speaker 1: disclosed by the bank and aren't disclosed by by the regulators, 128 00:07:48,120 --> 00:07:51,360 Speaker 1: and often never made public. So there's a lot of 129 00:07:51,400 --> 00:07:54,720 Speaker 1: opacity into into what supervisors are actually doing. But it's 130 00:07:54,720 --> 00:07:57,440 Speaker 1: it's fairly obvious, and I'll go through a few examples 131 00:07:57,640 --> 00:08:01,240 Speaker 1: that what supervisors today tend to focus on is the process, 132 00:08:01,320 --> 00:08:04,080 Speaker 1: and so they will look to see does the bank 133 00:08:04,200 --> 00:08:08,160 Speaker 1: have a good risk management process, does it have the 134 00:08:08,280 --> 00:08:11,920 Speaker 1: right board committees, does it have the right management committees 135 00:08:12,200 --> 00:08:16,760 Speaker 1: looking at its risk decisions? Are there three lines of defense? 136 00:08:17,120 --> 00:08:22,120 Speaker 1: And if the supervisors see the requisite process, they are 137 00:08:22,200 --> 00:08:26,120 Speaker 1: very reluctant to make judgments about the actual decisions that 138 00:08:26,160 --> 00:08:29,000 Speaker 1: are coming out of that process, and so they don't 139 00:08:29,040 --> 00:08:33,160 Speaker 1: want to impose. They are reluctant to impose their own view. Oh, 140 00:08:33,280 --> 00:08:37,240 Speaker 1: that is excessive risk, that is too much interest rate 141 00:08:37,360 --> 00:08:41,120 Speaker 1: risk as opposed to we like the procedures that you're 142 00:08:41,160 --> 00:08:43,120 Speaker 1: set up to manage interest rate risk. Just to be clear, 143 00:08:43,200 --> 00:08:47,840 Speaker 1: though they certainly could under current law, they're allowed to 144 00:08:48,040 --> 00:08:51,280 Speaker 1: say they're supposed to. Arguably, that's what current law is about, 145 00:08:51,320 --> 00:08:55,920 Speaker 1: and the process approach being grafted onto this is an innovation. 146 00:08:56,240 --> 00:08:59,559 Speaker 1: The purpose of safety and soundness law is really very 147 00:08:59,640 --> 00:09:04,559 Speaker 1: much to address risk, and the process angle is born 148 00:09:04,640 --> 00:09:07,199 Speaker 1: of the view that the best way to do that, 149 00:09:07,559 --> 00:09:10,079 Speaker 1: the most efficient way to do that across a massive 150 00:09:10,120 --> 00:09:12,760 Speaker 1: banking system, is just to make sure that the procedures 151 00:09:12,760 --> 00:09:15,199 Speaker 1: are good. If the procedures are good, the problem will 152 00:09:15,240 --> 00:09:17,760 Speaker 1: sort of take care of itself. So as long as 153 00:09:17,760 --> 00:09:22,959 Speaker 1: you see the bank kind of debating its risk exposure internally, 154 00:09:23,240 --> 00:09:26,000 Speaker 1: which you know seems to have been the case at SVB, 155 00:09:26,160 --> 00:09:28,319 Speaker 1: and I know I brought this up in the previous episode, 156 00:09:28,400 --> 00:09:31,000 Speaker 1: but you know, there were some internal documents which I've 157 00:09:31,000 --> 00:09:34,640 Speaker 1: seen where they're talking about interest rate exposure and they're 158 00:09:34,679 --> 00:09:37,760 Speaker 1: debating it, you know, with their asset liability committee and 159 00:09:37,840 --> 00:09:42,000 Speaker 1: presumably with their risk specialists. But if they come to 160 00:09:42,040 --> 00:09:46,040 Speaker 1: the conclusion that actually we're okay, the regulators are just 161 00:09:46,080 --> 00:09:47,800 Speaker 1: going to look at that and take out on face 162 00:09:47,880 --> 00:09:50,640 Speaker 1: value because the process is there, and they assume that, 163 00:09:50,760 --> 00:09:52,800 Speaker 1: you know, the bank is kind of doing what it 164 00:09:52,840 --> 00:09:55,080 Speaker 1: should be doing. Yeah, exactly, if you're not one of 165 00:09:55,120 --> 00:09:58,640 Speaker 1: the big gesips, the global systemically important banks, and you're 166 00:09:58,679 --> 00:10:02,160 Speaker 1: not in the stress testing route game, I think that 167 00:10:02,360 --> 00:10:04,679 Speaker 1: is what tends to happen. It doesn't have to happen, 168 00:10:04,720 --> 00:10:07,240 Speaker 1: As Joe said, they're certainly going to be examples where 169 00:10:07,240 --> 00:10:11,880 Speaker 1: supervisors exercise them independent judgment. But there is a tendency 170 00:10:12,080 --> 00:10:16,000 Speaker 1: still in the supervisory process to look at compliance with 171 00:10:16,040 --> 00:10:19,520 Speaker 1: the rules, to check for processes, and if you see 172 00:10:19,520 --> 00:10:22,280 Speaker 1: compliance with the rules and you see processes in place, 173 00:10:22,720 --> 00:10:26,719 Speaker 1: to give the bank a clean bill of health, as 174 00:10:26,720 --> 00:10:28,880 Speaker 1: it were. And so the question is how did we 175 00:10:28,920 --> 00:10:31,720 Speaker 1: get to this place, because actually this was an innovation. 176 00:10:32,200 --> 00:10:35,640 Speaker 1: At one point, we used to do safety and soundness 177 00:10:35,679 --> 00:10:41,079 Speaker 1: substantive supervision without much bright line rules at all. Capital 178 00:10:41,160 --> 00:10:45,280 Speaker 1: rules date only to the mid eighties, and this focus 179 00:10:45,400 --> 00:10:49,440 Speaker 1: on process is really an innovation from the nineteen nineties. 180 00:10:49,760 --> 00:10:52,439 Speaker 1: And so it's part of what I think is the 181 00:10:52,520 --> 00:10:56,079 Speaker 1: toxic brew of regulatory supervisory policies that brought us the 182 00:10:56,120 --> 00:10:59,160 Speaker 1: two thousand and eight crisis. And we still sort of 183 00:10:59,200 --> 00:11:05,160 Speaker 1: have supervision guided by this nineties approach, and I think 184 00:11:05,160 --> 00:11:09,680 Speaker 1: the SVB failure is one of several really significant examples 185 00:11:09,800 --> 00:11:14,160 Speaker 1: of post two thousand and eight supervisory failure where the 186 00:11:14,240 --> 00:11:20,600 Speaker 1: supervisors are still focused on process and too unwilling to 187 00:11:20,640 --> 00:11:24,600 Speaker 1: make substantive judgments, reflecting the sort of approaches that were 188 00:11:24,600 --> 00:11:27,880 Speaker 1: developed by primarily the greenspan fed but also the Ludwig 189 00:11:27,880 --> 00:11:31,520 Speaker 1: occ in the nineties. Can you explain what it was 190 00:11:31,720 --> 00:11:34,440 Speaker 1: or what happened in the nineties, was a directive that 191 00:11:34,640 --> 00:11:38,120 Speaker 1: came down what caused this philosophical shift or just maybe 192 00:11:38,200 --> 00:11:40,880 Speaker 1: mechanical shift in the approach to supervisory Let me start 193 00:11:40,880 --> 00:11:43,240 Speaker 1: with the eighties, actually just with the birth of the 194 00:11:43,320 --> 00:11:47,240 Speaker 1: capital rules. So what's the baseline. So supervision, safety and 195 00:11:47,280 --> 00:11:50,280 Speaker 1: signed supervision dates all the way back to the nineteenth century, 196 00:11:50,520 --> 00:11:53,480 Speaker 1: and so the way that the government's managed the incentive 197 00:11:53,520 --> 00:11:58,040 Speaker 1: misalignment between bank shareholders and managers and bank depositors and 198 00:11:58,080 --> 00:12:03,920 Speaker 1: the public has been through discretionary supervisory oversight safety and 199 00:12:03,960 --> 00:12:07,800 Speaker 1: soundness oversight. That's been the bywords of federal law since 200 00:12:07,840 --> 00:12:11,760 Speaker 1: the nineteen thirties. And the way that supervisors would do 201 00:12:11,800 --> 00:12:14,280 Speaker 1: their job is they would make judgments about the riskiness 202 00:12:14,280 --> 00:12:18,520 Speaker 1: of banks assets and the riskiness of banks leverage and 203 00:12:18,640 --> 00:12:22,680 Speaker 1: the amount of capital and they would write letters, and 204 00:12:23,760 --> 00:12:27,240 Speaker 1: they would job bone and they would take enforcement actions. 205 00:12:27,520 --> 00:12:29,640 Speaker 1: They would issue cease and desist orders if they thought 206 00:12:29,640 --> 00:12:31,520 Speaker 1: banks were under capitalized, or like in the case of 207 00:12:31,559 --> 00:12:35,120 Speaker 1: Silicon Valley Bank, they would tell Silicon Valley Bank that 208 00:12:35,160 --> 00:12:37,920 Speaker 1: it had to shorten its duration risk. That's what supervisors 209 00:12:37,920 --> 00:12:41,920 Speaker 1: would do. In the eighties. You have a moment that's 210 00:12:41,960 --> 00:12:45,520 Speaker 1: quite similar to today in that the banking system business 211 00:12:45,520 --> 00:12:48,720 Speaker 1: model comes under a lot of pressure for macroeconomic reasons. 212 00:12:49,000 --> 00:12:51,640 Speaker 1: Inflation goes up and then interest rates go way up 213 00:12:51,640 --> 00:12:54,680 Speaker 1: because of the Vulker shock. This causes the yield curve 214 00:12:55,040 --> 00:12:57,839 Speaker 1: to change in a way that's very ugly for a bank. 215 00:12:57,880 --> 00:13:00,640 Speaker 1: Because a bank's business is a positive net interest margin. 216 00:13:00,679 --> 00:13:02,320 Speaker 1: You earn more on your assets than you pay on 217 00:13:02,360 --> 00:13:07,520 Speaker 1: your liabilities, and your liabilities are short duration, and so 218 00:13:07,800 --> 00:13:10,640 Speaker 1: if interest rates go way up quickly, you can end 219 00:13:10,720 --> 00:13:13,200 Speaker 1: up in a position where you are paying more on 220 00:13:13,200 --> 00:13:15,360 Speaker 1: your liabilities than you are in your assets, which is 221 00:13:15,720 --> 00:13:17,559 Speaker 1: which is going to run right through your capital. That's 222 00:13:17,600 --> 00:13:20,480 Speaker 1: not a profitable business model. This happened in the eighties 223 00:13:20,520 --> 00:13:25,160 Speaker 1: and a lot of banks became undercapitalized and supervisors were 224 00:13:25,160 --> 00:13:29,400 Speaker 1: swamped with cease and desist orders and supervisory directives to 225 00:13:29,480 --> 00:13:32,000 Speaker 1: banks all over the place to raise more capital. Some 226 00:13:32,080 --> 00:13:35,400 Speaker 1: banks sued. One bank was able to prevail in the 227 00:13:35,440 --> 00:13:39,480 Speaker 1: fifth Circuit, and Congress intervened and pass a new law 228 00:13:39,760 --> 00:13:45,200 Speaker 1: authorizing forward looking, ex anti brightline capital rules for the 229 00:13:45,280 --> 00:13:49,920 Speaker 1: first time and saying that capital judgments of supervisors can't 230 00:13:49,960 --> 00:13:52,760 Speaker 1: be second guests by courts. And so, in a sort 231 00:13:52,760 --> 00:13:55,599 Speaker 1: of accidental way, you have the birth of capital regulation. 232 00:13:56,000 --> 00:14:00,400 Speaker 1: The supervisors are overwhelmed and there are laws, suits, and 233 00:14:00,440 --> 00:14:03,199 Speaker 1: you have Congress saying, actually, just write a rule that 234 00:14:03,800 --> 00:14:06,120 Speaker 1: the banks all have to comply with so that you 235 00:14:06,160 --> 00:14:08,600 Speaker 1: don't have to get into litigation over whether this bank 236 00:14:08,679 --> 00:14:12,160 Speaker 1: or that bank is undercapitalized. Fast forward a few years. 237 00:14:12,480 --> 00:14:15,600 Speaker 1: You get these rules, and you get you get Basel one, 238 00:14:16,000 --> 00:14:19,480 Speaker 1: you get an effort to align these rules internationally, and 239 00:14:19,600 --> 00:14:23,480 Speaker 1: you get Alan Greenspan as fed share. Going into the nineties, 240 00:14:23,520 --> 00:14:26,440 Speaker 1: the banking system starts to transform. You have the emergence 241 00:14:26,480 --> 00:14:32,600 Speaker 1: of large, complex banking institutions, and you have a lot 242 00:14:32,680 --> 00:14:36,440 Speaker 1: of soul searching in Washington and the Federal Reserve at 243 00:14:36,440 --> 00:14:40,160 Speaker 1: the occ about whether supervisors are really up to the 244 00:14:40,280 --> 00:14:46,200 Speaker 1: task of assessing the risk taking of these new large 245 00:14:46,280 --> 00:14:50,200 Speaker 1: complex financial institutions, these large complex banking organizations that we 246 00:14:50,320 --> 00:14:53,920 Speaker 1: never had in this country before through the traditional means, 247 00:14:54,240 --> 00:14:57,120 Speaker 1: or whether we should actually embrace these new rules that 248 00:14:57,160 --> 00:15:01,240 Speaker 1: have developed up and rely primarily on the rules and 249 00:15:01,440 --> 00:15:04,520 Speaker 1: shift supervisors to a task that they are that they're 250 00:15:04,560 --> 00:15:07,920 Speaker 1: more capable of performing. This is this is very self 251 00:15:07,960 --> 00:15:10,160 Speaker 1: conscious for the policymakers at the time. You can go 252 00:15:10,200 --> 00:15:12,560 Speaker 1: back and read some of Alan Greenspan's speeches about the 253 00:15:12,640 --> 00:15:15,640 Speaker 1: changes that he's making, and he basically thinks that, especially 254 00:15:15,640 --> 00:15:18,200 Speaker 1: for large banks, supervisors are just not going to be 255 00:15:18,240 --> 00:15:20,000 Speaker 1: able to do it the way they used to. What 256 00:15:20,120 --> 00:15:24,400 Speaker 1: we need are capital rules that require shareholders to have 257 00:15:24,520 --> 00:15:27,280 Speaker 1: enough skin in the game, and then the shareholders will 258 00:15:27,280 --> 00:15:30,720 Speaker 1: do it. The shareholders were supervised banks. And so Alan 259 00:15:30,760 --> 00:15:34,320 Speaker 1: Greenspan says, it's not about needing net less regulation. It's 260 00:15:34,360 --> 00:15:37,480 Speaker 1: about whether it should be public sector regulation or private 261 00:15:37,520 --> 00:15:40,520 Speaker 1: sector regulation, and we need to reorient the banking system 262 00:15:40,560 --> 00:15:43,960 Speaker 1: so that we have more private regulation. So that obviously 263 00:15:44,000 --> 00:15:48,280 Speaker 1: goes terribly wrong in two thousand and eight. It's not funny, 264 00:15:48,440 --> 00:15:51,640 Speaker 1: but this happens over and over and over it does, 265 00:15:51,680 --> 00:15:54,120 Speaker 1: and so by two thousand and eight you have supervisors 266 00:15:54,160 --> 00:15:58,280 Speaker 1: have more or less unilaterally disarmed. They have shifted to 267 00:15:58,800 --> 00:16:03,480 Speaker 1: enforcing the capital rules. The banking agencies are relying almost 268 00:16:03,640 --> 00:16:07,360 Speaker 1: entirely on the capital rules for making judgments about whether 269 00:16:07,400 --> 00:16:10,320 Speaker 1: a bank has adequate capital for the risks that it's taking, 270 00:16:10,880 --> 00:16:14,880 Speaker 1: and instead they are looking at processes. And there's a 271 00:16:14,920 --> 00:16:18,760 Speaker 1: real theory behind this. The theory is, in order for 272 00:16:19,400 --> 00:16:22,480 Speaker 1: market regulation to work, private regulation to work, there has 273 00:16:22,520 --> 00:16:24,720 Speaker 1: to be disclosure, and so a bank has to be 274 00:16:24,760 --> 00:16:27,720 Speaker 1: transparent about the risks that it's taken. A bank can't 275 00:16:27,720 --> 00:16:30,040 Speaker 1: be transparent about the risks that it's taking if it 276 00:16:30,040 --> 00:16:33,200 Speaker 1: doesn't have processes to monitor and disclose those risks. And 277 00:16:33,240 --> 00:16:36,080 Speaker 1: so the job for supervisors is to make sure banks 278 00:16:36,080 --> 00:16:39,520 Speaker 1: are monitoring their risks and disclosing them to the shareholders 279 00:16:39,560 --> 00:16:42,280 Speaker 1: so that the shareholders can discipline the banks. And by 280 00:16:42,280 --> 00:16:46,120 Speaker 1: two thousand and eight, supervisors have stopped bringing in cease 281 00:16:46,160 --> 00:16:48,760 Speaker 1: into sists. There's no safety and soundness enforcement actions against 282 00:16:48,800 --> 00:16:50,720 Speaker 1: any of the major banks, any of the major banks 283 00:16:50,720 --> 00:16:52,800 Speaker 1: that take TART for years running up to two thousand 284 00:16:52,840 --> 00:16:54,920 Speaker 1: and eight, because if they're in compliance with the rules 285 00:16:54,920 --> 00:16:58,280 Speaker 1: and they're disclosing to the market, the judgment is that 286 00:16:58,440 --> 00:17:02,240 Speaker 1: system is going to work. What goes wrong is that 287 00:17:03,000 --> 00:17:05,600 Speaker 1: bank shareholders have an incentive to take much more risk 288 00:17:05,640 --> 00:17:07,600 Speaker 1: than is in the interests of the government or depositors. 289 00:17:07,760 --> 00:17:10,800 Speaker 1: It's sort of basic economic stuff. The shareholders have an 290 00:17:10,840 --> 00:17:13,959 Speaker 1: incentive to extract wealth from the depositors and from the public. 291 00:17:14,200 --> 00:17:16,480 Speaker 1: And so the shareholders is gonna be much more comfortable 292 00:17:16,840 --> 00:17:19,240 Speaker 1: with a lot more risk than the public should be. 293 00:17:19,520 --> 00:17:21,199 Speaker 1: And so if you're going to rely on them to 294 00:17:21,320 --> 00:17:22,919 Speaker 1: monitor risk, cake and you're going to get a much 295 00:17:23,000 --> 00:17:26,520 Speaker 1: riskier bank. And this is Silicon Valley Bank story. I mean, 296 00:17:26,560 --> 00:17:29,040 Speaker 1: it's very much Silicon Valley Bank story. So you get 297 00:17:29,040 --> 00:17:33,200 Speaker 1: two thousand and eight, and you get a modification after 298 00:17:33,320 --> 00:17:36,119 Speaker 1: two thousand and eight, which is stress tests, but a 299 00:17:36,119 --> 00:17:40,439 Speaker 1: lot of ordinary day to day supervision continues to be 300 00:17:40,720 --> 00:17:44,520 Speaker 1: I think procedurally oriented. And you see this with the 301 00:17:44,600 --> 00:17:48,159 Speaker 1: London whale, and you see this with the fake account 302 00:17:48,240 --> 00:17:50,880 Speaker 1: scandal at Wells Fargo, both of which I think are 303 00:17:51,040 --> 00:17:55,399 Speaker 1: really important data points for outside observers to think about 304 00:17:55,600 --> 00:17:59,080 Speaker 1: how much did we fix supervision after two thousand and eight, 305 00:17:59,080 --> 00:18:01,679 Speaker 1: how much do we move away from the green span 306 00:18:01,800 --> 00:18:06,440 Speaker 1: nineties cocktail of bright line capital rules and procedural oversight 307 00:18:06,520 --> 00:18:10,560 Speaker 1: oriented to shareholder discipline. And I think the answer is 308 00:18:10,600 --> 00:18:13,360 Speaker 1: for the small banks that are not subject to stress tests, 309 00:18:13,520 --> 00:18:15,919 Speaker 1: and even for the big banks that are subject to 310 00:18:15,960 --> 00:18:20,160 Speaker 1: stress tests, outside of the stress testing regime, we still 311 00:18:20,200 --> 00:18:24,840 Speaker 1: have a lot of procedural oversight. So this is actually 312 00:18:24,840 --> 00:18:28,359 Speaker 1: a very quick mechanical question. But for a bank like 313 00:18:28,480 --> 00:18:33,000 Speaker 1: Silicon Valley Bank, is it as supervisor? Is it a 314 00:18:33,040 --> 00:18:34,919 Speaker 1: panel like hot Like what do you know? Do you 315 00:18:34,920 --> 00:18:37,119 Speaker 1: have a sense of like how many people? I mean, 316 00:18:37,160 --> 00:18:40,760 Speaker 1: because it's someone at the SFED presumably, Now assume there's 317 00:18:40,760 --> 00:18:43,800 Speaker 1: thousands of banks in California probably or at least hundreds, 318 00:18:43,840 --> 00:18:46,400 Speaker 1: Like what kind of just like human resources could even 319 00:18:46,480 --> 00:18:50,200 Speaker 1: go currently to paying attention to Silicon Valley a bank 320 00:18:50,240 --> 00:18:54,119 Speaker 1: like Silicon Valley Bank. So there are thousands of supervisors 321 00:18:54,119 --> 00:18:58,000 Speaker 1: across the federal system. Okay, they're split across three agencies, 322 00:18:58,040 --> 00:19:01,680 Speaker 1: the Federal Reserve, the Federal Deposit Insurance Corporation, and the 323 00:19:01,760 --> 00:19:07,280 Speaker 1: Controller of the Currency. They split up responsibility for supervising bank. 324 00:19:07,359 --> 00:19:11,120 Speaker 1: Silicon Valley Bank is a state chartered bank and it's 325 00:19:11,160 --> 00:19:13,719 Speaker 1: a member of the Federal Reserve system. So as a result, 326 00:19:13,760 --> 00:19:16,480 Speaker 1: as you say, it's the FED that would have responsibility 327 00:19:16,560 --> 00:19:20,520 Speaker 1: at the federal level for primary responsibility for supervision if 328 00:19:20,560 --> 00:19:23,560 Speaker 1: there's always overlap, So the FDIC has some ability to 329 00:19:24,160 --> 00:19:26,880 Speaker 1: come in because it's insuring the deposits obviously, and then 330 00:19:27,000 --> 00:19:30,040 Speaker 1: it's very involved now. But the day to day job 331 00:19:30,119 --> 00:19:35,440 Speaker 1: here is FED personnel in San Francisco who are really 332 00:19:35,480 --> 00:19:39,760 Speaker 1: actually exercising delegated authority of the Board of Governors, which 333 00:19:39,960 --> 00:19:45,800 Speaker 1: is the federal agency with the power to supervise member banks. 334 00:19:46,320 --> 00:19:48,560 Speaker 1: And the Reserve Bank of San Francisco is actually a 335 00:19:48,560 --> 00:19:53,000 Speaker 1: federal bank of Federal corporation, and so it's it's facilitated, 336 00:19:53,040 --> 00:19:56,520 Speaker 1: it's helping the board, and the board has supervisory staff 337 00:19:56,600 --> 00:19:59,880 Speaker 1: that are supposed to sort of oversee what is going 338 00:20:00,200 --> 00:20:02,520 Speaker 1: at the reserve banks. So is San Francisco doing a 339 00:20:02,560 --> 00:20:04,840 Speaker 1: good job, And obviously at the top of that is 340 00:20:04,880 --> 00:20:25,120 Speaker 1: Michael Barr, the Vice champer supervision. I'm going to have 341 00:20:25,160 --> 00:20:28,520 Speaker 1: some more questions on the San Francisco FED and the 342 00:20:28,720 --> 00:20:32,920 Speaker 1: fhlbs as well. But just going back to the evolution 343 00:20:33,480 --> 00:20:37,720 Speaker 1: of bank capital rules. So one of the big things 344 00:20:38,440 --> 00:20:41,040 Speaker 1: that happened, and you sort of outlined it in the 345 00:20:41,160 --> 00:20:43,000 Speaker 1: lead up to the two thousand and eight crisis, but 346 00:20:43,080 --> 00:20:46,639 Speaker 1: like it definitely hardened after two thousand and eight. Is 347 00:20:46,640 --> 00:20:52,080 Speaker 1: this idea that banks should be holding more bonds in general, 348 00:20:52,160 --> 00:20:55,439 Speaker 1: the safest bonds, so, you know, US treasuries in the 349 00:20:55,440 --> 00:20:59,679 Speaker 1: case of US banks, maybe agency mortgage backed securities that 350 00:20:59,760 --> 00:21:03,400 Speaker 1: are implicitly guaranteed by the US government, things like that 351 00:21:03,480 --> 00:21:08,719 Speaker 1: for their regulatory capital and liquidity buffers. And it seems 352 00:21:08,760 --> 00:21:11,800 Speaker 1: to me like that probably made a lot of sense 353 00:21:11,960 --> 00:21:15,440 Speaker 1: in the low inflation environment of two thousand and eight, 354 00:21:15,960 --> 00:21:18,879 Speaker 1: But now that you have the FED raising rates, you 355 00:21:18,920 --> 00:21:22,840 Speaker 1: have a lot of volatility. It seems like these bonds 356 00:21:23,160 --> 00:21:26,919 Speaker 1: might not be I don't think safe is the right word, 357 00:21:27,080 --> 00:21:31,720 Speaker 1: but not as unproblematic as maybe we imagine them to 358 00:21:31,920 --> 00:21:35,520 Speaker 1: once be. Could you talk a little bit more about 359 00:21:35,560 --> 00:21:39,200 Speaker 1: basically how we built the modern banking system on top 360 00:21:39,240 --> 00:21:41,760 Speaker 1: of a bedrock of bonds that are presumed to be 361 00:21:41,920 --> 00:21:45,760 Speaker 1: somewhat stable in price. So I think that you're right 362 00:21:45,840 --> 00:21:52,879 Speaker 1: to sort of highlight the appeal of treasuries and agencies 363 00:21:53,040 --> 00:21:57,240 Speaker 1: to both bankers and supervisors in the wake of two 364 00:21:57,640 --> 00:22:01,680 Speaker 1: and eight. Bank that loads up on treasury, that's, like, 365 00:22:01,760 --> 00:22:05,240 Speaker 1: you know, very wholesome. It seems very wholesome for a 366 00:22:05,280 --> 00:22:08,120 Speaker 1: bank to do right. The government likes that. The government 367 00:22:08,200 --> 00:22:10,480 Speaker 1: is like banks that buy treasuries since the Civil War, 368 00:22:10,920 --> 00:22:16,560 Speaker 1: and so it's gonna cut against even the most ambitious 369 00:22:16,600 --> 00:22:20,000 Speaker 1: and confident, you know, safety and soundness overseas. It's going 370 00:22:20,040 --> 00:22:23,320 Speaker 1: to cut against their their impulses to to sort of 371 00:22:23,359 --> 00:22:26,000 Speaker 1: fault a bank for loading up on treasuries. I mean, 372 00:22:26,119 --> 00:22:29,200 Speaker 1: that's that seems that seems that's a good thing, right, 373 00:22:29,400 --> 00:22:33,840 Speaker 1: And so it's it that helps to explain part of 374 00:22:33,840 --> 00:22:38,919 Speaker 1: what's happening here. And it's also true that banks do 375 00:22:39,040 --> 00:22:44,960 Speaker 1: have the ability to weather usually a fair amount of 376 00:22:45,440 --> 00:22:50,240 Speaker 1: interest rate losses on their assets. So many banks think 377 00:22:50,280 --> 00:22:56,920 Speaker 1: of themselves as structurally hedged against interest rate increases because 378 00:22:57,680 --> 00:23:02,040 Speaker 1: while their assets, if they have law assets like long 379 00:23:02,119 --> 00:23:04,960 Speaker 1: dated treasuries, that's those are going to lose value when 380 00:23:04,960 --> 00:23:08,600 Speaker 1: the interest interest rates rise, their liabilities or deposits, and 381 00:23:08,640 --> 00:23:12,600 Speaker 1: their deposits are sticky, they don't pass through, and so 382 00:23:12,720 --> 00:23:16,160 Speaker 1: actually their deposit funding becomes much more valuable when interest 383 00:23:16,280 --> 00:23:18,960 Speaker 1: rates rise. So if in a zero interest rate environment, 384 00:23:19,400 --> 00:23:23,200 Speaker 1: interest rates or zero deposit rates or zero deposits aren't 385 00:23:23,200 --> 00:23:25,719 Speaker 1: that useful. You're getting a little benefit that you have 386 00:23:25,760 --> 00:23:28,920 Speaker 1: deposit funding. But if interest rates go way up, you're 387 00:23:28,960 --> 00:23:30,800 Speaker 1: not gonna if you're the bank, you're not actually going 388 00:23:30,880 --> 00:23:34,000 Speaker 1: to be forced to raise your extracting rents right from 389 00:23:34,000 --> 00:23:35,960 Speaker 1: the deposit public. But you're not going to be forced 390 00:23:35,960 --> 00:23:39,200 Speaker 1: to raise your deposit rates. And this is actually strengthening 391 00:23:39,240 --> 00:23:42,479 Speaker 1: your business. And Silicon Valley Bank is going to think, yeah, okay, 392 00:23:42,520 --> 00:23:44,960 Speaker 1: so we take some we take some hits on our 393 00:23:45,040 --> 00:23:48,600 Speaker 1: long assets, but actually our net interest margin is going 394 00:23:48,640 --> 00:23:51,000 Speaker 1: to position, is going to main strong, our deposits are 395 00:23:51,000 --> 00:23:53,560 Speaker 1: going to be much more valuable, and we're just gonna 396 00:23:53,640 --> 00:23:56,320 Speaker 1: we're gonna work through, you know, year to eighteen month 397 00:23:56,400 --> 00:23:59,200 Speaker 1: period and be totally fine, right, which it seems like 398 00:23:59,240 --> 00:24:01,640 Speaker 1: they lose was sort of the assumption that they had, 399 00:24:01,680 --> 00:24:04,680 Speaker 1: like they knew they it wasn't great and maybe even 400 00:24:04,960 --> 00:24:07,320 Speaker 1: technical and solvent, but I mean, I think it was 401 00:24:07,359 --> 00:24:09,440 Speaker 1: in this leek one of matt Leview's news and letters, 402 00:24:09,480 --> 00:24:12,240 Speaker 1: he's like, this was actually like a very profitable time 403 00:24:12,320 --> 00:24:13,800 Speaker 1: for them, like it did. It would have been fine 404 00:24:13,840 --> 00:24:17,200 Speaker 1: if everyone's did. And presumably their expectation was, well, we're 405 00:24:17,200 --> 00:24:19,359 Speaker 1: just making a lot of income right now. So the 406 00:24:19,359 --> 00:24:20,760 Speaker 1: fact that we took it a hit on the asset 407 00:24:20,800 --> 00:24:23,520 Speaker 1: side is not really well. They had they had a 408 00:24:23,560 --> 00:24:27,000 Speaker 1: specific estimate in one of those internal documents where they said, 409 00:24:27,160 --> 00:24:30,840 Speaker 1: we could shorten duration, but that would mean an eighteen 410 00:24:30,880 --> 00:24:33,560 Speaker 1: million dollar hit to our net interest margin in one 411 00:24:33,640 --> 00:24:36,720 Speaker 1: year alone, going up to like thirty six million over 412 00:24:36,760 --> 00:24:39,760 Speaker 1: the next three years. So they knew that if they 413 00:24:39,840 --> 00:24:44,400 Speaker 1: reduced duration, they would be sacrificing earnings to some extent. Yeah, 414 00:24:44,400 --> 00:24:46,119 Speaker 1: I mean, I think it's fair to say that in 415 00:24:46,160 --> 00:24:48,440 Speaker 1: twenty twenty one they were making huge profits because this 416 00:24:48,520 --> 00:24:52,679 Speaker 1: strategy was really working. Interest rates went way up, and 417 00:24:53,000 --> 00:24:57,440 Speaker 1: I think it would have impaired their profitability, but they 418 00:24:57,440 --> 00:25:00,240 Speaker 1: were They weren't wrong to think that they were what 419 00:25:00,400 --> 00:25:02,760 Speaker 1: structurally hedge, even though they had no interest rate hedges 420 00:25:02,840 --> 00:25:06,040 Speaker 1: or anything, by virtue of the fact that they would 421 00:25:06,080 --> 00:25:08,920 Speaker 1: slowly be able to replace their treasuries with much higher 422 00:25:08,960 --> 00:25:12,359 Speaker 1: yielding treasuries while being able to pay depositors very little. 423 00:25:12,400 --> 00:25:15,400 Speaker 1: And we also, you know, we talked about this deposit 424 00:25:15,520 --> 00:25:18,760 Speaker 1: betas on a recent episode with Joe Batte and why 425 00:25:18,800 --> 00:25:20,920 Speaker 1: they're off at low and what if His points was like, well, 426 00:25:20,960 --> 00:25:23,840 Speaker 1: you know, you have a bank, you have an individual 427 00:25:23,960 --> 00:25:26,880 Speaker 1: has an account at Chase or something like that they're 428 00:25:26,960 --> 00:25:29,679 Speaker 1: providing a lot of services along with that. People are 429 00:25:29,760 --> 00:25:33,040 Speaker 1: not that inclined to move their checker account just because 430 00:25:33,040 --> 00:25:35,520 Speaker 1: the interest rate doesn't bump up a little bit. And 431 00:25:35,560 --> 00:25:40,040 Speaker 1: I imagine for Silicon Valley depositors these companies, the whole 432 00:25:40,080 --> 00:25:43,560 Speaker 1: story about Silicon Valley Bank was all of the products, 433 00:25:44,080 --> 00:25:47,240 Speaker 1: the startup specific products that they are that they offered, 434 00:25:47,400 --> 00:25:51,000 Speaker 1: which presumably to their mind, insulated them to some extent 435 00:25:51,040 --> 00:25:55,120 Speaker 1: against losing deposits. Absolutely, and I mean in the case 436 00:25:55,160 --> 00:25:58,000 Speaker 1: of SVB, there was also what an antitrust law we 437 00:25:58,160 --> 00:26:03,880 Speaker 1: call tying, where accompany ties one product to another product. Yeah, 438 00:26:03,960 --> 00:26:07,479 Speaker 1: so the bank would require that if you wanted to 439 00:26:07,520 --> 00:26:09,919 Speaker 1: borrow from the bank, that you would have Is that 440 00:26:10,000 --> 00:26:12,360 Speaker 1: unusual because people some people obviously some people are like, oh, 441 00:26:12,440 --> 00:26:14,000 Speaker 1: that's weird, and some people are like no, of course, 442 00:26:14,080 --> 00:26:17,040 Speaker 1: like any commercial loan. But is that unusual in your view? 443 00:26:17,240 --> 00:26:20,520 Speaker 1: I don't think it is unusual. There are strict rules 444 00:26:20,520 --> 00:26:24,359 Speaker 1: about bank tying in other areas. But my understanding is 445 00:26:24,359 --> 00:26:28,920 Speaker 1: that banks are explicitly permitted to tie deposit account services 446 00:26:28,960 --> 00:26:32,199 Speaker 1: to lending services. And historically it was core to the 447 00:26:32,200 --> 00:26:36,240 Speaker 1: banking business that you were the depository institution for the 448 00:26:36,800 --> 00:26:40,879 Speaker 1: for your borrowers that that went together, and you know, 449 00:26:40,920 --> 00:26:44,320 Speaker 1: we've moved away from that technology lots of things have 450 00:26:44,440 --> 00:26:47,520 Speaker 1: allowed people to borrow from banks that aren't the banks 451 00:26:47,560 --> 00:26:51,600 Speaker 1: where they bank at. But a long time, the idea 452 00:26:51,720 --> 00:26:53,719 Speaker 1: was that there's a lot of synergies between that no 453 00:26:53,760 --> 00:26:55,880 Speaker 1: one's going to be in a better position to determine 454 00:26:55,880 --> 00:26:59,159 Speaker 1: how much to lend to you than your own banker. 455 00:27:00,800 --> 00:27:03,000 Speaker 1: I imagine like there was also a bit of a 456 00:27:03,160 --> 00:27:06,879 Speaker 1: prestige element to banking at SVOB as well, given that, 457 00:27:07,160 --> 00:27:10,120 Speaker 1: you know, it was so popular among a particular type 458 00:27:10,119 --> 00:27:13,720 Speaker 1: of tech slash VC person. But you know, Joe touched 459 00:27:13,720 --> 00:27:18,040 Speaker 1: on the episode we did on deposit betas with Joe Abode. 460 00:27:18,320 --> 00:27:21,360 Speaker 1: But I'd love to hear from you, like why didn't 461 00:27:21,480 --> 00:27:26,000 Speaker 1: people pull more deposits from a bank that was essentially 462 00:27:26,480 --> 00:27:29,439 Speaker 1: paying them nothing? Because to some extent, this is the 463 00:27:29,480 --> 00:27:35,080 Speaker 1: big question, like why did SVB have so many deposits? 464 00:27:35,080 --> 00:27:39,119 Speaker 1: Well into twenty twenty two, at which point we started 465 00:27:39,160 --> 00:27:41,760 Speaker 1: to see some of the I guess most interest rate 466 00:27:41,800 --> 00:27:45,800 Speaker 1: sensitive parts of the economy, ie the tech industry lose 467 00:27:45,840 --> 00:27:47,720 Speaker 1: a bunch of money and have to pull funds. But 468 00:27:48,000 --> 00:27:50,840 Speaker 1: why why were people accepting of that for so long. 469 00:27:51,760 --> 00:27:55,359 Speaker 1: So we mentioned a couple of the sort of rational 470 00:27:55,480 --> 00:27:59,840 Speaker 1: explanations that you know, there's a strong brand, you want 471 00:27:59,840 --> 00:28:02,800 Speaker 1: to they're they're lending to you, they've required you to 472 00:28:02,880 --> 00:28:05,960 Speaker 1: keep deposit there. But you can't discount the fact here 473 00:28:06,040 --> 00:28:08,919 Speaker 1: that a big piece of this was a lack of 474 00:28:08,920 --> 00:28:13,560 Speaker 1: sophisticated financial management on the part of startup companies that 475 00:28:14,520 --> 00:28:17,800 Speaker 1: maybe didn't have CFOs, didn't have anybody on their teams 476 00:28:17,920 --> 00:28:22,600 Speaker 1: with any experience in managing cash. They're focused on their 477 00:28:22,640 --> 00:28:26,960 Speaker 1: their business and it's very hard to justify five hundred 478 00:28:26,960 --> 00:28:29,960 Speaker 1: million dollar bank account balance, and I think we have 479 00:28:30,040 --> 00:28:33,000 Speaker 1: one example of that that just there's there's no reason 480 00:28:33,080 --> 00:28:37,600 Speaker 1: for that's that's very bad management. No well run, mature 481 00:28:37,680 --> 00:28:42,680 Speaker 1: company would operate in that way. Among other things, you 482 00:28:42,680 --> 00:28:45,640 Speaker 1: you you have a huge uninsured deposit risk that we 483 00:28:45,840 --> 00:28:48,360 Speaker 1: that we saw, but you're also just giving up lots 484 00:28:48,360 --> 00:28:52,400 Speaker 1: of return. You could have that money invested in laddered 485 00:28:52,520 --> 00:28:58,640 Speaker 1: treasury bills or something. And significantly more so, there's a 486 00:28:58,680 --> 00:29:00,640 Speaker 1: huge amount of money that's just been left on the 487 00:29:00,640 --> 00:29:03,120 Speaker 1: floor here there, and it's you know, it doesn't it 488 00:29:03,120 --> 00:29:06,040 Speaker 1: doesn't really make sense. So we have to understand that 489 00:29:06,080 --> 00:29:09,520 Speaker 1: these that these customers, despite having lots of money, are 490 00:29:09,560 --> 00:29:12,480 Speaker 1: not actually very sophisticated. So I want to go back 491 00:29:12,480 --> 00:29:15,400 Speaker 1: to the supervisory question and ask about it, kind of 492 00:29:15,400 --> 00:29:18,880 Speaker 1: come at it from a different angle. You know. Obviously 493 00:29:18,920 --> 00:29:21,880 Speaker 1: the two thousand and eight two thousand and nine crisis 494 00:29:22,880 --> 00:29:26,000 Speaker 1: was very focused on the asset side of the business 495 00:29:26,080 --> 00:29:28,520 Speaker 1: and were these really high quality assets? And then part 496 00:29:28,600 --> 00:29:31,000 Speaker 1: of the reasonable bunch of banks failed is because the 497 00:29:31,080 --> 00:29:34,080 Speaker 1: assets like weren't very good that they held. And as 498 00:29:34,120 --> 00:29:38,000 Speaker 1: people have discussed with Silicon Value Bank, a lot of 499 00:29:38,000 --> 00:29:40,640 Speaker 1: the issues. Yes, maybe they made a wrong bet on 500 00:29:40,760 --> 00:29:43,800 Speaker 1: treasuries or they put too much, but is the flightiness 501 00:29:43,800 --> 00:29:46,480 Speaker 1: of the deposits? Can you talk a little bit more. 502 00:29:46,520 --> 00:29:51,840 Speaker 1: I know that regulators do bucket deposits from the most 503 00:29:51,840 --> 00:29:53,960 Speaker 1: sticky to the least sticky, but could you talk a 504 00:29:54,000 --> 00:29:58,120 Speaker 1: little bit about like how good supervisory in a sort 505 00:29:58,120 --> 00:30:02,520 Speaker 1: of like active pre nineties way might have approached the 506 00:30:02,720 --> 00:30:06,480 Speaker 1: uniformity of SVB deposits and the risk of them all 507 00:30:06,560 --> 00:30:08,360 Speaker 1: leaving at once. Yeah, I mean I think that if 508 00:30:08,360 --> 00:30:11,560 Speaker 1: you showed svb's balance sheet to supervisor brought up during 509 00:30:11,560 --> 00:30:14,480 Speaker 1: the new deal system. So let's say it's nineteen seventy five, 510 00:30:15,240 --> 00:30:20,560 Speaker 1: they would be horrified at the enormous concentration of uninsured 511 00:30:20,600 --> 00:30:27,520 Speaker 1: deposits controlled by a group of businesses with very similar 512 00:30:27,680 --> 00:30:30,880 Speaker 1: risks to their business and so all of your depositors, 513 00:30:30,880 --> 00:30:33,000 Speaker 1: and this is something that and this is something that 514 00:30:33,040 --> 00:30:36,600 Speaker 1: a new deal era supervisor would be familiar with from 515 00:30:36,600 --> 00:30:39,400 Speaker 1: press experience. Well, I think I think it would have been. 516 00:30:39,720 --> 00:30:42,040 Speaker 1: They would have been unfamiliar with it in the sense 517 00:30:42,080 --> 00:30:44,440 Speaker 1: that it would have been so unusual back then everyone 518 00:30:44,440 --> 00:30:47,440 Speaker 1: would have looked at it and said, WHOA, this bank 519 00:30:47,680 --> 00:30:50,840 Speaker 1: has a very unstable deposit base. It would not have 520 00:30:50,920 --> 00:30:54,160 Speaker 1: been novel to view this with concern. It would be 521 00:30:54,400 --> 00:30:57,560 Speaker 1: it would be even more concerning because of how risk 522 00:30:57,600 --> 00:30:59,760 Speaker 1: it would have been to operate a bank in this 523 00:30:59,800 --> 00:31:02,040 Speaker 1: way at that point in time, when when, of course, 524 00:31:02,040 --> 00:31:05,200 Speaker 1: people still remembered the bank runs of the thirties much 525 00:31:05,240 --> 00:31:08,400 Speaker 1: more than they do than they do today. And you know, 526 00:31:08,440 --> 00:31:10,640 Speaker 1: part of what went wrong at SVP is it's not 527 00:31:10,680 --> 00:31:13,760 Speaker 1: just that they had ninety seven percent or something in 528 00:31:13,920 --> 00:31:18,040 Speaker 1: uninsured deposits, but that all of their depositors were going 529 00:31:18,040 --> 00:31:20,520 Speaker 1: to withdraw at the same time. And so there's sort 530 00:31:20,520 --> 00:31:24,200 Speaker 1: of a classic issue in the banking business always is 531 00:31:25,400 --> 00:31:27,360 Speaker 1: in what circumstances am I going to be subject to 532 00:31:27,400 --> 00:31:30,240 Speaker 1: a deposit train? You know, you get to model your 533 00:31:30,240 --> 00:31:35,960 Speaker 1: deposits as sticky if you're a bank, because over time, 534 00:31:36,000 --> 00:31:38,280 Speaker 1: for the banking system, the deposit base is always sort 535 00:31:38,280 --> 00:31:40,160 Speaker 1: of growing. I mean, with the exception of over the 536 00:31:40,240 --> 00:31:42,520 Speaker 1: last year where monetary policy is trying to shrink the 537 00:31:42,520 --> 00:31:45,160 Speaker 1: money supply, but you know, over time it's a constant 538 00:31:45,160 --> 00:31:47,760 Speaker 1: growing base, and so deposits are really, in some simes 539 00:31:47,760 --> 00:31:50,920 Speaker 1: a very long duration asset, except if you're the one 540 00:31:50,960 --> 00:31:52,880 Speaker 1: bank that experiences a drain to the rest of the 541 00:31:52,880 --> 00:31:55,400 Speaker 1: system where everyone withdraws from you, and so if your 542 00:31:55,480 --> 00:31:59,160 Speaker 1: customers are all going to face hardship your depositories or 543 00:31:59,720 --> 00:32:02,960 Speaker 1: depot it was hard. The same time, you really can't 544 00:32:02,960 --> 00:32:06,360 Speaker 1: treat yourself as structurally hedged. You're the opposite of structurally 545 00:32:06,400 --> 00:32:09,360 Speaker 1: head And that's what that's what Silicon Valley Bank found out, 546 00:32:09,680 --> 00:32:12,160 Speaker 1: is it thought that, oh, you know, when when my 547 00:32:12,320 --> 00:32:15,040 Speaker 1: assets lose value, my deposits will become more valuable. But 548 00:32:15,080 --> 00:32:17,880 Speaker 1: actually all their depositors started to draw down their accounts 549 00:32:17,960 --> 00:32:21,200 Speaker 1: and the opposite happened, and so they were just very 550 00:32:21,480 --> 00:32:25,240 Speaker 1: very long low interest rates, silicon valuing. The whole business 551 00:32:25,320 --> 00:32:27,520 Speaker 1: model was tied to low interest rates, I think to 552 00:32:27,600 --> 00:32:30,000 Speaker 1: an extent that they did not appreciate, and to an 553 00:32:30,040 --> 00:32:34,720 Speaker 1: extent supervisors clearly didn't depreciate, but maybe weren't even thinking 554 00:32:34,800 --> 00:32:37,320 Speaker 1: as hard about as they might have in an earlier 555 00:32:37,480 --> 00:32:40,640 Speaker 1: period where they were more empowered to make those sorts 556 00:32:40,680 --> 00:32:43,640 Speaker 1: of judgments. Yeah, this is exactly what I said on 557 00:32:43,720 --> 00:32:46,600 Speaker 1: our episode with Dan Davies. It was interest rate exposure 558 00:32:46,840 --> 00:32:49,880 Speaker 1: kind of squared, but just on the deposit side. Because 559 00:32:49,960 --> 00:32:53,320 Speaker 1: to me, this is kind of the most novel or 560 00:32:53,520 --> 00:32:56,480 Speaker 1: interesting thing about all of this, because we know that 561 00:32:56,560 --> 00:33:00,080 Speaker 1: a lot of banks have unrealized losses on bonds, and 562 00:33:00,320 --> 00:33:04,800 Speaker 1: you know too. Seems like broadly they've been managing their 563 00:33:04,880 --> 00:33:08,920 Speaker 1: interest rate risk so far. But with SVB, the big 564 00:33:09,000 --> 00:33:15,560 Speaker 1: difference was that group of highly concentrated, extremely unreliable depositors 565 00:33:15,800 --> 00:33:19,120 Speaker 1: who themselves had significant interest rate exposure. And we're pulling 566 00:33:19,240 --> 00:33:24,040 Speaker 1: money over the past years. So what could regulation do 567 00:33:24,800 --> 00:33:28,080 Speaker 1: on that front? So I guess instead of the asset side, 568 00:33:28,120 --> 00:33:33,080 Speaker 1: looking more at the liability side. Yeah, So what you 569 00:33:33,160 --> 00:33:38,880 Speaker 1: want to see is a coherent asset liability management strategy 570 00:33:38,960 --> 00:33:42,920 Speaker 1: for a bank, and so a bank that anticipates deposit 571 00:33:43,040 --> 00:33:47,560 Speaker 1: trains for a bank that has flighty deposits, and there 572 00:33:47,600 --> 00:33:49,280 Speaker 1: are many banks that can fall into this category. This 573 00:33:49,400 --> 00:33:51,800 Speaker 1: is something that regulator supervisors do think a lot about. 574 00:33:52,160 --> 00:33:54,840 Speaker 1: If you're in that category, then you need to hold 575 00:33:55,440 --> 00:33:59,479 Speaker 1: liquid assets that you can sell and that at their 576 00:33:59,520 --> 00:34:04,080 Speaker 1: fair market value to cover the withdrawals. And so part 577 00:34:04,080 --> 00:34:07,440 Speaker 1: of the problem here is that Silicon Valley Bank did 578 00:34:07,560 --> 00:34:12,840 Speaker 1: not actually have available for sale securities at fair market 579 00:34:12,960 --> 00:34:17,560 Speaker 1: values sufficient to cover the withdrawals, and so the fix 580 00:34:17,760 --> 00:34:22,000 Speaker 1: for this would have been to have much less duration 581 00:34:22,160 --> 00:34:25,160 Speaker 1: in the in the in the asset portfolio, or many 582 00:34:25,400 --> 00:34:28,600 Speaker 1: many more reserves. This is the same problem, by the way, 583 00:34:28,800 --> 00:34:31,959 Speaker 1: that took down silver Gate Bank and to some extent, 584 00:34:32,080 --> 00:34:38,360 Speaker 1: Signature Bank. They had deposit bases that were flighty, that 585 00:34:39,120 --> 00:34:43,840 Speaker 1: their depositors suffered and their deposit the banks experienced deposit 586 00:34:43,960 --> 00:34:46,680 Speaker 1: drains because they were concentrated in a group of people 587 00:34:46,760 --> 00:35:07,040 Speaker 1: that were exposed to interest rate hiking. I just realized 588 00:35:07,080 --> 00:35:11,600 Speaker 1: I promised to ask about discount lending and the fhlb's 589 00:35:11,640 --> 00:35:14,600 Speaker 1: the Federal Home Loan Bank. So you know, in theory, 590 00:35:14,840 --> 00:35:17,480 Speaker 1: when you have this type of banking crisis or you know, 591 00:35:17,640 --> 00:35:21,000 Speaker 1: some sort of liquidity issue with the financial institution. You 592 00:35:21,080 --> 00:35:23,840 Speaker 1: would expect them to either go to the FED, to 593 00:35:23,960 --> 00:35:27,440 Speaker 1: the discount window and for all blots listeners, we recorded 594 00:35:27,600 --> 00:35:30,239 Speaker 1: an episode on this a month or two ago, or 595 00:35:30,480 --> 00:35:33,719 Speaker 1: they can borrow from the FHLBS. And some of the 596 00:35:33,840 --> 00:35:41,120 Speaker 1: talk out there is that SVB got cut off by FHLB. 597 00:35:42,080 --> 00:35:45,560 Speaker 1: Why would that have happened and why wouldn't those two 598 00:35:45,719 --> 00:35:49,480 Speaker 1: lenders of last resort do everything they can in order 599 00:35:49,560 --> 00:35:51,920 Speaker 1: to step in and support the bank. Or is it 600 00:35:52,000 --> 00:35:54,439 Speaker 1: the case that at some point, you know, maybe they're 601 00:35:54,480 --> 00:35:56,520 Speaker 1: talking to the FDIC and they just say this is 602 00:35:56,680 --> 00:35:59,480 Speaker 1: untenable and no matter how much money we provide, like 603 00:35:59,600 --> 00:36:01,200 Speaker 1: the bank is not going to be able to get 604 00:36:01,280 --> 00:36:04,520 Speaker 1: up and running again. So I'm speculating a bid here, 605 00:36:04,760 --> 00:36:08,880 Speaker 1: and you might want to talk to the FHLB expert 606 00:36:08,960 --> 00:36:12,120 Speaker 1: in the legal academy, K Judge, who's my colleague. But 607 00:36:12,880 --> 00:36:16,640 Speaker 1: the FHLBS are not a lender of last resort in 608 00:36:16,680 --> 00:36:21,719 Speaker 1: the way that the FRBs are. Right, the FHLBS they 609 00:36:21,840 --> 00:36:25,400 Speaker 1: do provide sort of lender of second to last resort 610 00:36:25,520 --> 00:36:30,239 Speaker 1: services to their members, but they are much more operated 611 00:36:30,800 --> 00:36:34,280 Speaker 1: by their members, and they pay dividends to their members 612 00:36:34,719 --> 00:36:37,920 Speaker 1: than the FRBs. So the FRBs were set up in 613 00:36:37,960 --> 00:36:42,719 Speaker 1: a similar model, but today basically function as public banks, 614 00:36:42,760 --> 00:36:45,400 Speaker 1: so they have no interest in profits or anything like that, 615 00:36:45,840 --> 00:36:48,480 Speaker 1: and they're willing to sort of take one for the 616 00:36:48,600 --> 00:36:51,880 Speaker 1: team in a way that the fhlbs are not. So 617 00:36:51,960 --> 00:36:54,319 Speaker 1: I think it's a mistake to look at the FHLBS 618 00:36:54,320 --> 00:36:56,680 Speaker 1: and say, oh, well, you really ought to have lent 619 00:36:56,880 --> 00:37:00,200 Speaker 1: into an insolvent institution and took on that potential. Rik k. 620 00:37:00,520 --> 00:37:03,160 Speaker 1: The FRBs are are are are wary of that for 621 00:37:03,880 --> 00:37:06,879 Speaker 1: various reasons we could get into. But the flhol bes 622 00:37:06,920 --> 00:37:09,399 Speaker 1: have even more reason to sort of to pull back. 623 00:37:09,600 --> 00:37:12,840 Speaker 1: We definitely have to do an FHLB episode at some 624 00:37:12,960 --> 00:37:15,160 Speaker 1: point with k Judge, because I don't know much about 625 00:37:15,200 --> 00:37:17,600 Speaker 1: them at all, and it definitely it's been too long 626 00:37:17,719 --> 00:37:22,520 Speaker 1: or it's far too long without having yeout having her on. 627 00:37:22,920 --> 00:37:26,120 Speaker 1: I want to ask another dimension. You know, people pointing 628 00:37:26,239 --> 00:37:31,320 Speaker 1: to the twenty eighteen law change to Dodd Frank that 629 00:37:31,840 --> 00:37:34,759 Speaker 1: seemed to exempt banks like Silicon Valley Bank from some 630 00:37:34,960 --> 00:37:37,279 Speaker 1: of these liquidity requirements that you were talking about, like 631 00:37:37,440 --> 00:37:39,960 Speaker 1: do you have enough liquid assets? Hey? Could you sort 632 00:37:39,960 --> 00:37:42,600 Speaker 1: of characterize the change that was made there in b 633 00:37:43,239 --> 00:37:46,600 Speaker 1: had that not been in place, like is that is 634 00:37:46,680 --> 00:37:48,839 Speaker 1: that change that was made in twenty eighteen? Does does 635 00:37:48,920 --> 00:37:51,480 Speaker 1: that tell the story of the demise? Had the old 636 00:37:51,680 --> 00:37:54,279 Speaker 1: Dodd Frank laws remained in place for a bank the 637 00:37:54,360 --> 00:37:57,160 Speaker 1: size of Silicon Valley Bank, would they have been able 638 00:37:57,200 --> 00:37:59,160 Speaker 1: to weather the storm? You can never know for sure, 639 00:37:59,239 --> 00:38:03,960 Speaker 1: but I would suggests yes, that is decisive. And so 640 00:38:04,560 --> 00:38:07,120 Speaker 1: this brings us back to how the government responded to 641 00:38:07,200 --> 00:38:09,960 Speaker 1: the two thousand and eight failure of supervision regulation. And 642 00:38:10,120 --> 00:38:13,840 Speaker 1: they responded with a set of tiered new requirements. And 643 00:38:14,680 --> 00:38:17,680 Speaker 1: for the very biggest banks you had the CCR stress 644 00:38:17,719 --> 00:38:21,799 Speaker 1: testing regime, and for all of the banks with more 645 00:38:21,840 --> 00:38:25,120 Speaker 1: than fifty billion dollars of assets, you had stress testing 646 00:38:25,280 --> 00:38:30,520 Speaker 1: as well as collection of other enhanced prudential standards. And 647 00:38:31,400 --> 00:38:35,800 Speaker 1: this new cocktail of regulation and supervision was geared towards 648 00:38:35,920 --> 00:38:38,520 Speaker 1: preventing a repeat of something on the scale of two 649 00:38:38,560 --> 00:38:41,680 Speaker 1: thousand and eight. And so we weren't going to impose 650 00:38:41,760 --> 00:38:43,719 Speaker 1: this on the whole banking system, on all of the 651 00:38:43,760 --> 00:38:46,640 Speaker 1: sort of smaller banks. But the thinking was, if we 652 00:38:46,719 --> 00:38:50,800 Speaker 1: could just really get back to serious government oversight of 653 00:38:51,280 --> 00:38:54,279 Speaker 1: banks over fifty billion dollars that would really go a 654 00:38:54,360 --> 00:38:58,800 Speaker 1: long way towards preventing another another calamity like two thousand 655 00:38:58,840 --> 00:39:03,480 Speaker 1: and eight. And what happened was immediately there was litigation 656 00:39:03,719 --> 00:39:08,719 Speaker 1: over the threshold for this new regulatory supervisory cocktail. And 657 00:39:08,800 --> 00:39:11,279 Speaker 1: so this fifty billion dollars threshold came under a lot 658 00:39:11,360 --> 00:39:15,000 Speaker 1: of political pressure from the banking agencies and from various 659 00:39:15,040 --> 00:39:19,520 Speaker 1: people in Washington, and the bank lobby fought a battle 660 00:39:19,640 --> 00:39:22,840 Speaker 1: over many years to raise the threshold. One of the 661 00:39:23,920 --> 00:39:28,480 Speaker 1: important figures lobbying for raising the threshold was the CEO 662 00:39:28,560 --> 00:39:31,600 Speaker 1: of Silicon Valley Bank. He was growing his bank and 663 00:39:31,680 --> 00:39:34,960 Speaker 1: he did not want to grow his bank into additional 664 00:39:35,080 --> 00:39:41,000 Speaker 1: regulatory and supervisory requirements. And in twenty eighteen, after winning 665 00:39:41,120 --> 00:39:44,680 Speaker 1: over people in both parties to this cause of raising 666 00:39:44,719 --> 00:39:49,239 Speaker 1: the threshold, Congress changed the law and the threshold moved up. 667 00:39:49,600 --> 00:39:52,120 Speaker 1: A bunch of thresholds moved around, but the relevant threshold, 668 00:39:52,280 --> 00:39:54,920 Speaker 1: I think, moved up to two hundred and fifty billion dollars. 669 00:39:55,000 --> 00:39:58,400 Speaker 1: And the result was Silicon Valley Bank and its peers 670 00:39:58,480 --> 00:40:03,200 Speaker 1: had successfully exempted themselves from the enhanced prudential standards that 671 00:40:03,280 --> 00:40:06,600 Speaker 1: Congress had created. After two thousand and eight, and the 672 00:40:06,760 --> 00:40:10,160 Speaker 1: result was you didn't have the stress testing, which is 673 00:40:10,200 --> 00:40:14,360 Speaker 1: the primary means by which supervisors now exercise substantive judgment 674 00:40:14,400 --> 00:40:18,759 Speaker 1: about risks, and so you had a much more I 675 00:40:18,880 --> 00:40:24,319 Speaker 1: think light touch process focused oversight that allowed rule compliant 676 00:40:24,440 --> 00:40:29,759 Speaker 1: balance sheet configurations like svbs to go relatively unchallenged. But 677 00:40:29,880 --> 00:40:32,680 Speaker 1: if you had been in the in the Enhanced Prudential 678 00:40:32,719 --> 00:40:35,440 Speaker 1: Standards bucket, I think that they would have been challenged. 679 00:40:35,480 --> 00:40:38,200 Speaker 1: They would have been challenged through all of these additional 680 00:40:38,320 --> 00:40:43,279 Speaker 1: rules and also supervisory programs. And it's unlikely. You can 681 00:40:43,320 --> 00:40:46,960 Speaker 1: never know, but it's unlikely that they could have taken 682 00:40:47,080 --> 00:40:52,279 Speaker 1: so much duration risk and not raised capital earlier, been 683 00:40:52,440 --> 00:40:55,399 Speaker 1: permitted to go for so long in a position where 684 00:40:55,440 --> 00:40:59,040 Speaker 1: their liquidation value was possibly negative. Yeah, since we're on 685 00:40:59,160 --> 00:41:01,880 Speaker 1: the topic of the blame game, I mean, one of 686 00:41:01,920 --> 00:41:05,520 Speaker 1: the things that you see people saying now is that, well, 687 00:41:06,239 --> 00:41:09,120 Speaker 1: it's the Fed's fault. The FED kept interest rate slow 688 00:41:09,280 --> 00:41:13,240 Speaker 1: for too long, and it basically forced people to assume 689 00:41:13,360 --> 00:41:17,560 Speaker 1: additional duration risk in order to seek out yield. And 690 00:41:17,680 --> 00:41:21,040 Speaker 1: I think, you know, financial repression is a real thing. 691 00:41:21,200 --> 00:41:23,680 Speaker 1: But on the other hand, you cannot ignore the individual 692 00:41:23,719 --> 00:41:27,480 Speaker 1: actions of one or a few specific banks, their managers, 693 00:41:27,520 --> 00:41:31,920 Speaker 1: their shareholders, and their depositors. But how would you describe 694 00:41:32,480 --> 00:41:38,520 Speaker 1: the overall monetary policies role in the current predicament. So 695 00:41:39,040 --> 00:41:43,080 Speaker 1: overall monetary policy is of course central to the current predicament. 696 00:41:43,200 --> 00:41:47,120 Speaker 1: But there's a sort of false dichotomy underline, the view 697 00:41:47,400 --> 00:41:51,480 Speaker 1: that somehow it's like monetary policy happening up here at 698 00:41:51,520 --> 00:41:54,680 Speaker 1: the FED that's then causing problems down here at the 699 00:41:54,760 --> 00:41:57,080 Speaker 1: banking system. The whole thing is monetary policy. The whole 700 00:41:57,080 --> 00:41:59,279 Speaker 1: reason we have banks is monetary policy. Banks are creating 701 00:41:59,320 --> 00:42:01,960 Speaker 1: the money supply, and the question is how much money 702 00:42:02,000 --> 00:42:04,200 Speaker 1: do we want to be created. So it would be 703 00:42:04,280 --> 00:42:07,800 Speaker 1: the tail wagging the dog if we had to change 704 00:42:07,920 --> 00:42:10,000 Speaker 1: our judgment about how much money should be created because 705 00:42:10,040 --> 00:42:12,640 Speaker 1: like somehow the system couldn't create that amount of money 706 00:42:12,960 --> 00:42:16,320 Speaker 1: safely and stably. We have a broken system if it 707 00:42:16,440 --> 00:42:18,719 Speaker 1: can't create the amount of money that the FMC says 708 00:42:18,800 --> 00:42:22,800 Speaker 1: is appropriate for macroeconomic conditions. And so I would not 709 00:42:23,000 --> 00:42:26,600 Speaker 1: blame the FOMC for thinking that we need to adjust 710 00:42:26,800 --> 00:42:29,360 Speaker 1: the amount of money that the banking system and the 711 00:42:29,480 --> 00:42:31,920 Speaker 1: financial system are creating. I would blame the banking and 712 00:42:32,040 --> 00:42:35,000 Speaker 1: financial system and the banking and financial laws. If they're 713 00:42:35,080 --> 00:42:39,000 Speaker 1: incapable producing the amount of money and changing the amount 714 00:42:39,040 --> 00:42:42,760 Speaker 1: of money they're producing overtime consistent with the fomc's directives 715 00:42:42,760 --> 00:42:45,400 Speaker 1: and the needs of the economy, that's a really big problem. 716 00:42:45,480 --> 00:42:48,200 Speaker 1: And it does look like we're facing that problem now, 717 00:42:48,280 --> 00:42:50,640 Speaker 1: where in the coming months we could be in quite 718 00:42:50,640 --> 00:42:54,320 Speaker 1: a predicament where the FOMC may make the judgment and 719 00:42:54,440 --> 00:42:56,160 Speaker 1: we can brack it whether it would be the correct 720 00:42:56,239 --> 00:42:59,919 Speaker 1: judgment that the economy needs less money and the banking 721 00:43:00,080 --> 00:43:05,759 Speaker 1: system may be incapable of functioning properly under that directive. 722 00:43:06,000 --> 00:43:08,520 Speaker 1: And that's the flip side of, you know, the suggestion 723 00:43:08,560 --> 00:43:10,760 Speaker 1: that the banking system should also be able to function 724 00:43:10,880 --> 00:43:13,640 Speaker 1: under the judgment that interest rate should be zero and 725 00:43:13,760 --> 00:43:16,080 Speaker 1: function in a way that is sustainable over time. And 726 00:43:16,160 --> 00:43:18,440 Speaker 1: so to the extent that is what's going on, I 727 00:43:18,560 --> 00:43:21,520 Speaker 1: think it's a real indictment not of monetary policy, like 728 00:43:21,600 --> 00:43:23,680 Speaker 1: the high level decision about how much money we need, 729 00:43:23,920 --> 00:43:28,160 Speaker 1: but the structure being unable to follow through to execute 730 00:43:28,200 --> 00:43:30,839 Speaker 1: on those decisions. Leveman on that was an amazing answer, 731 00:43:31,040 --> 00:43:34,120 Speaker 1: That was an amazing conversation that was so helpful that 732 00:43:34,320 --> 00:43:37,160 Speaker 1: was so helpful and so clear. I've said it every 733 00:43:37,239 --> 00:43:40,080 Speaker 1: time we talked to I'm like, oh, I've finally had 734 00:43:40,360 --> 00:43:42,480 Speaker 1: There's been a few more, but I so that was 735 00:43:42,520 --> 00:43:45,319 Speaker 1: a that was very good. I'll just leave it there. 736 00:43:45,560 --> 00:43:48,360 Speaker 1: I really I really appreciate that. So thank you so 737 00:43:48,440 --> 00:43:50,600 Speaker 1: much for coming back on up. Thank you so much 738 00:43:50,640 --> 00:44:06,560 Speaker 1: for having me that, Tracy. I love that whole conversation, 739 00:44:06,800 --> 00:44:08,960 Speaker 1: starting from the very end, which I think is a 740 00:44:09,080 --> 00:44:15,440 Speaker 1: really excellent way to sort of reconceptualize the monetary policy problem, 741 00:44:15,560 --> 00:44:17,480 Speaker 1: which is that if the FED is going to be 742 00:44:17,640 --> 00:44:22,000 Speaker 1: tasked with like the sort of like big sweep macro management, right, 743 00:44:22,320 --> 00:44:27,200 Speaker 1: getting employment inflation at its targets and so forth, in theory, 744 00:44:27,680 --> 00:44:31,200 Speaker 1: we want to have a financial system that can operate 745 00:44:31,360 --> 00:44:35,239 Speaker 1: under any you know, operate relatively safely under whatever rates 746 00:44:35,280 --> 00:44:37,960 Speaker 1: the FED deems to be appropriate. Absolutely, I mean, I 747 00:44:38,080 --> 00:44:42,520 Speaker 1: do think there is a fundamental tension between monetary policy, 748 00:44:42,880 --> 00:44:46,279 Speaker 1: which you know, like the big thing monetary policy does 749 00:44:46,440 --> 00:44:48,879 Speaker 1: is basically impact the price of bonds and then having 750 00:44:48,960 --> 00:44:52,759 Speaker 1: the financial system and banks specifically have to hold a 751 00:44:52,880 --> 00:44:56,160 Speaker 1: bunch of bonds as part of their capital and liquidity mandates. 752 00:44:56,239 --> 00:45:00,200 Speaker 1: Like that tension is there, but there are way is 753 00:45:00,280 --> 00:45:03,520 Speaker 1: to manage it such that we can avoid failures and 754 00:45:03,760 --> 00:45:08,480 Speaker 1: also provide for the effective implementation of monetary policy as 755 00:45:08,520 --> 00:45:11,200 Speaker 1: a whole. The other thing that really struck me is 756 00:45:11,560 --> 00:45:15,480 Speaker 1: this is kind of an incentives episode, right, And I 757 00:45:15,600 --> 00:45:19,799 Speaker 1: thought Lev's point about basically outsourcing a lot of bank 758 00:45:19,920 --> 00:45:25,880 Speaker 1: supervision to private shareholders and expecting them to you maybe 759 00:45:26,200 --> 00:45:29,359 Speaker 1: press the brakes on risk when things start to get 760 00:45:29,440 --> 00:45:33,080 Speaker 1: out of hand, that was a really interesting one. And SVB, 761 00:45:33,360 --> 00:45:35,280 Speaker 1: I think, is going to end up as a classic 762 00:45:35,360 --> 00:45:38,960 Speaker 1: case where you know, there was an acknowledgement that there 763 00:45:39,200 --> 00:45:43,400 Speaker 1: was an issue here. There was the asset liability duration mismatch, 764 00:45:43,480 --> 00:45:46,120 Speaker 1: and there was too much exposure to long bonds and 765 00:45:46,520 --> 00:45:50,480 Speaker 1: too much of an assumption that deposits would be around 766 00:45:50,600 --> 00:45:54,640 Speaker 1: forever or that they might even return or start growing again, 767 00:45:55,280 --> 00:45:59,520 Speaker 1: and it was a conscious decision to pick up net 768 00:45:59,640 --> 00:46:02,440 Speaker 1: interest margin, or at least it looks like that. I'm 769 00:46:02,480 --> 00:46:04,719 Speaker 1: sure more will come out over the course of all 770 00:46:04,760 --> 00:46:06,880 Speaker 1: of this, but for now, it certainly seems like it 771 00:46:07,040 --> 00:46:09,640 Speaker 1: was a decision to do that. That's really interesting, like 772 00:46:09,760 --> 00:46:12,680 Speaker 1: thinking about like, it's pretty fascinating that a lot of 773 00:46:12,760 --> 00:46:16,680 Speaker 1: these like capital requirements and ratios and regulations that we 774 00:46:16,760 --> 00:46:19,240 Speaker 1: think of as courtA how we manage the banking system 775 00:46:19,440 --> 00:46:21,799 Speaker 1: are all pretty young, and that for the most part, 776 00:46:21,920 --> 00:46:24,320 Speaker 1: for a long time in history it was like active 777 00:46:24,360 --> 00:46:29,239 Speaker 1: super advisory people making judgments based on the operations of 778 00:46:29,280 --> 00:46:33,200 Speaker 1: the bank, whether their decisions on loans and deposits were healthy. 779 00:46:33,640 --> 00:46:36,080 Speaker 1: But it does make total sense that it is sort 780 00:46:36,120 --> 00:46:39,080 Speaker 1: of like you know, I hate usually where it's like neoliberal, 781 00:46:39,640 --> 00:46:43,960 Speaker 1: but that like that the role of supervisors would essentially 782 00:46:44,120 --> 00:46:49,759 Speaker 1: transform to making sure that shareholders were getting adequate information. 783 00:46:49,920 --> 00:46:51,960 Speaker 1: That you start with the assumption that the market is 784 00:46:52,000 --> 00:46:54,400 Speaker 1: the best regulator, and then what is the role of 785 00:46:54,440 --> 00:46:56,360 Speaker 1: the government well, and the role of the government, and 786 00:46:56,480 --> 00:46:59,319 Speaker 1: that point is to make sure that market regulators get 787 00:46:59,360 --> 00:47:02,600 Speaker 1: good information. Like that seems like a very like big 788 00:47:02,760 --> 00:47:05,279 Speaker 1: theme that like you could like characterize across a lot 789 00:47:05,360 --> 00:47:07,960 Speaker 1: of different industries, a lot of different government and then 790 00:47:08,040 --> 00:47:10,360 Speaker 1: the failure of just like well, the problem is like 791 00:47:10,520 --> 00:47:13,480 Speaker 1: shareholders can lose everything and not be accountable for the 792 00:47:13,600 --> 00:47:16,719 Speaker 1: spill over when a bank fails. And so yeah, the 793 00:47:16,880 --> 00:47:19,400 Speaker 1: need perhaps to get back to a type of supervisory 794 00:47:19,719 --> 00:47:22,560 Speaker 1: that actually takes decisions into own hands and rather than 795 00:47:22,640 --> 00:47:25,839 Speaker 1: just outsourcing it. You know, I realized we didn't even 796 00:47:25,920 --> 00:47:28,880 Speaker 1: get into FED checking accounts, which is one of them. 797 00:47:28,960 --> 00:47:30,400 Speaker 1: Now that's the next step. So then I think the 798 00:47:32,160 --> 00:47:37,520 Speaker 1: series is if all deposits post SVB are presumed to 799 00:47:37,560 --> 00:47:40,640 Speaker 1: be ensured, which almost seems like implicitly the case, now 800 00:47:41,239 --> 00:47:44,640 Speaker 1: why do we have private deposit taking institution? So I 801 00:47:44,719 --> 00:47:46,600 Speaker 1: kind of think that's the next one in this series 802 00:47:47,040 --> 00:47:49,319 Speaker 1: to look at, Well, what does this tell us now 803 00:47:49,360 --> 00:47:52,320 Speaker 1: about even the point of private deposit taking institutions? And 804 00:47:52,360 --> 00:47:54,840 Speaker 1: should there be a point? I mean, that is what 805 00:47:54,960 --> 00:47:56,840 Speaker 1: I was kind of hinting at in the intro. But 806 00:47:56,920 --> 00:47:59,320 Speaker 1: we'll just have to leave that. You know, it was 807 00:47:59,360 --> 00:48:01,879 Speaker 1: a trailer not for this episode but for the next one, 808 00:48:02,160 --> 00:48:04,440 Speaker 1: so plenty more to come, but shall we leave it there? 809 00:48:04,520 --> 00:48:07,920 Speaker 1: Let's leave it there. This has been another episode of 810 00:48:08,040 --> 00:48:10,880 Speaker 1: the Odd Thoughts podcast. I'm Tracy Alloway. You can follow 811 00:48:10,960 --> 00:48:14,319 Speaker 1: me on Twitter at Tracy Alloway and I'm Joe wisn't All. 812 00:48:14,360 --> 00:48:17,320 Speaker 1: You can follow me on Twitter at the Stalwart, follow 813 00:48:17,400 --> 00:48:21,239 Speaker 1: our guest Levmnond on Twitter at levmanand follow our producers 814 00:48:21,280 --> 00:48:25,280 Speaker 1: Carmen Rodriguez at Carmen Arman and Dash Bennett at dashbot 815 00:48:25,719 --> 00:48:28,960 Speaker 1: Check out Bloomberg's podcast son to the handle at podcasts, 816 00:48:29,120 --> 00:48:31,480 Speaker 1: and for more Odd Lots content, go to bloomberg dot 817 00:48:31,520 --> 00:48:34,440 Speaker 1: com slash odd Lots, where we post all the transcripts. 818 00:48:34,600 --> 00:48:37,080 Speaker 1: Tracy and I have a blog and weekly newsletter that 819 00:48:37,120 --> 00:48:40,000 Speaker 1: comes out every Friday. Go there and sign up. Thanks 820 00:48:40,040 --> 00:48:40,440 Speaker 1: for listening.