Moody's Talks - Inside Economics - Systemic Threats, Supervisory Shortfalls

Episode Date: March 17, 2023

Mark and Marisa welcome third time returning guest Aaron Klein, Senior Fellow of Economic Studies at the Brookings Institute to discuss the recent bank failures. They converse and debate about how things went so badly off the rails, the government’s response and what could have been done differently, and the implications for the Fed’s interest rate decision next week.For more on Aaron Klein, click here.For the full transcript, click here.Follow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Sandy, the chief economist of Moody's Analytics, and I'm joined by my co-host, Marissa Dina Talley. Mercia, good to see you. Hey, Mark. How you doing? We're missing Chris this week. We are. Where is he? Strapsing through the Red Light District in Amsterdam. No, I'm just kidding. He's in the Netherlands.

Oh, that's right. His mom is, he says his dad is Italian and his mom is Dutch, I believe. And grew up in Argentina. Yeah. He's a worldly guy. No, really? He grew up in Argentina? Mm-hmm. Oh, so he speaks Italian.

I know that. Does he speak Spanish? You must. I would assume so. I've never heard him speak Spanish, but I assume so. And Dutch is not an easy language. I wonder if he knows Dutch. I don't know.

I can't even read. We'll ask him next week. Yeah, very good. And we've got a guest. Aaron Klein, good to see you. It's a pleasure to be back. Yeah, this is your third time on Inside Economics, and I don't think anyone's been on three times. Am I right?

I think that's the case. An outside guest now. I don't think so. No. Yeah. I'm setting a record. Yes, you are. You're setting the bar.

Yeah, absolutely. If I get to five, do I get a free sandwich or a coffee cup or something? Well, that's an interesting question. That's an interesting question. We do have these cowbells, you know, about our cowbells. So, yeah, we play a statistics game, which I don't think. Oh, yeah, no, I played that one time with you guys. That's right.

And you get a cowbell if you get the statistic, you know, right off the bat. But we'll make sure you get that. And also a bottle of wine. Unfortunately, the bottle of wine is under Moody's gift policy. So it's a good bottle wine, but, you know. One of the best lines in the season premiere of Ted Lasso, which we just watched, The other night was, you know, the thing, a great bottle of wine doesn't have to be expensive. Yeah, is that right.

That's true. That was a line set in the classic. And the cowbell will make me very popular among the other parents on the opposing side of my kid's soccer games. Well, these cowbells are heavy duty. I've learned a lot about cowbells. Apparently, there are many all over the world. And, you know, like every valley in Dell, I think that's the word you call it, you would say. Dell and Switzerland has its own.

cowbell, apparently. I could go figure. So we're on the quest for getting the cowbells. But anyway, it's good to have you. And you're a senior fellow of economic studies at the Brookings Institute and you're focused on anything financial related. And obviously, financial related is all we are talking about this week, you know, since the failure of Silicon Valley Bank and signature. It's hard to believe. But that. That wasn't even quite a week ago, right? I mean, at some point during this pot, the taping of this podcast, that's right.

One week because they closed it while the markets were open, which they are loath to do. The history of bank failures is they want to do it after the bank closes on a Friday and work all the way, they keep the bank closed on Saturday and work all the way through the weekend and have the resolution. In fact, during the financial crisis, when we had the record high number, of bank failures in 2009, they would be called Friday Blue Light Specials, so that the FDIC would close all these institutions on a Friday night and send out notes to all the other banks, you know, who wants to buy this, right? So the joke was like, if, you know, if you wanted to

buy another bank, you waited for Friday night to see who was on special. Yeah. That's great. So the fact that they closed the bank in the middle of market day is really a sign that the thing was collapsing faster than a house of cards. Right. And today's Friday, so a week later. And so I think everyone's kind of sort of on edge here, just waiting to see if, you know, there's going to be any other failures. And I guess we'll have to wait until hopefully until after the market closed to see that.

And hopefully there are no other failures. But I think the markets are a little nervous. Look, it's an interesting question about how many bank failures do you want. So I, well, if we want to play a game, yeah, America starts, right? I'm going to, you know, move us to the founding of the Constitution, not quite 1776. There was a declaration, but, you know, we didn't really have our own legal system. So America starts.

What year in America is the first year we're not a single bank fails? Oh, now that is a great question, a great question. Let me think. I'd say probably, and this is just a wild guess, 1832, because that's the year Tom Jefferson and John Adams died. All right. So you think we make it to 1832 without a bank failure? Marissa? Probably, probably, it's probably 1956 or something to go ahead. 50s were pretty stable, right? Supposed to be. Yeah, yeah. I'm going to guess there wasn't a bank. There wasn't a year without a bank failure. until not 2021. I know there was no failures in 21 or 22.

Right. That's all I. So the first year of American history without a bank failure, 2005. That is a great statistic. Man, we should have played the statistics game. That would have been, you were ready. Yeah. Oh, man.

The second year in American history without a bank failure is 2006. And I was up as chief economist at the Senate Banking Committee at the time. And the regulators come up and they say, we have done such a great job. We are such good regulators that we have such a great financial system where banks aren't failing because we're regulators. And it made me think, is your goal no bank failure? So we have like a little bit under 5,000 banks in America. And I started asking myself an intellectual question, what is the right number of failures? And I came away convinced the answer shouldn't be zero.

Zero bank failures has to be the wrong answer because that means that no bank is doing any different type of business model from each other, which means that they're all serially correlated risks. If you have 5,000 banks, a couple should try different things. And in the course of trying that, some will be good, some will be bad, right? Who knew that the answer to cell phones were little towers? you know, a couple thousand feet away, thousands of feet away from each other, as opposed to satellites in the phone, in the sky,

where a lot of capital, because they thought that was going to be how we were going to implement cell phones. A lot of people lost money investing in those satellites, right? We have plenty of history, you know, Netscape, pets.com, right? Like, there are plenty of, should it be the zero banks fan? That's got to be wrong. Although, yeah, I hear you. Although the most, I'm sure a lot of years, we had failures,

a few failures, and they're all pretty small institutions, right? So that's right. So the answer has to be twofold. One is you want a few failures but not a ton. You don't want a domino, right? Banking is at its core, a confidence game. It's trust. No bank can withstand the loss of trust of its depositors.

A mass run will take out any bank, no matter how great the bank is, because of the structure of the nature of the business of banking. So one, you want to have it so that, it isn't a domino. Now, the second question is, do they have to be small failures? That's a little tricky because if you go too far down the road, then you fall into too big to fail, right? Which is no bank, well, it's okay for banks to fail as long as they're not big, then they can never fail. Well, now you've created a, you know, a problem, right? There's a bunch of problems associated with too big to fail. So the goal, I think, ought to be, it's okay for banks to

fail regardless of their size. We have a system design where banks that take risks and make idiosyncratic bad choices, it's contained and it doesn't create a contagion that creates a loss of trust throughout the system where otherwise safe and sound banks fail not because of their bad business practices, but because of just the loss of trust in the entire system. Well, I also say I'm not sure bank failures is a good guide either because I'm sure there's a lot of failures that never fail, because other institutions come in and buy them up, right? I mean, I'm sure in all those years in 2005-06, 2021, 2021, when there are no failures, we saw a lot of M&A activity, right?

I think we're down to 4,700 banks, 4,900 in 2021 and steadily declining. So there's effective failure. Well, look, I think you're right about that. In fact, if you look at most banks that technically, that actually fail, they tend to be acquired. It tends to be the FDIC sells their assets. And from the depositor's standpoint, you know, there's almost no change. And it's kind of a different way to make a merger and acquisition. There weren't, you know, people said there weren't mergers between healthy banks in 2009 because it was cheaper to buy a failed bank, right?

Because the failed bank doesn't mean it's gone to zero. It tends to have a tremendous amount of value, right? Uninsured depositors historically get paid out over 90 cents on the dollar, I believe. there's a lot of value in the institution. It's just, you know, insolvent and its equity's gone down, right? I think we've all on this, right, all three of us have flown on a bankrupt airline, right, as the airline. Almost by definition, I'm sure that's true. Yeah, unless you just fly like Southwest and Qantas, right?

Quantis never crash, right? Was it a rain man? You know, all the others have bankrupted at least once. And so I agree with you, failures isn't a perfect measure, but it captures this concept that I think is important to appreciate that the goal of regulation shouldn't be perpetuation of all existing charters. Now, the other point you raise, Mark, is a spot on one, which we've seen a huge decrease in the number of banks. And the question starts like, oh, you know, we're down to below 5,000. you know, we used to have 16,000 banks in the 1980s. And the point I always like to make about that is, you know, we don't have 5,000 banks

because that's the economically optimal number of banks today. We didn't have 16,000 banks in the 80s because that was it. We had 16,000 banks because up until 1994, interstate banking was kind of very difficult to do legally. And we had a country, it shocks. I would, you know, most of the state. Most folks, even older listeners to the podcast who lived through the experience of the savings and loan crisis may not really remember that banks kind of couldn't really branch and operate

across state lines up until passage of what was known as the Regal Neal Act of interstate banking. You want to know, a quick tangential point. The company I started, along with my brother, in 1990, started because of the breakdown of interstate banking, right? Because at that point, banks needed information outside of their state. And that's what we did. Our company was called Regional Financial Associates. That was our bread and butter, providing that information to these banks

looking outside their immediate footprint to say, where am I going? And that's the company we sold the Moody's, you know, like 16 years ago. So, yeah. So I didn't realize that you got your start being ahead of the curve, realizing this interstate thing was coming.

No, no. I wasn't that smart. to, you know, stuff. Sounds like it. When I write the history, that's credit. This was coming. No, it happened.

And we could see, you know, what it meant, you know. And then also, the other beautiful thing was the PC. The PC was just coming into, you know, commercial use. We went out and bought some IBM PCs and, you know, data was becoming more accessible. And so you marry the PC, some data, you know, interstate, the breakdown, the interstate banking. And then, you know, we're off and running. You know, it's interesting you mentioned PCs because there was a brilliant conversation I once heard where they talked about the rise of computing power, changing the economics of banking because the ability to essentially process information and data, which is a lot of what banking is. I mean, banking is the movement.

I always say when I do a talk on payments, payments are two things, the movement of money and the movement of information. who's paying whom, how much went is a very separable element of the payment than the actual movement of the money between the two people. In fact, the actual money of the movement of the money often lags the movement of the information and that's okay. You know, banking is very information and that the rise of this has changed the core economics of banking in a way that favors economy of price. So in addition to- Sorry, you just broke up there. What was that? The economies of what? The economies of information and data processes change the value of scale and size and banking in a way that favors the bigger, the better.

Absolutely. And so, you know, the decline in the number of banks in America is a combination of the removal of prior regulation that created more banks that were economically, quote unquote, you know, the market would have created to. the rise of Moore's law and computing power, which changed the economies of scale to favor consolidation. And both of one, we can argue how temporary it was. I keep saying, well, you know, we keep changing the law so that, you know, to try and help smaller banks or to try and help bigger banks, we can debate what what the recent bailout of SVB does in moving that ledger. But Moore's law is just a thing, right? It keeps going. And it's, you can't legislate it away. You can't regulate it away.

It's its own power. But I think you're very wise to connect the rise of computing power and the changing nature of our banking system because I think they're deeply intertwined. Well, I want to come back to our, the U.S. banking system is somewhat unique in that we have so many banks. Most banking system around the world are very concentrated. A few banks dominate and they're very few smaller institutions. You know, I want to come back to that at some point in the conversation.

But let me, let me bring this back to the recent events. And, you know, the basic question is, you know, how big a deal is this? What caused the failure of Silicon Valley Bank? And let's say SVB from now on in signature. And how unique are those failures or is this symptomatic of something, you know, broader in the system? What's your sense of that? Right. So I've done a deep dive on SVB.

And, you know, first of all, what caused the failure of SVB was absurdly bad management. right and i've identified four core factors within the bank that are clear red flags and why their regulator allowed it is beyond me the fed the correct the federal reserve regulated Silicon Valley bank from head to toe usually in bank failures we start talking an alphabet soup of different regulators because you have a bank regulator you have a holding company regulator you have it a The Silicon Valley Bank was one of the largest banks in America that the Fed regulated from head to toe, along with the California state regulator. So America has state and federal bank charters. In fact, our earlier conversation in Marissa's historical insights, right, we only had state charters up until 1863.

We didn't have a federal bank charter until it was created under President Lincoln. who created it because it's hard to have state-based banking when half your states are trying to secede. So, but in the case of Silicon Valley Bank, head-to-to-fet, plus California. Here are the four red flags I've identified. One, explosive growth. The bank quadruples an asset size over five years, going from around 50 to 200 billion. Any time you see a financial institution grow this fast, it's a little. little tricky because the types of internal controls, risk monitoring, all the rest are very

different when you start to hit that hockey stick of growth, right? That's not usually how banks grow, even, you know, larger institutions. Just on that point, a CEO of a major bank that is no longer with us said to me once, he goes, Mark, if it's growing like a weed, it's probably a weed. So I thought that was, to me, like the key principle to good risk management. If it's going hockey stick, it could be real, you know, for sure, but you got to go take a really hard look at, you know, why that's happening. And, you know, that's really critical. Yeah. So, you know, banks are different, right?

This isn't like, you know, social media platform where you want that kind of growth. Banking is different that way. So two, paper reliance on uninsured deposits. So banks, when SVB failed, it was $200 billion, $16th largest bank by asset size. It had 16 branches. I actually think the true number is closer to four. The definition between a branch in an office can be a little squirly, but I'm just going to use the Federal Reserve's own data on this because let's not get into a data debate. So 16 branches.

The other $200 billion banks, Key Bank, M&T, Fifth Third, Huntington, these are the banks that are around $200 billion in assets that are banks, Main Street banks, community banks, regional banks, they'd be called, right? They have about 1,000 branches. If you're a $200 billion normal bank banking people and businesses and communities, you have about 1,000 branches. They had 16. They didn't bank people. They bank business, specifically, peck businesses, biotech businesses, venture capital businesses, right? Businesses have a lot of money in the bank. And most of it is uninsured.

And uninsured depositors, when there's a sign of trouble, are more likely to run from the bank than insured depositors. That's the purpose of insurance, right? And so, you know, anybody who's listening to the podcast who has under $250,000 in their bank, account, which is the vast, vast majority of Americans, your money is safe, whether your bank is or not. Don't run around and try to move your money. It's there. You'll have access to it. Whatever happens, the government stands behind the first $250,000. Everybody's bank, money in a bank account. And, you know, that's people. But businesses behave very differently. And when a business runs, it, you know, takes a lot of its money with it, right? If it's afraid. And so that's 90,

percent of their deposits were uninsured. That's insane relative to their peer group. Okay, here's a statistic. I'm going to ask you. I'm going to turn this on you. What is the average, what was the average size of a deposit at Silicon Valley Bank before it's failure? Ooh, average or median? No, the good question, but I don't know the median. Average. Average. Oh, that's lovely. So you had one crypto with over $3 billion, so that's going to knock it over here. I'm going to guess, three billion, wow. Yeah, yeah, yeah.

They got bailed out. Yeah. I'm going to guess the average deposit was 15 million. No, no. Well, okay, I got 1.25 million. Over a million bucks. Over a million bucks. 1.25 million.

Okay, here's the other for context. Yeah. What's the average size of a deposit account at a regional bank? These are the big. Yeah, this, this I think I'm going to be much closer. So I was doing something about it. And if you just took Americans, forget about businesses, but just people. And you took 20 people in a room together.

And you lined them up by income. And you grabbed the 19th highest earner. And you said, what's your bank account? How much money you got in the bank, right? 19th out of 20th. He'd say $69,000. So that's under a third of that, right? For the 19th, which I forget about the 18 below him, right?

So I'm going to guess for the average regional bank, the average amount in their bank account is like $8,000. Oh, no, that's too low. Well, I like the deductive reasoning, though. That's kind of cool. 177K. Okay. So again, these are averages. Yeah, I think that's not medians.

Not medians. I think the median would, I'm sure, would be closer to the number of the $1,37. K that you mentioned, but nonetheless, it gives you context. So that's reason number two. Right, right. So they're about seven or infines as high. And the core insight isn't just that it's seven times as high in average balance. It's that 177 is fully guaranteed so you don't have to worry. At 1.25, a million bucks of your money is not insured. Or wasn't before the bailout. Yeah. What's number three? Okay. Number three, interest rate risk. So, when, When this thing exploded, they went, and I did a little Twitter thread on this, you can follow me at Aaron DeKline.

You pull up their call report, they're publicly available information from like 2019, and they have like 20 million bucks in Fannie Freddie mortgage-backed securities. Two years later, three years later, they have 100 million bucks. So you remember when you could get a mortgage at three and a half and four percent and you were wondering who's buying, like Silicon Valley Bank didn't a originate those mortgages, right? They didn't really lend to people that much. Somebody else originated them. Fannie or Freddie, securitized them, and they bought that mortgage security. And then they didn't hedge it. I didn't, I couldn't find any hedging in their balance sheet. So you have a hundred billion dollars of mortgages and some treasuries, that I saw, unhaged against interest rate risk.

And, you know, as, as you know, and most listeners, I'm guessing, that this podcast now, right, when interest risks, when you hold low yielding securities, the value of that security falls. And that, you know, that eats into your balance sheet, right? Now, whether they're unreal, the accounting rules on that, whether you have to realize or unrealize that has to do if you're holding to security, holding to this or that. But it was unhedged interest rate risk. Banking Ludo-1. Here's another statistic to strike that point, huh? And I'll play another game. What do you think SFB's Tier 1 capital ratio?

Tier 1 is like high quality capital. Capital and capital is the cushion that banks have to digest any losses on their lending. It was like it was I want to say it was book value like non accounting for the actual losses that they had. Yeah. I think was around like 8%. 12%. 12%. 12%. 12%. And what was it if you marked? mark to market zero 30s. Zero.

So to your point, if you take the securities and value them at current market values because of the rise in interest rates and all these securities had interest rates with coupons very low, the value of those securities. And this is both in their so-called hell to maturity book where they had no plans to sell sensibly. And also they're available for sale, which is where they did need to mark. But if you did both, then there would be no capital left. They were effectively in solid.

So that's your point. Right. So that's number three. And by the way, this begs the question. The Federal Reserve saw this as their regulator. I would think the Federal Reserve might know that interest rates possibly could rise. And I'm not saying the central bank should have inside information and regulate banks

in a way that isn't what they're telling the world. But last, I remembered when they started rate hikes, Chairman Powell was very clear to the entire world that the Fed was going to aggressively raise interest rates to stamp out inflation. This wasn't like a secret thing, the monetary policy people and the Fed weren't telling the bank regulation people, right?

It's like if you're a bank regulator and you see your bank that you're regulating doesn't have interest rate hedges, and the chairman of the Fed is out there saying, we're going to aggressively raise rates to, stamp out inflation, like alarm bells? Where's your cowbell? Like, who's ringing that? So that was three. Unhedged interest rate. Yeah. Point four, I call dash for cash to the federal home loan bank system. And so your Silicon Valley Bank, you're sitting on these mortgage back

securities that are losing value. You can't, you don't want to sell them, right? Because then you're going to take the loss and realize the loss, but you need liquidity and money. So there's this thing in American banking. It's an anachronistic holdover from the 1930s. President Hoover signed it into law called the federal home loan bank system, which existed in a time where there were things called thrifts, which were different than things called banks. And thrifts made mortgages in commercial banks didn't really. And we can get into more of a history lesson on this. And Freddie Mac actually comes from the federal home loan bank system if you go back roots in history. But the home loan banks today will allow any commercial bank who's a member insurance company and some other people

to park mortgages on their bound sheet and give them in advance of liquidity and cash. Which is what the Fed's doing now. Correct. In fact, the home loan bank system has been called the lender of next to last resort, because folks do this, including there's a brilliant paper by Scott Frame, who's then at the New York Fed, and now is at the Dallas Fed, documenting how countrywide, WAMU, Indy Mac, all these folks ran to the home loan banks in 2007 as their mortgage business was imploding. Remember, like, the real estate market peaks late 06, right? 07, you're seeing all these troubles in this situation, but the bank failures hadn't started. And you wonder, well, how do they hold off, right?

It's like, what do you do when you're Wiley Coyote and you've run off the cliff, right? And, you know, don't look down, right? You fall when you look down. So you keep running. The home loan bank is what kind of lets you keep going. So a year ago, the Silicon Valley Bank appears nowhere on the federal home loan bank's top list of borrowers from San Francisco, their home loan bank. A year later, they're the number one borrower with $20 billion. So within a year, they've gone and put at least $20 billion of these mortgage-backed securities to the home loan bank for cash.

Now, one huge thing to realize, the FDIC, when a bank fails, goes in and takes over the bank. You think they own everything. Guess the only entity in America that legally has a right to the bank's assets before the FDIC, who gets paid back in full before the FDIC gets to see how much is there to give to the uninsured depositors, other claimants, Uncle Sam. FHLBs. Yeah, they're in person line. So the home loan bank gets paid back. So the bank a year ago was in trouble.

It starts hollowing out its assets, putting itself at greater risk of loss if it loses to the taxpayer, to the uninsured depositors, by running to the home loan bank and blowing up its exposure there, which is exactly what equity does when in trouble. When equity is in trouble, it makes riskier and riskier bets to double down because if it wins, it wins, it can't lose below zero. Right? And so, right?

This is all, you know, the San Francisco. On this point, I would disagree. I mean, I think the federal home loan banks play a very critical role in the system broadly, particularly to smaller institutions, to provide liquidity when there are panic, scares events. Now, it can't solve every problem, and you will have institutions that, you know, ultimately go belly up like SVB. But there are many, many cases where because of the federal homeland bank liquidity, it allowed those institutions to survive and fight on for another day. And that goes back to the need, in my view, for keeping having a banking system with a lot of smaller institutions.

Because if you didn't have the federal loan bank, we would probably, I don't know the counterfactual, but my guess is we would probably be more like the banking systems overseas that are highly concentrated because liquidity is very fleeting, particularly in these smaller institutions. But having said all that, that's another podcast. That's a whole other debate, which I'm going to have you on because I actually do some research in this area, too, and take a different view than I think it sounds like your take. No, no, no. So let me be clear because we're actually in more agreement than it sounds. Okay, okay. The federal home loan bank system put out $90 billion over 90, I think almost 100 on Monday in liquidity to help small institutions during a panic. I have no problem with that.

I agree with you. They play a vital role. But so it's not anachronistic. So you said you called them anachronistic. I called them anachronistic in the sense that they were originally created to be a central bank when these things called thrifts existed. And they didn't have access to the Federal Reserve because the Federal Reserve was only for banks. So it was like a central bank for thrifts. And now there is no difference between thrifts and banks.

In fact, both are members, both can access the Fed and both can access the home loan bank. But we digress. But let me make the core point. Let me make the core point. The core point isn't that the home loan bank system doesn't have a lot of value and provide a lot of incentives and should exist. The point is that when an institution off the radar to a massive amount of money during times of good, there was not stress last year, not a single bank failed last year, right? I'll give you two other institutions that, ramped up their home loan bank exposure last year. Silvergate and First Republic. If you look on the list, number one was Silicon Valley SVB. Number two is First Republic, right? So what it is, it's a signal that an institution. Yeah, I agree.

It's in trouble. Yeah. That's another, that's a great point. you're saying number four, why didn't you should have seen this because the advances, the loans they were taking out from the federal bank were taking off and that's a sign that you got a problem, there's a liquidity problem there. So where were, where was the Fed effectively, you know, because that was another sign. Hockey stick, a lot of uninsured depositors, the interest rate risk in the, in the asset side of the balance sheet and the federal home loan bank advances.

The combination of all those things. Each one begets each one, right? Explosive growth, where's it coming from, uninsured depositors? Well, what are they doing with the money? They're buying what they think are safe assets on the credit side, but they're not hedging the interest rate risk side. And then, oh, they got into trouble a year ago. How are they managing this trouble?

How is it that they didn't implode then when rates started rising? Well, they kept going to the home loan bank rather than take the expensive head. If you rewind the tape when all this stuff was obvious, the supervisor needs to sit down with the bank and go, look, you built up a pretty unhedged exposure. You got to eat the hedge. And the hedge is expensive and your earnings per share are going to fall. You're going to have an ugly earnings report and your stock price is going to lose value. Keep in mind, SVB triples in stock price from like 250, right, to almost 750 between 2020 and 2021, I think, 2022. right? So the same time you're having the Hockey's to growth and assets, the stock price is shooting up.

Why? Well, it turns out they weren't paying the money for that interest rate hedge. Unhedged exposure is more profitable when the market's in your favor, rates stayed longer than people expected, right? Particularly COVID, right? Rates went down. Right. Your 2019 mortgage book looks better. And, you know, you're loving the ride up. So the broader point, though, here to bring this back to the beginning of the conversation is that it feels like what you're saying. And I think I would concur that this is idiosyncratic. This is a feature of a few institutions, obviously SVB. And Signature and Silvergate were crypto banks.

So they have their own idiosyncratic thing going on. But broadly in the banking system, these may be issues. but they're nowhere near the issues as they were in these institutions. Right. So, I mean, I take, so one, broadly speaking, I think the under, absent the run of confidence or trust, the system had some pretty strong points. There's a lot of idiosyncrasies. But you look at the FDIC who published a chart on Monday, a week ago Monday, I think,

that showed some pretty large unrealized balance balances across the system on the mortgage security. like Silvergate. Silvergate was a total outlier. I think, Mark, you faintly between the Tier 1 capital at 12 and the unrealized at zero. And their chart, I think I saw it in the journal, that tried to do the same thing for all the rest of the banks. Well, if you do, just because I know the statistics, because I calculated, I didn't look at the FDIC, so hopefully they're roughly the same. But if you go look at the G-Sibs, these are the globally, systemically important banks, these are the big guys. they have a boatload of capital. But if you look at Tier 1 capital, it was around 13.

And then if you mark to market, there are security holdings, both the held in maturity, which they don't need to do and the available for sale, which they do need to do, it's down to around 10, you know, 10. And by the way, 10 is higher than what it was before the financial crisis. Yeah. Regional banks, just to round that out, they're in a little bit different situation. And I'm speaking from memory, so I might not have it exactly right, But their tier one before marking is like 9, 10%,ish.

And now with marking, it's down to 7%, you know, something along with those or is magnitude. Tier 1, tier 1. And does that include any, when you say mark to market, does that include the hedging that they've done that would would buffer the loss of security? No, no, no, no. It could even be higher. Yeah, because I couldn't count. I don't know how to count. That's pretty, I don't have the information to calculate.

The derivative hedge exposure is difficult. All you see in the banking call reports. Yeah. So I'm overstating the case because most of these institutions, they hedge. I mean, you know, they didn't, they're pretty, they're well managed and they hedge. But nonetheless. So so it sounds like though then you're saying, yes, the system is on pretty solid ground, but, you know, maybe there might be some other issues out here because of the unrealized losses on their,

on their treasury and mortgage security holding. That's what that sounds like you're saying. That's right. That's right. But even when you, per your analysis, even when you incorporate that, things are worse, but not insolvent. Yeah, not even close to insolvent. Right. So, yeah. So the level of the magnitude of it. And then the core question, right? Like, where was the hitch? Yeah. Okay. Let's move the conversation one step forward. And, you know, of course, the U.S. government stepped in aggressively on this Monday. The FDIC, the Fed, and the U.S. Treasury came together, proclaimed this a systemic event, and this is something they can do based on the post-financial crisis reforms,

and said that they are going to guarantee the deposits, all the deposits of these failed institutions. Now, effectively signaling, I think, that if anyone else gets into trouble here or most anyone else who gets into trouble in any other bank, those depositors are money good. They're going to get their money. Whether it's $250K,000 or above, they're going to get their money. And the other thing the government did was the Fed stood up a credit facility to allow banks to use their security holdings to borrow against them. them to get liquidity. And they could borrow as if those securities had no one realized losses. They were at par. So they can go out and borrow money. And it's a one-year loan at a somewhat higher interest rate to make it a little less attractive, but nonetheless. And then the third thing they did, the government did behind the scenes, was they cajoled and organized 11 big banks to come

in and provide $30 billion of deposits to First Republic, which is another banking institution that, you know, is in headquarter in California that's under a lot of pressure with deposit outflows. So those are the three things they did. So the first question, two basic questions. The first question is, what do you think of those steps? You know, do you think they were appropriate? And second, are they going to work? Do you think they're going to work in resources? restoring that confidence that you talked about and stabilizing the system. So question number one, what do you think? Was that the right thing to do? I would have done something different. Okay. All right. You know, one, let me say it's really easy to say I would have done something

different and not be in the chair of the people doing it. I was in that chair. I lived through tar. Because you were in treasurer. You were in Obama's treasury, right? I was in Obama's treasury. And before that, I was Dodd's chief economist on Senate banking. So I helped write TARP. So I lived through TARP from the two and a half page proposal. The administration sent us. By the way, fascinating little story tied together. The original proposal from Secretary Paulson was for the troubled asset relief auction.

You may recall, Mark, reverse auction. It was a wacko reverse auction. So that's TARA, if you do the analogy, right? All right. And what it, you know, what does Tara conjure? Gone with the wind. Exactly. Oh. That's it. Right. How does it do that? Gone with the wind, Tara?

That was the name of the plantation. It was Tara? The wind. Yeah. Okay. Okay. That is exactly the right. So think about that idea, right? We're heading into a financial crisis and the government's like the name of the government's program is the, the, the, the, the, the, the, the, the, the, the, the, the, the, the, the,

you know, the decrepit plantation and gone with the win. That's funny. And so all of us instead of banking are all baseball fans, you know, and we're sitting around here. And one, we're debating the wacky reverse auction versus what we thought was the right thing to do, which was capital injections, which is what the Treasury Department ultimately did. And we gave them the authority. The original proposal didn't even have authority for capital injection. We added that, even though at the time of passage, they still said they were going to do the auctions.

They reversed course wisely. They were wise. In theory, it was a brilliant idea. Yeah, but actually implementing that thing, you know, pretty, I don't know, couldn't do it. Certainly not given the time that the treasury had. So we thought to ourselves, what's the right analogy for the American public, right? It's not gone with the wind, right? It's a tarp, right?

When you're in a baseball game and the storm clouds come and the rain comes and everybody has to leave the field. you roll out the tarp storm passes you roll it back fields good we can all come back out so interesting i didn't know that that is so cool right so is that widely known is it just me i does that most i i don't know if that that was in uh some of the various books i mean you know just change one letter in the acronym yeah um but tarp is you know among the banking world a household name right like you know for good or bad it just for folks out there we're kind of talking a beyond folks, but this is the bailout. Remember the $700 billion bailout for banks, the housing industry and the vehicle industry? That was TARP. And it got voted down by Congress

initially. Chaos ensued. Then Congress reversed itself within 24 hours, I think. Mark, since you point that out, when the House voted down the original bill and market chaos went absurd, we regrouped and said, what can you add to this bill to get more votes? one of the things we add it, increasing the deposit insurance cap from 100 to 250. So you can go back and pull up the roll call vote on the text put before the House, which was the deal, right? If the House had passed that first deal, the Senate was going to pass it, the President was going to sign it. And that would have been the law, no increase in deposit insurance. After the House votes it down and we need more Republican votes, we go, what are the things we can give that will attract,

more Republican votes that aren't going to mess up the core premise of the bill, right? Because some people want to do all sorts of different things, right? And one of which was an increase in the deposit. So that's how you even get from 100 to 250. But, you know, the core kind of point that you're raising, right, which is what should we, so I just, all this is by way. You said you were going to do something different. All this is saying, you know, I don't have access to the information.

they had, I wasn't subject to the time constraints that they were, and wasn't requiring the level of consensus that is required to turn all the keys, right? I mean, because the Treasury, the Fed, and the FDIC all had to agree. So even, you know, even if Aaron was in charge or whatever of one of those levers, if I couldn't convince the other people to do what I wanted to do, right? One, could you have sold SVB on? somebody else. Could you have sold the bank and its deposit network to another institution? That would have seemed to me to be preferable. That's very much how the traditional bank failures are resolved over a weekend. The other bank gets the business. They pay some money for it. In the United Kingdom, they did that. I think it was sold for one pound. Yeah, to HSBC. But that's one pound more than we got in this failure. In fact, it's a lot more because we're going to suffer the losses.

So that's option one, which I think was prefer. In all fair, that goes to the information, right? I mean, you can't do that unless, I mean, they tried. I mean, at least reporting suggests that they tried. Well, they failed. Well, they tried. They got some bids. The reporting says that one of the main hiccups was legal indemnification in case of lawsuits,

which, you know, at various levels could be provided, right? If you go back, right, and one of the reasons we keep going back is because going back is deeply illustrative, right? A lot of banks going back bought failed banks, WAMU, which is the larger failure, right? Everybody says Silicon Valley Bank is the second largest, right? These are all nominal terms. WAMU was larger, but WAMU was sold. WAMU didn't get uninsured deposit bailout because, right, J.P. Morgan bought it. But WAMU got sued.

what J.P. Morgan underappreciated in that purchase, and I think Jamie Diamond has said this, is I knew the assets of the bank, I knew their liabilities. What I couldn't know was what their legal risk was for the scuzzy practices that they'd been associated with in all the crappy, toxic mortgages and subprime stuff that they had been part of. So I got sued, not for what JP did, not for practices under my life, but for practices under what I acquired. watch. And part of the people suing me were the government. And he said, fool me once. Right. And so even it's not JP, the other industry. So could you have offered legal protection? Would that have made a difference? I don't know. But the reporting seems to indicate that was one of the

hangups. I think most people would agree with you. If they could have sold it over the weekend, that would have been preferable. Maybe, although, you know, I'm not sure that would have stemmed the confidence line that we're still, you know, it's still, even despite all the things the government has done here, which is massive, you know, people have no reason to worry about their deposit, but nonetheless, there's still a lot of angst out there, right? So, but, you know, that's a case where I would, I kind of sort of give them the benefit of the doubt because of the information. I mean, okay, fair enough. Okay, what else would you have done? I would have had the uninsured depositors take a haircut.

Oh, you would have. Because of moral hazard? Why? For a variety of reasons. It's not just moral hazard. You know, it's the way the law is. Right? No, the law says if it's systemic and they deemed it to be systemic, I can guarantee that's the law.

I understand that. But if SVB had been deemed systemic before that day, they would have been subject to enhanced prudential standards under the federal. The Federal Reserve is the one who decided. whether or not you're systemic for regulatory purposes, and the Fed had chosen not to subject them to enhance regulation. But the reality was they were systemic. I mean, at least that was the judgment of the people involved. I mean, if I don't do this, the system is going to evaporate in front of my eyes, right? So it's a judgment call. Look, look, I mean, the judgment was also said that if we didn't bail out money market mutual funds due to COVID, it would be systemic. If we didn't,

if the Fed didn't bail out junk corporate bonds, it would be, I mean, there's been a lot of deciding that things are systemic that have resulted in large taxpayer gifts to wealthy holders of investments who didn't quite turn out the way they'd hoped. But the risks are asymmetric. I mean, you may be right, but if you're wrong, that's a problem for everybody, including and most importantly for low-income households and they're going to get crushed. They're going to get crushed in that kind of scenario. It turns out to be successful. You're talking about getting crushed in the recession that would come. Not about the deposit. Maybe the bank, there could be a lot of bank failures. It could be pretty messy to everybody else for everybody involved.

What you're saying is true. I mean, I believe there's some low-income people. It would stagger me if there weren't, right, that experienced hiccups in their paychecks as a result of this, right? Sure. One of the arguments that was being said was, well, businesses need this to meet payroll. I'm dubious of that claim. I'm sure that's not, I'm sure that's true in some business case, right? But Roku had $450 million. Well, one second. Talking now as a small business owner with cash in the bank, and at the time, it was a long time ago, so I had over $100K in the bank. if I didn't get that money, payroll would have been a problem.

But hold a second. How much of that money did you need? So Roku had $450 million. By the way, Roku had $450 million at Silicon. They had other bank deposits, right? And so they would have had access 60, 65% of that money Monday morning.

Were you running your business to the point that your bank account was going? At times, I was trying to figure out whether I should pay my electric bill. Yeah. Yeah. Okay. You're running no closer to now. Yeah.

I don't know how many of those guys at Silicon Valley Bank were in the situation I was in. Right. But we do know Roku, right? Roku had about I think 470 something million. And they would have had access to a little bit under 300 of that immediately. And then the rest they would have gotten access to over time, right? The history says that you probably would have gotten 90 to 95 cents on the dollar. But depends.

By the way, one of the ironies is the tumult in the market. has radically increased interest rates, which has increased the value of the security that they'd held that they'd lost, right? So the carcass of Silicon Valley Bank is worth more today than it was a week ago because of its own failure. Let me ask you another question on the moral hazard. Just to explain that to the listener. The idea is that if you have big depositors, they need to be sensitive to the financial

condition of the bank. they're putting their money. And if they don't care, then that incensed the financial institution to go out and take bigger risks with their deposits because everyone, you know, knows that they'll get their money back. So by not forcing a haircut on these large depositors, you run the risk that no one's disciplining the financial institution and making it sure that it's prudent in its practices. Right. Not just.

Do you find that a big, a good argument? Yes. Not just Silicon Valley Bank, but all banks, right? Because as you point out, if another bank failed, right? It's implausible to imagine that their uninsured depositors wouldn't be made hold. And this was a question that I think Senator Langford. At this time.

At this time. At this time. Because of the action. Friday, we talked about, like, we're taping this on a Friday. Another bank could fail over the weekend. Yes. But you were mad. If it was small, like super small.

Not at this point, no. That's what economists call that horizontal inequity. Two equal, like Peter Thiel had 50 million bucks in Silicon Valley Bank. Yeah. He's getting all 50 million of that. There's no way if you had the smallest bank in America fail and you had one person who had $1,000, they're going to take a haircut. Right.

This goes back to systemic. I'm worried. I'm talking about the least systemic bank in America if it failed over the weekend. Right. Would their uninsured depositors be made whole? I think in the current environment, I suspect they probably would be. Yeah. I mean, if they would be.

It would be outrageous. It would be outrageous. It would be outrageous. It's so fragile. Right. So now every bank is systemic. In this current environment, yeah. We are in a systemic crisis.

Every whole, $4,700 are systemic. Yeah, they are. And the same with the credit unions? Yeah. Every institution, if I were king for the day and I was sitting there today, literally today, Friday, March 17, it was going. Right. Yeah.

In this environment. In this environment. Absolutely. Yeah. So I'm going to read a quote from the, from what became the Banking Act 35 by the, by FDR's chair. Did you just have this handy? I mean, you say you have a banking act of 35 on your computer screen? What's what heck is that all about?

It's framed on this wall. Yeah, yeah. Go ahead. Go ahead. Okay. So they're debating what the deposit insurance cap should be, right? in the New Deal FDR era in the midst of the Depression. This is the chair of the FDIC, Roosevelt's new dealer.

Quote, we recommend that the maximum limit of insurance to any one depositor be retained at the present figure of $5,000. Congress in establishing deposit insurance was presumably most concerned with the mass depositors with small accounts. Our reports cover 51,000 million of which over 98% are fully insured, with a $5,000 limitation. Many of the accounts not fully covered are interbank accounts, public funds, deposits of corporations, institutions, and trust estates. The actual number of individuals with deposits in excess of $5,000 is probably less than 1% of the total number of depositors. To rate of insurance above $5,000 would materially increase the maximum possible liability of the FDIC. If all deposits were insured, this would be more than double.

It would be increased, blah, blah, blah. the insurance corporation's interest in the sound operation of banks is more tangible and more vital than that of any supervisory authority deposits in practically all commercial banks and trusts there are two courses open to the fd i be a charitable institution which will pay for the mistakes bad banking and dishonest of bankers in which case the cost of insurance must be set so high that it will be an injustice to every sound bank. Or by placing that on a sound basis, the corporation may be used as an instrument to improve the standards of bank management and reduce the losses to depositors through bank failures. Of course, which I prefer, requires that the standard of bank supervision

throughout the country be improved, that the FDIC be given the right to protect itself against excessive risks. And finally, the FDIC not be handicapped by taking into the fund, which are unsound or by continuing in the fund which are mismanaged, end quote. Look, I'm not arguing that all bank deposit should be insured or guaranteed forever. I'm not arguing that. I think we need to roll that back. And maybe we take a 250 pay up to something. When the systemic crisis is over.

But then the next systemic crisis happened. We are in a systemic, in my view, confidence is so fragile. that if we allow any depositor to not to get a haircut, we're toast. The whole system is going to come on. Mark, just so I understand your view, there's some systemic, non-systemic toggle. Yeah. Which the government picks. That's right.

And. Because they have information to make that judgment. Yes. Well, but hold on a second. We know what their information of their judgment was 10 days ago. Not really. Yes, we do. No, we do because.

under current law, the Federal Reserve is required to pay banks between $10,250 billion as to whether or not their failure would be systemic. No, no. Yeah, I understand that. I understand what you're saying. That's ex post. No, that's ex-ante. I mean, it's ex-ante.

Now we're in the real world. You're observing the liquidity drain from the system. And because of the law change after the financial crisis, you now have the ability to say, okay, we're in a systemic crisis or environment. And in that period, I am going to guarantee all the costs. I understand that. My point, you mark, is before the crisis, the government got it wrong. Yeah.

I'm sorry, the Federal Reserve got it wrong as to whether or not the failure of Silicon Valley Bank would trigger this topic. Any individual institution may be non-systemic, but when you take it in the context of the environment that you're in, one institution that you can push you over. the context of the environment is 100% predicated on the failure of SVB. No, no, it's not. It goes beyond that. Now it does. Well, no, even before that, I mean, the economy was weakening. You know, there was a lot of angst over the economy and where that was headed.

Recession risks, you know, most economists think it's the entire backdrop of, you know, the environment that you're operating in. Also, it's a global system, too. I mean, you could see the system seemed to be writing itself and then Credit Suisse becomes an issue There's a great piece in the FT where the European regulators were crashing the U.S. decision to bail out the uninsured depositors. I think one of them called it a joke and said I've sat through years of their meetings and lectures about systemic risk and now, right?

The scenario that you're describing where sometimes uninsured depositors get bailed out and sometimes they don't, they only get bailed out if the failure is systemic is going to lead all uninsured depositors to go to the too big to fail banks. There's no way to keep the community banking system, which I think both of us, you and I think systemic events are rare. You know, there may be once every decade or 15 years. We've had three since 2007. Right. COVID was systemic.

People got bailed out. We didn't have to go through bank failures. Generally, the money market. COVID is COVID. I mean, okay. Every recession is systemic. I mean, the 1990 recession, we had the savings and loan crisis. That was a systemic collapse of that.

Every recession becomes systemic almost. Yeah, I wasn't. Maybe it gets abused. I don't know. Maybe as we move forward here, this becomes, you know, a regular occurrence for folks in power to do it. But I, so far that has not been the case. But anyway, well, let's move on.

Let's move on. Because there's a couple, there's so many things I want to explore with you, and we're going to run out of time. One other thing I wanted to talk about, and then last thing I want to talk about a little bit is, if you've got any of you what this means for monetary policy, you know, what the Fed should be doing next week. But before we get there. Yeah, yeah, yeah. You know, one of the things, debates that have come to the fore in this is around the rollback of some of the Dodd-Frank position. Dodd-Frank was the piece of legislation passed after the financial crisis that reformed the system, more capital, more liquidity, stress tests and everything else. That was rolled back a bit in 2018, maybe more than a bit. And one of the things, one aspect of that was that for banks with less than $250 billion in assets, and of course SVB and these others are less than $250 billion, they did not have the same kind of stiff requirements on capital, stress testing, liquidity, liquidity and risk management that banks over 250K,000.

Do you, what do you think? Is that a reasonable debate argument? I mean, do you think that had an impact, that rollback on the events that are unfolding here today? Let me say the following. Dodd-Frank subject banks over $50 billion to enhance prudential standards. it's tougher regulation. That threshold was changed in the legislation you're describing,

often called S-2155, from 50 to 250, mandatory. SVB, as we all know, went from just under 50 to 200. The key point, there are two key points. One is the law said it was mandatory over 50, and then it was changed to discretionary between 100250 at the discretion, and mandatory above 250. So, one, clearly the Fed botched its discretion on whether or not to handle, put in enhanced prudential standards between 100 and 250, right?

This gets back to the conversation we're just having where the Fed judged SVB not to be systemically, their failure to be not systemically important. Right. two, had the Fed judged it right, would enhance prudential standards have caught this. My core point, getting back to the beginning of our conversation, is you didn't need enhanced prudential standards to catch this. It failed basic prudential standards. This isn't a question of whether or not the honors test would have caught you, right? Could you have passed the honors test? You shouldn't have passed the remedial test.

Now, maybe the honors test would have flagged it sooner. Maybe not. We can go back. I think there's already been varying pieces of analysis looking at each debate, right? The stress tests, which is another element of enhanced prudential standards, which the Fed touted as being a major advance, stop testing for interest rate risk, I think, in 2015 on an upright scenario. Right? So, you know, the third level analysis is going to be, well, you know, it depends which test you were used.

using. The test that was being used by the, you know, a Democratic era regulators was tougher. The Republicans weakened the test, right? It wasn't just a question of whether you had the stronger test, it would be the honors test. It was this or that. My core point in this conversation is the basic test should have caught this thing. And I think that the bigger issues here have to do with the core competency of the Federal Reserve as a bank supervisor. Right. We use the term regulation and supervision interchangeably in discourse, but they aren't. There's separable concepts. Regulation are the rules. Supervision is the enforcement. I know, Mark, we share a fandom in football of the same team, but of the same game.

My fandom's trunk as has the value and competence of my team, right? You're the company commanders. So when I was a kid, Washington football was a great organization from head to toe with a great owner and a great coach and Joe Gibbs and won three Super Bowls. Then we had a horrible owner who's like possibly the worst human being on the planet. I take over the team in Dan Snyder. And we've suffered through nearly 25 years of misery and disgust. Like I gave up my tickets. 25 years.

Just about. He took the team in like 97, 99. 98. It's complicated when you take ownership and blah, blah, blah. Jack Hank died for a while. right, like when you have a bad owner, the toxicity of that franchise from head to toe is revolting. And like, you know, I don't think I watched, I didn't watch a full game. I don't know if I watched more than, you know, 30 minutes.

I watch soccer now mostly. So my point to you here is, right, in football, there's a rule as to whether or not something's a catch. And sometimes you watch a game and you see a play and you're like, oh, God, that's really tough. and like two rules experts disagree and like the actual play doesn't really comport with the rule book and it's so weird. That's regulation, the rule book. Supervision is the enforcement. It's the referee.

Sometimes the ref just botches the call, right? The rule isn't the problem. The rule is crystal clear. The ref just made the wrong call. Supervision can't be legislated. Congress can't legislate judgment or compromise. They can make the rules and they can decide we're going to write the rule or we're going to give you the discretion you write the rule. Congress can decide how much of the specifics to fill in in the rule and how much discretion to give the experts the regulator, right? But they can't legislate competence and judgment. Although in this case, if the old Dodd-Frank rules applied to banks down to $50 billion, that certainly would have helped with the supervision, right?

Maybe. Well, almost by definition, because then these banks would have had taken these stress tests that the big guys take every year. They would have taken them. But the stress test stopped testing for raising interest rates in 2015. Which, by the way, you're right about that, which I'm so confused about. I mean, when I got the stress test, because we do a lot of work with the banks and helping them in their capital planning and their stress testing. When I saw the stress test and didn't see an interest rate shock scenario, I was perplexed by that. What do you, that just, blew my mind. What do you think? That was all. I think this gets to the core thing, right? Which is we keep being told over and over again, trust the Fed. They're awesome. They're super smart. And you raise the point about monetary policy. Okay. Yeah. And I want to get to that because our time is limited. But one just to nail you down. So you're saying it, you don't really think it matters. No, I think it mattered. I think it mattered. The Dodd-Frank rollback mattered. But at the end of the day, it's a supervision that really matter, how well the regulation was implemented or not implemented.

If you're saying enhanced prudential standards would have helped in the case of Silicon Valley Bank, yes, would they have necessarily gotten it and had the thing happen sooner? Hard to know, never know the counterfactual. But it's, if you can't pass the remedial test, why are we sitting here arguing whether the honors test should have been applied? and should have been written better. Yeah. Okay.

So let's move to the Fed. And let me frame it in this way. So the Fed obviously has been aggressively raising interest rates for the past year in an effort to slow growth and bring inflation back down to its target. Those interest rate hikes, you know, fundamentally did contribute to the stresses in the banking system. But that's by design. That's how monetary policy works.

You know, one of the channels is that it works through the banking system and makes banks more cautious in their lending and that slows economic growth. So nothing unusual about that. But here we are. The Fed has a meeting next week. The question that is on folks in the market's minds, at least, is should the Fed continue on with its rate hikes, which it would most likely have done if we had not had the events of the last week? Or because of the events of the last week and concerns about financial stability, the ones I've been expressing and you've been expressing, should they pause? No one's talking about an interest rate height, let me cut at this point, but a lot of discussion around pause. So as that is a frame, you know, take that wherever you want

to go with. Yeah. So, Mark, let me take that in a couple different ways. One is the week before, right, Silicon Valley Bank failed. Chairman Powell went around the hill. Republicans pressured him to lower bank capital standards and to not go, not be. a tougher regulator. Nobody asked him about problems with Silicon Valley Bank. Nobody asked him about financial stability that I can see. And he projected, he didn't raise the issue at all to Congress. That Monday, before he spoke, the chair of the FDIC went out and gave a public presentation to the institution of international makers and said, there are a lot of unrealized losses on these mortgage back security. So the chairman of the FDIC is waving the flag on Monday. Powell's not saying a word.

on going around the hill. Nobody's asking him about it either. In fact, the questions look pretty bad in retrospect. And now, boom, right? We were talking about the central bank as a regulator and his monetary policy center. And, you know, there's a thing about institutional management and organizational philosophy that I've been reading, which says that all organizations only have one telos, one guy. one guiding principle, core, most important thing to the institution. What word did you use, kilos?

Telos. Tilos. It's Greek. Tilos. My Greek pronunciation may be poor, but my boss and mentor, the late great Senator Paul Sarbanes, you know, a proud Greek American who frequently spoke in Greek of folks and, you know, would use Greek words and concepts in the ancient Greeks. Brilliant, brilliant man, Rhodes Scholar, just a wonderful, wonderful senator. And I often think what would he do in this situation?

He says, in or is a, you know, Tilos is the guiding core principle. The Federal Reserve's Tilos is monetary policy, as well it should be. It can only be a guiding principle can only be monetary policy. And you can only have one. Now, bank regulation should that be married in with the central bank? Or are we going to constantly see these problems? We're number one. There's a good frontline special where Sarah Bloom Raskin, who is a Fed governor and a deputy secretary of the treasury and a Maryland state banking commissioner.

So the same thing. So the number one thing of the Fed is always going to be monetary policy. Bank regulation is this thing to decide, right? And so here we've entered a bizarre situation. Fed Chairman Powell has been trying to prep the markets for an even greater interest rate hike, 50 basis points. You look at the was March going to be 25 or 50. If we take this podcast 10 days earlier, that would have been the dominant question, right? Now you have a system situation where bank instability driven by the failure of the Fed as the supervisor of Silicon Valley Bank to have done the right thing.

to it a couple years ago as a supervisor and head this thing off has now interfered with their monetary policy. So you can pause rates and be dovish. Stock market will go up, right? Presumably, right? There'll be more confidence in banks. The value of the losses that these banks hold on these types of securities will diminish. Right. And is that going to then, what does that mean for inflation? I, I, I, haven't followed this, was it the PPI that was due this morning? That was yesterday. That was yesterday.

It was good. It was a good number because the number of- Yesterday or the day before. It might have been the day before. Two days ago. Two days ago, yeah. The days during SVB like blowing the months. I know.

The prior number was bathed. Well, the CPI was bad, but within expectation. So really, markets didn't react. Of course, they were all focused on. But if I'm asking the question, Hold aside market. I'm asking the question, is inflation coming down? Is inflation getting under it?

It's coming down. Is it the question? But it's statistically coming. Right. It's coming down because of what, you know, the numbers that are rolling off 12 months ago, Danny Blanchbauer. Well, that's a whole other discussion to be. But the CPI number was not great.

Right. Well, let's put it this way. If not for SFB and SVB in the last week, the Fed would have raised at least a quarter point, probably maybe. 50, but now the question is given, and there's real economic consequence to what's going on now, right? I mean, look, the financial conditions here are going to tighten. The banking system is going to become more cautious. And yes, you have some benefit from lower interest rates, but they're not down that much for,

they're down for treasuries, but they're not down for mortgages. They're not down for corporates. You know, the actual borrowing rates haven't really come down that much. So the net of all of that is probably a meaningful drag on economic growth, which would be disinflationary. So in that, and of course, there's a lot of uncertainty. Who the hell knows what's going to happen next and, you know, how much financial stability there will remain and what's the fallout of that going to be. So those things would argue, hey, Fed, just why don't you take a break, pause, take a look around, you know, if the system stabilizes and you get another strong job number and CPI number, you've always got the May meeting six weeks from now, start raising rates again and fight inflation. That would be my argument. But so Mark, Mark, you're saying that, and you know, I've been very

critical of the Fed. I'm not a conspiratist, right? But I'm, I've been critical of their job as a bank supervisor. We haven't even talked about their holding company regulation and what was going on with the venture capital fund of the different podcast, but I think could be the next shoot a drop.

Oh, then we're definitely having another podcast. That with the federal home loan banks. We've got to have you back. You should have Kate Judge and Con Hurley join that one because they're really Yeah, yeah. Yeah, that would make for a real interesting podcast. They're really good. Or Mark Calabria, they're former record.

Karen Petro. Yeah. Oh, Karen's great. So the point you're saying is this banking earthquake, right? It's not a tremor, right? It's a quake. It's a quake. This quake is going to be.

disinflationary. All else being equal, yeah. So even though interest rates have fallen for treasuries, the drag on economic growth as a result, right? Because there is a macroeconomic point, and you made the point about working people, and I think laser-like on working people. I made a comment, I didn't finish it, that the payroll disruptions, right, we got sidetracked on how big that was, somebody missed their paycheck on Friday because of this. It was reported at a coffee shop that I go to in D.C. Compass coffee, not as good as bump and grinded silver spring, but still when you're in D.C. You got to get a car.

Wawa, my friend. Wawa, strong. I love the wa. The point here is, they said they had problems making paycheck. Did one of their employees get an overdraft over the weekend because their paycheck didn't come through on Friday? Overdraft is a huge business. Huge punitive cost. It doesn't cost a bank 35 bucks.

to give you money to cover your overdraft when your bank, when your payer doesn't come through. They didn't suspend overdrafts over the weekend. Peter Thiel got all 50 million of his dollars guaranteed, but somebody is eating an overdraft because their company didn't make payment because of SVB and the regulators, right? We've had a failure to focus on working people and protecting working people. While we're running around making sure that Peter Thiel has access to all 50 million bucks immediately, not two-thirds of his 50 million bucks with a potential small haircut for having an uninsured deposit. By the way, rumors also that Theo encouraged his company to yank their money

causing the run, right? And I'm not blaming the companies that yanked it. I'm just simply pointing out that if you're back to monetary policy, I mean, I hear you. Yeah, but back to monetary policy. Back to monetary policy, I have no problem with a pause. Pause. I've often thought, you know, that is raising, are raising rates attacking the root cause of inflation, or is the root cause of inflation a supply shock as it relates to COVID, as it relates to energy, right? What, right? Because monetary policy works to curb inflation far better on demand shocks than supply

shocks. Yep. And if you believe, as I did prior to SVB, that supply shocks were more at the root cause of inflation than demand, then the impact of rising rates is less influential on so I'm trying to be intellectually consistent and prior is from March 1. And that would be where I, you coming on your podcast is tough, man. You really get you down to, you know. Well, you know why, Aaron, because it's just in our DNA, because we have to actually put

pen to paper, create numbers, put it in a database. Clients use it and then they come back and say, well, why was it 3.45678, not 3.54678? You know, so we're down to brass tax here. But this was fantastic. And we're going to have to call it quits because I know you're incredibly busy and you've spent well over an hour with us. Thank you. And we didn't even get to a bunch of the other debates.

But we will definitely have you back. I do want to have you back for that federal homeland bank discussion and any other risk you see out there. So, well, that was a great podcast. I want to thank everyone for listening in. I do want to mention that it was obviously a busy week and I was on two other podcasts you might want to tune into. The first is the big picture. That's another Moody's Talks podcast that we went into depth with Bill Foster on the debt limit issue. Bill is the analyst in the rating agency that rates the U.S. government debt. And I think you find that very interesting. And in the bubble podcast with Andy Slavitt, it was on with Justin Wolfers and Ben Eisen of the Wall Street Journal.

And we were obviously talking about recent events in the banking system. So those are two other podcasts that you might find of some value. And with that, dear listener, we're going to call this a podcast. Talk to you next week.