The Daily - A Third Bank Implodes. Now What?

Episode Date: May 2, 2023

On Monday morning, the federal government took over a third failing bank — this time, First Republic.Jeanna Smialek, an economy correspondent for The Times, discusses whether we are at the end of the banking crisis, or the start of a new phase of financial pain.Guest: Jeanna Smialek, an economy correspondent for The New York Times.Background reading: First Republic bank was seized by regulators and sold to JPMorgan Chase.Key takeaways from regulatory review of bank failures.For more information on today’s episode, visit nytimes.com/thedaily. Transcripts of each episode will be made available by the next workday.

From New York Times, I'm Michael Barbaro. This is The Daily. On Monday morning, the federal government took over a third failing bank, this time First Republic. Today, I speak with my colleague, Gina Smiley, about whether we're at the end of this banking crisis or the start of a new phase of financial pain. It's Tuesday, May 2nd. So, Gina, another day, another bank failure. Starting to be the pattern these days.

Very much. And after these two banks had failed, Silicon Valley Bank, then a couple days later, Signature Bank, the hope, and I'd say the expectation, was that this crisis might be over. It was not over. In fact, a third bank, First Republic Bank, collapsed, and it was even bigger as a bank than the previous two that failed. So tell us about why First Republic Bank ultimately went under. So tell us about why First Republic Bank ultimately went under. I think that what happened at First Republic was sort of a slow motion reaction to what happened at Silicon Valley Bank, that first bank that failed. So Silicon Valley, as you'll remember, had planned pretty poorly for rising interest rates. It had to sell a bunch of investments that had lost value as interest rates rose, and that spooked customers. So the customers pulled out their money to interest rates, and a lot of customers over

the $250,000 federal deposit insurance limit also collapsed a few days later. Right. And just to remind people why that $250,000 number matters, that's the point at which if you fear your bank might fail, you're very worried about that money. You should pull it out is the thinking, which actually becomes a self-reinforcing cycle that leads to a run on a bank. Yeah, exactly. If you have deposit under $250,000 at a bank, you don't really care if the bank fails because the federal government is going to insure that. Your money's good. But if you're above $250,000, the federal government doesn't insure that. And so your money's good. But if you're above $250,000, the federal government doesn't insure that. And so you are much more likely to look around

and feel a little nervous if your bank is doing anything funny and feel like you need to run for the exits and make sure that money is safe. And so that's very much what we saw with these two banks. So these first two banks fail, and then people are looking around to see who else is vulnerable.

Some investors now concerned about the health of First Republic, which also operates in Silicon Valley. And First Republic has a lot of shared characteristics with these other banks. And so what we start to see is really an exodus of deposits from First Republic. Tonight, a lifeline for First Republic. And we see the big banks try and stop that, actually. Eleven of the country's biggest banks unveiling a rescue plan to pump $30 billion in deposits to prop up the structure.

And so they pool together and inject $30 billion of cash into First Republic to try and say, hey, it's safe. It's okay. It's going to make it through this period. We have confidence in it. And so that basically served as a lifeline. It gave First Republic a few weeks to get back on its feet. But that, unfortunately, did not work. Tonight, we're getting our first glimpse of just how dangerously close to collapse First Republic Bank has come. So Monday of last week, they disclosed that a bunch of deposits had left. The bank revealing that customers pulled more than $100 billion in deposits during the crisis.

That's a 41% drop. It is a staggering number. $100 billion is out the door. Stock price, it just plunges all week long. It seems really obvious that this bank is not going to make it. Breaking news overnight, another American bank has failed. Just this morning, financial regulators in California seized First Republic Bank. It marks the second largest bank to fail in American history. The Fed struck a deal to sell... So we should think of what happened to First Republic as pretty similar to what happened to Silicon Valley Bank and to Signature Bank, but just a slower motion failure. It took longer, but it was more or less kind of the same.

Yeah, I think it was really sort of a chain reaction. It was the last domino to fall after Silicon Valley Bank set off the cascading dominoes. But this was also a slightly different situation. When it came to Silicon Valley Bank and Signature Bank, the government swooped in and backed up big depositors. In the case of First Republic, the government instead immediately announced that it had arranged a shotgun marriage to JPMorgan Chase.

And so by selling it off to a private buyer, the government also managed to make sure that depositors aren't going to lose their money, but it did it in a different way. Got it. And you know, why would JPMorgan Chase want to buy a bank that is failing so badly, losing money every single day? might collapse and leave its depositors out in the cold is pretty nerve-wracking for the rest of the banking system. First Republic's a big bank, and if something goes wrong with it, you could really see sort of panic moving all through the banking system. So this really staves

off that possibility. I think the other thing is a lot of the sort of assets on First Republic's balance sheet, a lot of its loans, a lot of its, you know, sort of business isn't actually all that bad looking. It just didn't hold up well in the face of rising interest rates. And JP Morgan has also, in this case, got some guarantees from the government. The government is going to share in losses on the portions of the business that aren't looking so hot. Now, does that mean that the government, and by that I mean you and me, the taxpayer, are now subsidizing JPMorgan Chase's purchase of First Republic? So far, the government has been careful to say that no taxpayer money is being used to bail out any of these failing banks.

So is that true in this case as well? It is, but it's a little bit complicated. This deal is going to cost the government about $13 billion, which is going to be covered by the insurance fund that's paid by every federally regulated bank. So it's not taxpayer money per se, but the banks will tell you, and some people outside of the banks will tell you, that while this is paid for by assessments on banks, at the end of the day, that comes back to hit the bank customers. Because the banks are going to raise the money by charging more fees on mortgages, on bank accounts, on things like that. And so it's possible that you'll still end up subsidizing this, whether it's directly or not. And even if you don't want to.

So if you have any relationship with a federally regulated bank, which almost all of us do, you're in one form or another eventually helping to pay for this deal. Yeah, exactly. So if you're JPMorgan Chase, this is a pretty good deal, obviously. Yeah, exactly. So if you're JPMorgan Chase, this is a pretty good deal, obviously. But there's something a little bit funny about it, which is that JPMorgan Chase is already the nation's largest bank. And after the financial crisis in 2008, the whole idea was that big banks shouldn't get any bigger,

shouldn't be buying up their rivals because they might become too big to fail. So this deal seemed kind of at odds with that. So it is a little weird. I think the message we all took from 2008 was that really big banks can be dangerous. And certainly that was baked into the legislation that we saw passing after 2008. We saw a restriction that said

the largest banks in America can no longer acquire really big banks because we don't want too much of the nation's deposit base concentrated at any one bank. However, there was an exception to that rule. And the exception is that if a bank is failing, a large bank can acquire it. And that's really what we saw come into play here. J.P. Morgan was also able to offer the least cost option to acquire First Republic, and the government's required to take the least cost option. And so ultimately, because of the exception, because of the cost calculus, it was the bank that was chosen to take over First Republic.

Got it. So if this sounds like something that violates the 2008 principles, it's because it did, but those 2008 principles had a little exception clause, and this situation just happens to fit it. We had an asterisk. This is the asterisk. The Times published data over the past couple of days that kind of blew my mind. It found that during this latest banking crisis, the banks that have failed so far held more assets than all of the banks that collapsed in 2008 at the height of the global financial crisis. So given how costly this crisis has already become, three bank failures into it. I wonder if we've now achieved a better understanding of who is most responsible

for this latest crisis and whether it's the banks or the regulators. So these failures have been really big. At the same time, it's not 2008. It's not clear that we're at the start of some sort of cascading financial crisis like we were back then. There hasn't been the same kind of risk taking.

We don't think we're not seeing that kind of interconnected disaster. But it is clear that something went wrong here. That something allowed these risks, these banks to sort of grow out of control to a point where they could crash like this. So the government has started to take a look into what exactly that something was. And we saw their first pass at that last week. They released some autopsies into what happened at Silicon Valley Bank and at Signature Bank. Who dropped the ball? What happened? And the upshot from those is the government really took a finger and pointed it right back at themselves.

We'll be right back. So, Gina, why do these government autopsies point a finger so strongly right back at the regulators themselves? So we have these couple of reports that come out last week. And the one that I thought was really interesting was this report that the Federal Reserve put out on Silicon Valley Bank. This thing is hundreds of pages long. It's a ton of documents about you've discussed on the show before, which is there were some pretty important regulatory rollbacks that happened in 2018 and 2019 that allowed banks to get a lot bigger before they were subject to the government's strictest both regulations and supervision, so day-to-day oversight. And Silicon Valley Bank was growing pretty rapidly in the years leading up to these reforms. And because of them, it didn't move up into sort of big bank oversight, which tends to be a bit more strenuous, a bit more professionalized, just a little bit

more intensive all around until a few years later than it otherwise would have. Right. Before these regulatory rollbacks, Silicon Valley Bank would have been supervised more strictly earlier, faster, with less money under management. But after these rollbacks, it just took longer. Exactly. And that mattered because some risks were able to sort of grow and metastasize and get worse without a lot of intervention. And by the time they were recognized, it was pretty late in the game. And what were some of the things these supervisors finally did find? So the regulators, the supervisors, start really noticing that management has some pretty bad risk management practices. They're really not minding their

liquidity risk. And that means that they're just not keeping sort of a good enough cushion in the case that something might go wrong. But despite all of these findings, they're not really cracking down on this bank all that hard. You know, what we saw was that they gave them a decent score on liquidity. Again, that financial cushion component of this, even after they had recognized some of this pretty significant risk-taking. And how do you explain that? I mean, what is it that this report finds animates that decision to say everything's okay or to let it slide when it looks problematic?

So this is alluded to a little bit in the report, but my reporting has also shown, I think in a little bit more depth, that it's pretty clearly the case that the supervisors who are overseeing these institutions felt like you really couldn't crack down on an institution the first year that it moved up into this stricter oversight regime. has kind of cascaded through this bank's whole story and really resulted in, even as recently as 2022, when it's really starting to get its wrists slapped for the first time, a pretty gentle oversight regime that allowed a lot of problems to go unresolved. So what you're describing is a crucial set of years where Silicon Valley Bank doesn't get regulated in the way it would have if these laws hadn't been rolled back. And then once it does get regulated,

the culture of people inside the Fed is to not be too hard on the new guy, the new big bank. And so taking this all together, there's kind of, you know, a missed opportunity in these two or three years to nip serious problems in the bud at Silicon Valley Bank? Things went too slow. There was also just simply some plain old misdiagnosis that happened here. So, for example, one of the interesting documents showed that in the middle of 2021, some of the supervisors watching over Silicon Valley Bank were worried about the possibility that they

weren't properly protected in the case that interest rates fell, that interest rates went down, which is interesting because by the middle of 2021, inflation had started to pick up. And so increasingly, the risk by that point was that interest rates would increase, which we saw them do in 2022. You know, the Federal Reserve within a few months of that had started raising interest rates. And so not only was the bank not properly prepared for that, but it seems like maybe the supervisors weren't aware that they needed to be taking that risk into account. They were focused on the wrong risk, as it turned out. Exactly. So I think what happened here was sort of this cocktail of actual regulatory changes,

a fairly lax supervisory culture, and just plain old, you know, boring mistakes. Which you're saying when they're finally all brought together in this cocktail, ultimately lead to Silicon Valley Bank having so much risk that it fails, and that that failure brings us to where we are right now, which is the failure not just of Silicon Valley Bank, but of Signature and now of First Republic. Exactly. But ultimately, Gina, these banks, the three of them that we've been talking about, made decisions that caused their own failures. And one of the common threads for all three of them was that they were focused on customers,

depositors who had a lot of money to put in these banks. And because they had so much money in the bank, that put the whole bank at a higher risk of a bank run because these people worried that anything over $250,000 wasn't going to be insured by the federal government. So I wonder if these banks could have, on their own, really lowered their risk of being in the situation they're now in by just having a more balanced group of clients the way that the big banks do. You know, people with a lot less money could be their customers too. You know, I think anytime you have a bank failure,

you have clearly had a failure of bank management. Like bank managers are supposed to make sure that their banks aren't vulnerable to failing. But at the end of the day, what you just explained is really a situation of sort of concentrated risk. There's nothing wrong with having big customers. There's nothing wrong with having uninsured deposits. The problem is when you don't have enough of a variety of customers, when you're not thinking about making sure that you're balancing all of your risk, which is what happened particularly in the case of Silicon Valley Bank. And those kinds of problems, those sort of gaping vulnerabilities are the kinds of things that regulation is supposed to catch.

So I've spent a lot of time talking about this with my sources over recent weeks. And I'll often say, you know, I'm getting told that a lot of this was the fault of the managers. And they will say back to me, of course it was the fault of the managers. But this is why we have regulation. Regulation is supposed to step in where CEOs fail. And there's a reason we do this to banks in particular, right? You know, we don't regulate everything like this. Your local toy store is not regulated the way a bank would be regulated. It's because these banks are the beating heart of the center of our economy. They have such big knock-on effects when something goes wrong. And so we as a nation,

as sort of a society, have decided that it's really important to make sure that we're keeping an eye on these folks. Gina, where do we now go from here? Because this now feels like a crisis that in terms of dollars is significant. We talked about that. And yet it's oddly contained as banking crises go. And perhaps that's because these are regional banks and lots and lots of people were untouched by these collapses. You know, 2008 touched everybody because it was so interconnected with the entire economy, as you said. But if you bank at Bank of America or Wells Fargo or Chase

right now, what happened at these three banks doesn't really affect you that much. And it kind of feels like we might now be at the end of whatever this set of dominoes was, right? Is that how you see this? I think that's the optimistic take, is that this could be the end of it, stick a fork in it, we're past this. I think there's a more nuanced take, one that an economist described to me this morning, which is that we might be past the acute phase of this situation. You know, the bank failures that we were going to see in response to SVB are now behind us, but we might be moving into the chronic phase. And the chronic phase here has a lot to do with the interest rate increases we've seen over the last year and a half. When interest rates go up,

it tends to displace other parts of financial markets. It tends to sort of show us where the weaknesses are. We pretty clearly saw that in the case of these banks. You know, Silicon Valley Bank was very exposed to rising interest rates in a way that it hadn't handled well. And that's a big portion of why it failed. And so the Fed is set to meet on Wednesday and it's expected to raise interest rates again. That might be its last interest rate increase in this cycle.

They've suggested that they might hit pause after that. We don't know for sure. But regardless, rates are a lot higher than they've been in a really long time. And we could have more weaknesses out there that we just haven't recognized yet. You know, there's this phrase that you often hear in finance, which is when interest rates rise, the tide goes out and you see who's swimming naked. And I think we've seen a couple of the people who are swimming naked, but the tide's not all the way out yet.

So we might still see more to come. There may be additional vulnerabilities. More naked banks. Exactly. Well, Gina, thank you very much. We appreciate it. Thank you for having me. We'll be right back.

Here's what else you need to know today. On Monday, Treasury Secretary Janet Yellen said the United States could run out of money to pay its bills by June 1st if Congress fails to raise or suspend the debt ceiling. spend the debt ceiling. That deadline, which is earlier than previously forecast, will put pressure on President Biden and House Republicans to reach a swift agreement to avoid a financial disaster. House Republicans say they will not raise the debt ceiling unless Biden agrees to deep spending cuts and rollbacks to some of his signature legislation, conditions that Biden has rejected. And the U.S. now estimates that at least 100,000 Russian fighters have been killed or wounded in Ukraine since December, a staggering measure of the war's toll on Russia's military. According to the U.S., Russian casualties have accelerated over the past few months

because it sent waves of poorly trained recruits to the front lines. The U.S. did not disclose comparable estimates for the Ukrainian military. Thank you, Terry. by Marian Lozano and Rowan Nemisto and was engineered by Chris Wood. Our theme music is by Jim Brunberg and Ben Landsberg of Wonderly. That's it for The Daily. I'm Michael Bilboro. See you tomorrow.