Bank blowups are dangerous, but this isn’t 2008

We’ve entered a new and risky period for the US economy, which is already under stress from inflation, rising interest rates, and nagging recession fears.

Silicon Valley Bank and Signature Bank are no longer after regulators took over the lenders and said depositors would not lose any money.Jeenah Moon/Bloomberg

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Bank stocks are tumbling. Federal regulators have stepped in to shore up confidence in the banking system after two lenders failed and one chose to liquidate amid a mass exodus by depositors. President Biden went on television to assure Americans, “Your deposits will be there when you need them.”

Echoes from the past might abound, but this not a repeat of 2008, when the financial system was on the verge of collapse. Silicon Valley Bank, whose demise precipitated the turmoil, isn’t Lehman Brothers, the investment bank whose bankruptcy in September 2008 became the touchstone event of the Great Recession.

We have, however, entered a new and risky period for the US economy, which is already under stress from inflation, rising interest rates, and the nagging fear that a recession is just around the corner.

“It isn’t clear that there are other similarly situated banks” like SVB, said Bill English, a former Federal Reserve official who is a professor at the Yale School of Management. “But concern about SVB . . . could lead uninsured depositors at other banks to pull out. Those runs could cause those banks to fail, undermining confidence in the banking system.”

The fear of more bank runs was a primary reason the Federal Reserve, US Treasury, and Federal Deposit Insurance Corp. decided that none of SVB’s customers would lose money — even those with deposits exceeding the FDIC’s $250,000 insurance limit. The regulators extended the same protection to New York’s Signature Bank, a lender to the beleaguered crypto industry that was shut down by its state regulator on Sunday.

And, for good measure, the Fed said it was ready to provide emergency loans to banks so they could meet any surge in withdrawals.

“Recent US bank failures are disconcerting to watch, but they are not symptomatic of a serious broader problem in the financial system,” Mark Zandi, chief economist at Moody’s Analytics, said in a note to clients. “Policymakers’ aggressive response should ensure the failures do not weaken the system or the fragile economy.”

The Standard & Poor’s 500 index went on a roller coaster ride on Monday, ending with a modest loss after being the black for a good part of the day, as investors sorted through fallout of the weekend’s news. Yields on US Treasuries fell sharply on expectations that the banking chaos would prompt the Fed to hold off raising interest rates when officials meet next week.

But most bank stocks continued to get pummeled. Most dramatically, First Republic Bank, a California institution with a presence in Boston, lost about 60 percent of its value despite saying on Sunday it had $70 billion to fund operations after getting assistance from the Federal Reserve and JPMorgan Chase.

How banks got into this situation — and how they and regulators can avoid it happening again — will be examined and argued over for months and years to come. One issue already sparking debate: Whether regulators should have “bailed out” SVB and Signature depositors.

People walked by the Wall Street Station subway stop in front of the New York Stock Exchange in February.Spencer Platt/Getty

In 2008, when the nation’s megabanks were on the ropes, Congress approved hundreds of billions of taxpayer-funded aid, protecting their investors and the jobs of top executives.

It’s a different story today. SVB and Signature are dead, their shareholders and lenders left holding an empty bag. This time around, regulators are bailing out depositors, with banks absorbing any losses.

Yes, a fair number of very rich venture capitalists and other depositors are getting bailed out, too, but the alternative was more than likely a run on other regional banks as their customers feared they would be next. That didn’t happen on Monday.

Uninsured depositors have been paid in full in every bank failure in recent history except one: IndyMac, which went under in 2008. Large depositors eventually got half their money back.

If SVB’s customers lost most of their money, layoffs and perhaps bankruptcies would have followed. The combination of financial contagion and job losses throughout the tech and biotech industries would increase the likelihood of a recession.

As The Wall Street Journal noted, Fed chairman Jerome Powell was a senior Treasury official back in 1991 when Bank of New England went under.

“We came to un­der­stand that ei­ther the FDIC would pro­tect all of the bank’s de­pos­i­tors, with­out re­gard to de­posit in­sur­ance lim­its, or there would likely be a run on all the money cen­ter banks the next morn­ing,” he said in a 2013 speech. “We chose the first op­tion, with­out dis­sent.”

So what lessons can we take away this time around?

First, a bank doesn’t have to be among the biggest in the industry to be “systemically important,” a regulatory definition for a company whose collapse would pose a serious risk to the economy.

SVB had about $210 billion in assets at year-end, according to the Fed, making it the 16th largest US bank. JPMorgan Chase, the biggest US bank, had $3.2 trillion in assets.

SVB was large but it was not seen as the kind of institution whose shut down would have widespread impact. Indeed, in 2018, Congress freed banks with less than $250 billion from the most rigorous regulatory requirements.

FDIC officials stood with SVB customers in line to enter the SVB Private bank branch in Wellesley on Monday.David L. Ryan/Globe Staff

Second, it’s potentially dangerous for a bank to be overly dependent on a niche customer base like SVB and Signature were.

SVB had essentially cornered the banking market for startups and their venture capital investors, both here and in California, where it was based. When SVB launched in 1983, many banks didn’t want to do business with risky startups, and that’s still the case for some lenders.

When startups and VCs learned of the bank’s nearly $2 billion investment loss caused by higher interest rates, they moved fast and in herd fashion. Some VCs even urged their portfolio companies to take their money out of SVB, which accelerated the run. SVB lacked liquidity: It didn’t have enough free cash to meet withdrawals.

“This was a risky business model — focused and with a lot of uninsured deposits,” said Eric Rosengren, a former president of the Federal Reserve Bank of Boston. “Regulators are going to reevaluate liquidity requirements.”

Similarly, Signature courted another type of customer shunned by other banks: crypto companies, which have been dropping like flies since the collapse of FTX.

Third, rapid changes in interest rates can have unintended consequences.

The Fed has boosted rates by 4.5 percentage points in a year. Its aim was to cool inflation by slowing the economy, but the tightening, the fastest since the early 1980s, has made it tough for some banks to profit by lending and investing their deposits.

“My problem with the Fed is what they have done over the last 90 days or so,” a real estate investor told me. “Inflation was starting to slow. They seem determined to keep raising until they break things and damn if they didn’t almost do it.”

And finally, banks that take in a lot of uninsured deposits can pose a heightened risk to the financial system because they are more prone to runs. The overwhelming majority of SVB’s $170 billion in deposits were uninsured.

“There are other banks with a lot of uninsured deposits,” Rosengren said. “There’s more risk now that large deposits could be flighty in the future. We need to think of ways to make sure that these kinds of runs don’t become destabilizing.”