Preet Bharara:

From CAFE and the Vox Media Podcast Network, this is Stay Tuned: In Brief. I’m Preet Bharara.

The failure of Silicon Valley Bank has sent shockwaves across the country and throughout the markets. Not since the financial crisis nearly 15 years ago has the banking system faced this level of vulnerability, according to many. On March 10th, the Federal Deposit Insurance Corporation or FDIC took over the bank, which has been the 16th largest in the country. A day later, Signature Bank was also put under government control, making it the third largest bank failure in US history. How did we get here? Is there a comparison between recent events and the great financial crisis? Have regulations worked?

My guest this week is Sheila Bair. She served as chair of the FDIC from 2006 to 2011 and was at the center of government decision making throughout the financial crisis. She’s also author of the children’s book series Money Tales, which provides financial literacy lessons to children. Sheila Bair welcome to the show.

Sheila Bair:

Thanks for having me.

Preet Bharara:

So you’ve been busy.

Sheila Bair:

Yeah.

Preet Bharara:

Trying to explain all of this to a lot of folks.

Sheila Bair:

Right.

Preet Bharara:

We’re recording this on Wednesday, March 15th, and maybe some things will happen between now and when this drops, but for now, let’s first focus on the cause of the failure of Silicon Valley Bank.

Sheila Bair:

Right.

Preet Bharara:

Everyone understands that there was a bank run. Was that bank run caused by a rollback of certain regulation, bad investment decisions by the bank, unreasonable panic by depositors, all of the above or something else?

Sheila Bair:

Yeah. Well, I would like to just comment on one thing you said in your introduction about this being the second largest failure we had too big to fail, so-called too big to fail institutions did fail during the great financial crisis. We bailed them out. I’m sorry, but it’s a little bit of a issue with me because an institution like Citigroup got four bailouts and then to say they didn’t fail is not how I would describe it. So thank you for indulging me in that clarification.

Preet Bharara:

Of course. Fair enough.

Sheila Bair:

But I think it’s important, too, because to put this in larger context, I mean a multi-trillion dollar bank failing, they should be allowed to fail too and I thought we fixed that during Dodd-Frank. But certainly a $200 billion bank and a $23 trillion banking industry should be able to fail without bailouts and without broader system-wide instability. So I guess-

Preet Bharara:

When you say bailout, are you drawing a distinction between the bailing out of depositors and the bailing out of shareholders and others?

Sheila Bair:

So I am defining bailout as any special breaks, any deviation from the rules, and special benefits that a failing institution gets. So we, as every school child knows, had gone into a bank and seen a bank teller window, FDIC insurance is capped at $250,000. Silicon Valley Bank and its very rich depositors got a break from that rule. They didn’t have to take a haircut on their uninsured deposits, even though it probably would’ve been not very significant. They came and lobbied and got full protection from the government, using a systemic risk designation, which is an extraordinary measure, which should only be used if there’s truly system-wide peril by not doing these special exceptions, AKA bailouts. So they got a special break from the rules. They got a break that a regular household every day depositor who might have been at a community bank that failed and they had more than 250, they would’ve taken losses. But the depositors, mostly very wealthy depositors, at this bank, poorly run bank, did not. So I do think that’s important to understand.

Preet Bharara:

Yeah, no, absolutely. Let me ask you further about that, then we’ll go back to the causes.

Sheila Bair:

Sure.

Preet Bharara:

Wasn’t part of the reason for the bailout of the depositors, and tell me if this is off base, a concern about massive contagion and that those other community banks you’re talking about that didn’t get special treatment, we’re also going to see runs?

Sheila Bair:

Yeah, I guess, well, that wasn’t articulated, but I guess gets back to my point. So we’ve been told repeatedly by the government over the years since Dodd-Frank, that this is a safe, resilient banking system. If this banking system cannot withstand the failure of a $200 billion bank and some 10% haircut on their very wealthy uninsured depositors, if this system can’t even withstand that, then this is not a safe, resilient banking system. I think the banking-

Preet Bharara:

Well, that may be true.

Sheila Bair:

Well, but then you send signals like that and people start to panic. I think the banking system is basically sound. I think regional banks and mid sized banks are basically sound. But you create the systemic risk exception as a rationale to bail out very rich uninsured depositors? I think you set off alarm bells for people, and I don’t think that’s right.

Preet Bharara:

To flesh that out a little bit, you are a very sophisticated person who ran the FDIC for a number of years. I talked to sophisticated people in the private sector, including clients and others, over the prior weekend who did not believe and were not led to believe that they were only going to take a 10% haircut. If it had been clear to them with absolute certainty that it would be a 10% haircut, it might have been different. But I heard, not a manufactured, but genuine panic in the voices of people, some of them well-to-do, who were really concerned about losing everything they had in Silicon Valley Bank and other banks that are like Silicon Valley Bank. And so I don’t know what that says about the banking system. And these are not mom and pop folks. These are real people who invest and have engaged in entrepreneurship and they thought they might lose everything. Was that unreasonable?

Sheila Bair:

I think what you’re saying reflects kind of the attitude, which is unfortunate because the ma and pa people, if this had been a bank that truly catered to ma and pa businesses, I would’ve felt better about it. I still don’t think it would justified because I don’t think it was systemic. But these were very wealthy people. I mean, it’s a who’s who list of venture capitalists and very large tech companies. There may have been a few small startups, but the FDIC announced they were going to pay a dividend this week. There were a lot of analysts over the weekend disseminating analysis saying the haircut, it would probably be around 10%. They are actually private sector participants setting up markets to go ahead and buy the uninsured claims to be able to immediately monetize the uninsured claim. So there was market analysis out there-

Preet Bharara:

It took a few days.

Sheila Bair:

Well, just, look, boy, did I hear this during the crisis.

Preet Bharara:

There’s a black hole over the weekend. I guess that weekend after the Friday when Silicon Valley Bank was shut down, as I was saying before, there was a widespread panic. And so my question to you is, if the government had done nothing, and there’s an argument for them doing nothing, what do you think the week would’ve looked like?

Sheila Bair:

The government needed to do an orderly resolution on this. I think if the FDIC had done what it had originally said it was going to do, which is take control over the weekend, pay a dividend, it would’ve been at least, so I think we need to clarify, there’s usually an initial advance that’s paid on uninsured deposits. That would’ve been at least 50%, probably significantly more. When IndyMac Bank failed when I was chair, we paid a 50% dividend on that bank and that was a way worse bank than Silicon Valley. Silicon Valley was actually had a pretty good book of assets. So I’m guessing they would’ve gotten a 60 or 70% advanced dividend and eventually probably would’ve recovered almost all of their uninsured.

And surely that would’ve been enough. And thank you for acknowledging this is all anecdotal because I’ve never seen, I’d like to see their depositor base and how many small startups were really in there with transaction accounts that needed access to their payroll. That’s the kind of thing that I think the public needs to understand.

But to the extent there were, they would’ve had an advanced dividend, which is what the FDI announced it was going to do. I think over the weekend the FDIC came under tremendous pressure, under the guise of systemic risk, because, boy, did we hear that constantly for the Wall Street bailout. Systemic risk, systemic risk. A lot of influential people, the elites you’re talking to, coming in and saying, “Oh my gosh, oh my gosh. We can’t lose our money. We’re important to the economy. You’ve got to save us.” And so Sunday night they did this.

I don’t agree with that. I sympathize with them. I know they’re under a lot of pressure. I know exactly where they were. I was getting the same thing during the financial crisis. But no, I don’t think these were systemic. I think it sets a very bad precedent. It sets expectations for future bailouts of uninsured deposits, which frankly they’re not equipped to do. If every single failure, they’re going to have to make a systemic risk designation, they’re setting up an expectation they may not be able to deliver on because systemic risk determinations are meant to be extraordinary. Super majorities of the Fed, the FDIC, the Treasury Secretary, the President. And are they going to do that for community banks? And if they have a community bank failure and they haircut the uninsured depositors? What’s that going to do the uninsured deposits of the community banks? They’re going to be running too.

So I think the dynamic is such that you can say it calmed the markets. I don’t think it did. I think some of the regional banks are unjustifiably under deposit withdrawal pressure. It could spread. There is an expedited procedure for the FDIC to go and get Congressional approval to provide a guarantee for all uninsured deposits in transaction accounts, which is something they might want to consider. But doing these one-off bailouts, and let’s just take your point and assume that pre you’re right, that, okay, this is systemic and they had to do this. The fact is, the perception is this, is this was a bailout of a lot of rich depositors and it was a bailout of a lot. So the question is, “Well, what was the real motivation here?”

If you’re going to do bailouts, do it for everybody because you do this one-off special treatment, inevitably the public’s going to perceive, “What’s going on? You’re bailing them out. You may not bail out others.” So there is a process to assess a fee, charge for it, and provide some blanket coverage, at least for the transaction accounts, which would be where the payroll accounts would be. And there’s a streamlined procedure for Congress to do that.

So I think if there is a broad-based problem, that’s what they should do, not pick and choose who we’re going to bail out now. And they may not even be able to for their systemic risk exceptions. So that would be my preference. Right now, the fear is a thing that we have to fear, and if people start irrationally pulling their uninsured or even uninsured deposits out because they’re worried about the stability of the banking system, then we do have a real problem. That is a systemic risk.

Preet Bharara:

Let’s go back and talk about the causes. Is one cause irrational panic and withdrawals on the part of elite depositors at Silicon Valley Bank?

Sheila Bair:

Well, certainly. It was a classic run on the bank.

Preet Bharara:

On Thursday and Friday, right?

Sheila Bair:

Yeah, it was a classic run. I think from what I’ve been able to read and I just have access to public information, they had a plan to recapitalize, and if people had kept their heads and left their deposits in there, I think they probably could have avoided failure. But, yeah, this is a classic bank run and that’s definitely what brought it down. They couldn’t raise money fast enough to pay off the depositors. And then, of course, they were having to sell securities that were in what’s called a hold to maturity portfolio that where they assumed they would be able to hold them to maturity. And if they had been able to do that, they would’ve been fine. But because of rising interest rates, the securities had lost market value, and then when they had to sell them to meet deposit withdrawals, that’s what really created problems.

Preet Bharara:

Is it appropriate to find fault with that investment decision?

Sheila Bair:

Oh, yeah. Well, I think, one, it was a bad investment decision, and two, they didn’t hedge their interest rate risk. So they should have piled into those longer dated low yielding instruments. But if they were going, especially, I mean the Fed was going to be raising interest rates. That wasn’t hard to figure out. But if they did, they should have hedged their interest rate risk, which they apparently didn’t do or didn’t do very effectively. So, yeah, that there was definitely mismanagement on the bank’s part.

Preet Bharara:

You have been vocal about interest rate hikes. What’s the relevance of interest rate hikes to this?

Sheila Bair:

And it’s a good question for you because I think people need to understand. Basic rule, when interest rates go down, the value of financial assets go up, especially bonds, because those higher yielding bonds are now worth more as the Fed lowers rates. So the new stuff is having a lower rate than the previously issued higher rate ones. And we saw all that. We saw booming bond markets and booming stock markets too. A little different dynamic, but the general rule is you lower interest rates, financial assets go up in value,.

Then when you raise rates, financial assets go down in value. And for bonds, that is true because now you’ve bought bonds, more recent bonds in a lower interest rate environment, and there have lower yields than what you can get now on a newly issued bond because the Fed has been raising rates. So they lose market value, if you had to sell them, into the market before they matured. If you can wait until the bond matures then you just redeem it for the full face value of the instrument. But if you have to sell it before maturity, then you are going to take losses. Because they’ve lost market value, because again, the interest rate on those bonds is lower than what you can get today with the higher rates.

Preet Bharara:

Aren’t we always at risk of bank runs in a variety of circumstances because as you have said, human beings are human beings?

Sheila Bair:

Well, no. I think again, that making a systemic risk determination for these small banks was disettling to the market in of itself. I think characterizing this for what it was, which I think is it was an unusual situation, and having an orderly resolution, paying the advanced dividend, I think frankly that would’ve been a better signal to the markets than what they did. Again, because they’ve set up an expectation of uninsured bailouts in the future they can’t necessarily deliver on unless they go to Congress and ask for approval to do a blanket program.

So I do think it could could and should have been handled differently. If we’re saying that, so, but let me just ask you-

Preet Bharara:

Uh-oh.

Sheila Bair:

Well, no, but let me challenge you to just think this through for me with a minute. What would be the new benchmark for uninsured? Do you want all uninsured to be protected? So a $500 million community bank, if it fails, should we protect those uninsured deposits?

Preet Bharara:

That’s actually what I was I was going to ask you next and we can talk about it together. So the current threshold, it used to be for years and years when I was growing up, it was a $100,000 insured.

Sheila Bair:

Right, right.

Preet Bharara:

And then it was 200, now it’s $250,000. What’s the level between 250,000 and unlimited that is plausible and realistic that would help a large proportion of people, but not the richest.

Sheila Bair:

It’s important to understand that there are already ways to get hundreds of millions of dollars of insured deposits. And, again, getting back to these sophisticated Silicon Valley depositors, it’s not clear to me they used all the tools that are available. So there’s an organization called IntraFi, for instance. So they have a switch, basically. If you have uninsured money in a bank, they’ll break that up for you in 250,000 components and send it out to a lot of other banks. So each of those accounts are insured and you can get a lot of coverage that way. There are also sweep accounts into government money market funds, and some of the deposits did that at SVP. So there are already ways to protect your money. So when we say the 250,000 cap, it sounds, for very rich people in large businesses, it sounds small, but there are already a lot of ways now to get significantly more coverage.

As I said before, I believe Japan has unlimited deposit insurance for transaction accounts, I think there’s at least a case for a temporary guarantee of all uninsured deposits in transaction accounts. Now, these are the ones that are used for operational expenses, so low to no yield. They’re just there to make payments. I think there would be a good case, at least now to do that on a temporary basis. And, again, we’ll need Congressional approval to do that. And maybe a partial solution to this problem is for Congress to give the FDIC authority when there is instability to institute that program without having to go get Congressional approval each time.

We had it before, during the great financial crisis, we instituted such a program. It was very successful in curbing uninsured run risk at community banks, which is why we put it into effect. And for some reason, Congress decided they didn’t want the FDIC doing it again without Congressional approval. So I think now that would’ve been a nice tool for the FDIC to have and I would encourage Congress to think about just going ahead and giving them that authority now in case they need to use it. But I think that that might be a halfway house in terms of the challenge that we’re talking about.

Preet Bharara:

Final question to you. Given what the government has done and the FDIC has done, what do you think the medium term outlook is for banks?

Sheila Bair:

Well, again, I think most banks are just fine. Now, when rates go up, that can be a benefit to banks where they’re traditional banks that take deposits and make loans and don’t have a lot of large securities portfolios. So there’s some benefits to rising interest rates. I don’t want people to think just because interest rates rise, it puts all banks into trouble. The traditional lenders have actually benefited from it. They are starting to have to pay more on their deposits. I’m glad about that. I’m happy as a depositor and I’m happy for mainstream America to get more money on their deposits. So that is going to compress the profit margin they get between what they have to pay on deposits and what they yield on their investments and loans.

But I still think, and we may go into recession. I really hope we don’t and they need to be prepared for that. So there’re going to be challenges ahead. But I do think the banks, for the most part, they’re not all perfect, but most of them are well regulated and well supervised and there’s a lot of data out there if you want to take a look, if you’re a sophisticated uninsured depositor, take a look and see how your bank holds up. I think you’ll find that most of them are just fine.

And again, we just need to not lose our heads. Frankly, I worry more about the non-bank sector. These private funds have grown dramatically, because they use leverage, they feed on leverage. So with credit so cheap for so long, they’ve really gotten big and there’s not a lot of transparency about what kind of risks they’re taking and how these interest rates are impacting them now. So I think stay tuned on the non-bank sector, but, again, for the regulated sector, people keep their heads, I think we’ll be just fine.

Preet Bharara:

Well, I want to thank you for using the title of the show in your final answer. Stay tuned.

Sheila Bair:

Very good.

Preet Bharara:

Sheila Bair, thank you so much for joining us, and thank you for your insight.

Sheila Bair:

Absolutely. Thanks for having me.

Preet Bharara:

For more analysis of legal and political issues making the headlines, become a member of the CAFE Insider. Members get access to exclusive content, including the weekly podcast I co-host with former US attorney Joyce Vance. Head to cafe.com/insider to sign up for a trial. That’s cafe.com/insider.

If you like what we do, rate and review the show on Apple Podcasts or wherever you listen. Every positive review helps new listeners find the show. Send me your questions about news, politics, and justice. Tweet them to me @preetbharara with the hashtag askpreet. Or you can call and leave me a message at 669-247-7338. That’s 669-24-PREET, or you can send an email to letters@cafe.com. Stay Tuned is presented by CAFE and the Vox Media Podcast Network. The executive producer is Tamara Sepper. The technical director is David Tatasciore. The senior producer is Adam Waller. The editorial producers are Sam Ozer-Staton and Noa Azulai. The audio producer is Nat Wiener, and the CAFE team is Matthew Billy, David Kurlander, Jake Kaplan, Nama Tasha, and Claudia Hernandez. Our music is by Andrew Dost. I’m your host Preet Bharara. Stay tuned.