We have these three major regional bank failures.
We're looking sort of the rearview mirror to learn what went wrong and what
can we do to avoid it next time. So what's your take basically on what
went wrong? A number of things went wrong.
First, we made meaningful changes in the regulatory scheme governing large
regional banks. With the benefit of hindsight, that was
clearly in error. We've had three large regional banks
fail, all in ways that impose significant hits to the deposit
insurance fund. So clearly the deregulation was a
problem. The banks themselves were a problem.
It looks like they were taking a lot of risks without understanding those risks,
appropriately hedging those risk and managing those risks.
And there were also shortcomings in supervision.
It does look like some of those should have been identifiable.
Some of that was identified. But supervisors didn't act quickly
enough and aggressive enough in escalating the concerns in ways that
actually would have resolved the situations before we had such massive
failures. We've heard a lot about interest rate
risk, which is a terrible thing to have. Obviously, we've just seen at the same
time, given what the Fed was doing, it shouldn't have come as a surprise to the
banks or to the supervisors that their interest rate risk.
I mean, we were raising interest rates at an unprecedented pace.
We were. And the Fed really did signal that.
And again, there was a long period of low for long and a period where rates
were going up more slowly. But first, while interest rate risk is a
classic bank risk, I mean, in my very basic banking glasses, I go back the SNL
debacle and I show how a changing interest rate environment affects the
value of all assets the banks hold. So this is what banks are in the
business of doing. And as you just pointed out, the Fed
really did signal this. They said, look, we're really worried
about inflation and their concerns about inflation and we're going to tighten as
long as we need to to really get that inflation under control.
So both the amount of interest rate risk, the lack of hedging around that
risk looks like a really inappropriate way of managing those risks.
The reason we look at these things is not just to say I told you so, as much
fun as that might be. We saw some of that maybe in the
Congress on Capitol Hill this week, actually with some bank leadership.
But to say what should we or could we be doing differently for the future?
What did we learn? And did we learn specifically about
regional banks as opposed to the very big banks or for that matter, the
community banks? A little bit of all of the above.
So the biggest lessons have to do with regional banks that we saw, three large
regional banks fail, two of them fail in a way that required regulators to invoke
this systemic risk. Stefan suggests that that is where the
is the biggest gap between what the regulatory scheme ought to look like and
what the rules actually look like. But we also saw the failure of Credit
Suisse. On the other side of the Atlantic, we
saw a rash merger with UBS that raises concerns about resolution planning.
And there was already some meaningful work underway for Basel 3
implementation, which basically just means even the largest banks are going
to face some tougher capital liquidity requirements and that's probably
appropriate. Is there also a potential flaw in the
business model? That is to say, you're taking deposits.
By definition, people going to have whatever they want.
So you're getting funding that is very, very short term and you are necessarily
putting in a longer term investment such as 30 year mortgages.
But also, as we learned treasuries, it does not inherently put a lot of banks
at risk. Yes and no.
So, I mean, the business of banking is to engage in maturity transformation.
So there is a fragility that exists. On the other hand, it's been pretty well
managed for a very long time. But then we have these periods of
significant disruption. One of the things that's really striking
right now is you look at the small community banks and they've actually
been remarkably stable even before the March turmoil.
We saw depositors were leaving regional banks.
They were leaving the largest banks because they just wanted to get a higher
rate of interest than they were getting on deposits.
But the small community banks were really holding onto those deposits and
they managed to continue to provide meaningful credit.
So it's not the entire bank business model.
I do think we're seeing very real questions about the regional bank
business model. So what is it?
I'll use the term social contract. Should have with the regional banks
because on the one hand, we want them to really support the real economy, as you
put it. On the other hand, if they get in
trouble, they turn to the federal governments, say bail us out.
What should the central social contract be with rural banks?
This is what we want you to do. We want you to lend money.
We want you to help with credit. The same time, these are the situations
under which will actually help you out. We think a social contract is part of
what we're discussing on the Hill this week, last week for the last couple of
months and in ways that have been really positive.
Right. I think one of the the silver linings,
if we can call it that, is revisiting this core question, not just respect to
retail banks, but banks generally. We are reminded of the fact that the
government very frequently steps in to protect against losses.
And here they allow shareholders to lose money.
They allow non depositor predators to lose money.
But there were a lot of uninsured depositors that ultimately were
protected. And so if you're gonna provide that type
of support, then you want to ask ex ante, what are we really getting out of
it? What about the non banks?
You mentioned those before. They certainly have expanded
dramatically, certainly since the great financial crisis.
Why can't we just. Turn a lot of it over to them.
What's the risk in that? What's the downside?
So there's a number of right. So one is they are part of the
ecosystem. They're going to remain part of the
ecosystem. So trying to say should it be bank
should be non banks is a false dichotomy at this point.
It's both. And they're also integrated in very
meaningful ways. But there are a lot of downsides.
I mean, at this point, banks are subject to very meaningful regulation and
oversight. Ideally, that promotes their safety and
soundness and the resilience of the system.
But it also provides policymakers a lot more insight into how well the financial
system is serving the needs of the real economy.
We talked about deposits and what you called maturity transformation.
Some people just were seeing a mismatch between short term and long term.
There are some who are saying we should just guarantee federally guarantee all
deposits without limit. What do you make of that proposal?
Well, I think we need to rethink the structure of the deposit scheme.
It doesn't make a lot of sense that I have access to deposit insurance at the
same level of a mid-sized business that needs far more just to make payroll.
That being said, at this point, we ensure a lot more than just what we
think about as deposits. It's not just your checking account.
It's also a city. And we've moved away from the days where
we used to have interest rate caps on those deposits.
There's a lot of reasons to think that we should rethink the structure of how
we go about deposit insurance. FDIC has a great new report on how to
rethink it. But just removing the caps without doing
a lot of the other work that we would potentially need to do could also
involve a lot of money flowing to a lot of very troubled institutions.