The Fed wants more power after the banking collapse. We need real reform — and less Fed.
We have the highest respect for the Federal Reserve, but we do not believe that it should be regulating banks or their parent companies; it has its hands full choreographing the U.S. economy and acting as the world’s central bank.
This past week have seen a swirling vortex of troubled bank activity.
First Republic Bank was closed and taken over by J.P. Morgan; the FDIC issued a summation of its supervision of the failed Signature Bank; Federal Reserve Vice Chair Michael Barr issued a highly anticipated report on the Fed’s oversight of Silicon Valley Bank; and the Government Accountability Office published its analysis of the regulatory lapses that accompanied the failures of Silicon Valley and Signature banks.
Barr’s report has drawn the most attention, given its admission of regulatory ineptness. But we see these events as underscoring the fact that the U.S. bank regulatory system desperately needs an overhaul.
The Fed’s report attempts to accept some of the blame everyone knows the central bank deserves — Federal Reserve Bank of San Francisco admittedly focused more on ratios than on risks — but it is primarily focused on shaping the narrative that will play out in the press and on Capitol Hill. As former regulators who have spent their entire careers dealing with financial crises and bank regulation, we hope no one is misled into believing that giving the Fed more power to write more rules is going to fix the country’s broken system of financial regulation or end the never-ending cycle of financial panics. On the contrary, the situation demands reorganizing U.S. financial regulation — including removing the Fed from direct bank supervision.
The principal responsibility for any bank failure should be laid at the feet of its directors and officers. That said, state and federal regulators have clearly not been up to the task. Unfortunately, the Fed’s report pivots to a full-throated embrace of the political escape hatch conjured up within hours of SVB’s failure. That theory blames Barr’s predecessor for loosening the rules and general expectations in 2019 after Congress, in a bipartisan action, lowered capital and liquidity requirements for banks of SVB’s size. The excuse rings hollow, however, because SVB could and should have been regulated properly no matter the written standards or ratios applied.
The responsibilities of the Fed and the State of California to identify obvious operating missteps at SVB were not altered in 2019. Indeed, in 2021 and 2022, the Fed’s staff spent almost 300 regulatory hours supervising SVB. It would have taken only a fraction of those hours to identify the obvious interest rate bets that SVB made and lost. The Fed can’t genuinely be arguing that the 2019 change in the law prevented more than a dozen bank examiners that were on site each year at SVB from noticing that the bank had nearly tripled in size in just two years thanks to a dangerous deposit base, 95 percent of which were uninsured accounts susceptible to running at the first hint of trouble.
It also wasn’t prevented from taking action when those deposits were invested in government and agency securities that would eventually became underwater as the Fed raised interest rates. Regulators had all the power they needed to act forcibly when they saw such fundamental financial mistakes. A shortage of laws, rules and regulations wasn’t the problem in the 2008 crisis, and it is clearly not the problem today.
Perhaps this time policymakers will finally recognize that only wholesale modernization of deposit insurance and the financial regulatory systems will alter the cycle of repeating panics over the past 50 years. The size and velocity of our 21st century economy requires a paring down of the half-dozen U.S. federal financial regulators that exist, as well as oversight of all financial companies — whether nonbank lenders or crypto issuers — and the arming of regulators with the technological resources to regulate in real time.
We have argued for many years that consolidation of the crowded field of regulators into a single agency supported by more highly paid professional examiners focused on the evaluation of real-time market risks rather than the production of rules is the first step in creating a more successful system of oversight.
We have the highest respect for the Federal Reserve, but we do not believe that it should be regulating banks or their parent companies; it has its hands full choreographing the U.S. economy and acting as the world’s central bank. The Federal Reserve should have a seat on a new bipartisan, five-member regulatory commission with the other financial regulators who oversee the regulation and supervision of all financial services, markets and risks in the United States.
There is even a silver lining for the Fed in this formulation: It would finally be free of the obvious conflict of interest inherent in Federal Reserve Banks’ regulation as well as lending to members whose CEOs sit on their boards of directors.
The ball is in Congress’ court. Fifty years of crises on top of crises without any meaningful revamping of the financial regulatory system is inexcusable.
Thomas P. Vartanian was general counsel of the Federal Home Loan Bank Board and the Federal Savings and Loan Insurance Corporation (1981-83) during the S&L crisis. He is author of “200 Hundred Years of American Financial Panics” and “The Unhackable Internet.”
William M. Isaac was chairman of the Federal Deposit Insurance Corporation (1978-86) and Fifth Third Bancorp (2009-14) and is currently chairman of Secura/Isaac Group and related financial consulting companies. He is the author of “Senseless Panic: How Washington Failed America,” with forward by Federal Reserve Chairman Paul Volcker.