Q&A: Recent Bank Failures Do Not Mean It’s 2008 All Over Again

This meant that SVB experienced large deposit withdrawals, roughly $42 billion, in a short period of time. To repay customers for the deposits, SVB used up all its cash reserves and then had to start selling some of the long-dated assets on its balance sheet to cover the withdrawals.

When investors and depositors realized the “hole” in SVB’s balance sheet from the sales, they began to “run” on the bank, meaning all depositors wanted to get their cash out of the bank as quickly as possible, concerned that the bank asset value wouldn’t be able to cover all of their deposits. Once the run started, the FDIC had to step in and close the bank.

Signature was a New York bank that had lost big on some crypto investments and was also struggling. The bank also had long-dated assets. Depositors got nervous when SVB was closed and started to withdraw their cash quickly, causing authorities in New York to step in and close the bank.

David Smith (left) of the UVA McIntire School of Commerce and Bob Bruner, dean emeritus of the UVA Darden School

Q. Did the Federal Reserve’s interest rate increases, designed to rein in inflation, play a role?

Bruner: Yes, the Fed’s interest rate increases contributed to SVB’s demise. And those rate increases were a response to the inflation that was a consequence of the accommodative monetary and fiscal policies in response to the COVID pandemic. In that sense, financial instability of the past few days is, in part, a case of “COVID bites back.”

Q. How similar are the recent takeovers to what happened in 2008?

Smith: Not very similar at all. The 2008 crisis was precipitated by very risky lending into the housing sector, which, when housing prices stopped rising, led to substantial housing defaults across the country as homeowners could not repay the mortgages they took out on their houses.

Thus far, the SVB and Signature bank failures are relatively isolated and most banks – at least the nation’s largest banks – don’t have the big mismatch in assets and liabilities that SVB and Signature and a handful of other banks have.

Moreover, the Fed, U.S. Department of the Treasury and FDIC have stepped in pretty early and fast to assure depositors that their deposits are fully covered, so that the risks from these banks don’t spill over and cause bank runs elsewhere. That’s not to say that it’s out of the question that problems could spread, but at this point, I foresee those risks to be small.

Q. Were the takeovers the result of systemic weaknesses, poor management or panicked investors?

Bruner: Management heads up the rogue’s gallery. And we’re already seeing fingers pointed at regulators for not intervening sooner – at the depositors who should have known not to keep more than $250,000 in a checking account, and at the venture capitalists who should have avoided concentrating the cash of their portfolio companies at one bank.

Before the story ends, there will be plenty of blame to go around.

Q. There is some fear that other banks could be affected. Should people worry about their deposits?

Smith: Depositors in banks should not worry about their savings. First, the deposits of most individual bank customers, like you and me, are fully insured by the FDIC. You can’t lose any savings as long as your savings or checking account doesn’t exceed $250,000. It is only large deposit accounts of more than $250,000, like the accounts of the startup companies at SVB, that were uninsured.

Bruner: The announcement from Treasury Secretary Janet Yellen that all depositors will be protected and that they will have access to their funds marks a dramatic increase in the implied deposit insurance by the federal government and it should quell incipient contagion of the panic. The concern is that this will inflame moral hazard risk-taking by market participants who may be led to believe that, henceforth, they will always be made whole.

Q. So what happens next?

Smith: My guess is that actions by the Fed, Treasury and FDIC will prevent any more bank runs. SVB and Signature – and any other bank that is insolvent and forced to close – will be “wound down” by the FDIC. Their assets will be sold to a healthy bank or other financial institutions, while the deposits will continue to be protected so that savers can withdraw and deposit as they normally would do if the banks were healthy.

Bruner: Supervisory regulators will be scouring the financial system, examining the resilience of other fragile institutions. This crisis may well ramp up the rhetoric against the tech industry. Bank managers have already been terminated. Consistent with the history of financial crises, expect to see possible spillovers into the real economy and some frauds come to light. And expect to see civic anger take the form of Congressional hearings, lawsuits, regulatory investigations and severe chastisement of various decision-makers.

This interview originally appeared on UVA Today.