All about bank(panic)s and the implications for policy

Episode Summary

Executive Summary: This episode examines the 2023 U.S. banking stress after Silicon Valley Bank’s failure and debates whether it was a classic bank run, a supervision failure, or a broader policy problem. Guests agree that bank management and supervision fell short, but differ on whether monetary policy, Dodd-Frank rollbacks, capital rules, or uninsured deposits were the deeper cause. The discussion centers on how to reduce future run risk without crippling bank lending.

Main Topics: SVB as a textbook bank run (Priority: 5/5): Tarullo argues the episode followed the standard logic of a bank run, accelerated by social media and venture capital networks rather than physical lines outside branches. Causes of the failure: management, supervision, and policy (Priority: 5/5): Guests debate responsibility, with Tarullo and Hoenig emphasizing management and supervisory shortcomings, while Hoenig also blames prolonged easy monetary policy; Gorton argues the real issue is structural vulnerability from short-term debt. Limits of Dodd-Frank and the 2018 rollback (Priority: 4/5): The panel discusses whether the 2018 exemptions for mid-sized banks contributed to SVB’s collapse. Tarullo and Hoenig see weak substance and poor supervision, but not a direct causal link. Capital, liquidity, and mark-to-market reform (Priority: 5/5): Tarullo and Hoenig favor stronger leverage-based capital rules, more rigorous stress tests, liquidity review, and better mark-to-market treatment of securities portfolios. Deposit insurance and run prevention (Priority: 5/5): Gorton argues that uninsured deposits remain the core run vulnerability and suggests expanding insurance for transaction deposits, while Tarullo urges caution and a broader debate about government guarantees. Future structure of the banking system (Priority: 4/5): Tarullo warns SVB raises questions about the business model of banks in the $50B-$300B range and about merger policy, while Gorton points to future risks from stablecoins and other private short-term money.

Key Arguments: SVB’s collapse was a classic bank run: uncertainty triggered rapid withdrawal behavior, amplified by digital communication and concentrated uninsured deposits. The first responsibility lies with bank management, especially inadequate liability-side management and concentration of unstable deposits. Supervisors failed to react quickly enough to known warning signs, including rapid balance-sheet growth and unrealized losses. Easy monetary policy and then rapid rate hikes created the environment for duration losses and stress, according to Hoenig. Gorton argues financial crises are fundamentally about short-term debt vulnerability, not simply bad management. Dodd-Frank and the 2018 tailoring changes did not directly cause SVB’s failure, but they may have encouraged a lighter supervisory posture. Stress tests and liquidity ratios should be redesigned to capture interest-rate risk and multiple scenarios, not just a single benign case. Higher leverage-based equity requirements would make banks safer and slow excessive growth, especially at mid-sized and large institutions. Mark-to-market rules for available-for-sale securities are viewed as a near no-brainer, though hold-to-maturity treatment is more complicated. Insuring more uninsured deposits could reduce run risk, but it would require major changes in FDIC premiums, capital rules, or public subsidy. Gorton contends that more capital alone cannot solve run risk because the supply of safe assets is limited and risk can migrate outside the banking system. Policymakers should also consider the rise of stablecoins, crypto regulation, and potentially a central bank digital currency. The episode suggests there may be other weak points in the banking system, especially among longer-dated securities portfolios and mid-sized banks. The industry may face a strategic choice between greater safety and reduced competitive freedom/growth, especially for banks between roughly $50B and $300B in assets.

Data Points: Silicon Valley Bank size: about $200 billion - Used by Tarullo to highlight the unusual concentration of deposits and the need for scrutiny. Top depositor concentration: 10 depositors held $13 billion - Tarullo cited this as evidence of an anomalous, highly runnable deposit base. Balance-sheet growth: 4-fold increase in a few years - Tarullo said rapid growth should have been a warning sign for supervisors. Insured deposit share in 1984: about 75% - Gorton used this to show that most deposits used to be insured, reducing run vulnerability. Insured deposit share today: about half - Gorton said the system has shifted toward more uninsured, runnable funding. Period without major U.S. bank panics: 1934 to 2007 - Gorton said deposit insurance suppressed panics during this era. Federal Reserve base money expansion: $100-$120 billion per month - Hoenig cited this as part of the overly loose policy mix after the pandemic. Interest-rate increase pace: factor of 20 or more - Hoenig argued the Fed then pivoted too sharply, causing instability. Current banking capital ratio mentioned: 6% capital to assets - Hoenig said the industry still looks thinly capitalized by leverage standards. Suggested equity-to-assets target: 10%-15% - Hoenig recommended higher simple leverage capital ratios for resilience. Brown-Vitter proposal: 15% - Hoenig referenced this as a prior proposal for stronger bank equity requirements. Banking assets in the U.S.: roughly $23 trillion - Tarullo used this to argue SVB may not be an isolated weak point. Stress-test coverage threshold proposed: all banks over $100 billion in assets annually - Tarullo advocated expanding rigorous annual stress testing to more banks. 2018 tailoring threshold: $250 billion in assets - Tarullo criticized this as too high for exempting banks from special regulation.

Pivotal Quotes: "there was nothing unusual about this bank run" — Dan Tarullo: Describing SVB as a textbook run that unfolded through rapid, modern channels. "the problem is: it's short-term debt. That's simple. Go find it." — Gary Gorton: Explaining the core mechanism behind banking panics and financial crises. "I think monetary policy errors were also a major contributor to this scenario." — Tom Hoenig: Arguing that prolonged low rates and later sharp tightening helped create the stress.

Implications: Expect continued debate over bank capital, stress tests, deposit insurance, and the future of mid-sized banks. Regulators may need to choose between tighter safety rules and preserving bank competitiveness, while run risk remains a live threat.