In a recent analysis, professors Anat Admati, Martin Hellwig, and Richard Portes present a scathing critique of the U.S. banking sector’s systemic issues, brought into focus by the 2023 banking crisis. Their analysis, in particular, centers around the failure of Silicon Valley Bank (SVB) and First Republic Bank, highlighting the systemic issues afflicting U.S. banks.
The analysis suggests that the crisis in U.S. banking is systemic, not because of the interconnectedness of banks, but due to similar banking strategies they’ve adopted. SVB’s failure in March 2023, following a run on deposits, is a case in point.
In 2019, SVB’s financials showed $62 billion in deposits, $33 billion in loans, and $29 billion in securities. Fast forward to March 2022 and the bank’s deposits had tripled, with loans and securities also experiencing significant growth. However, the Federal Reserve’s decision to raise interest rates in 2022 started a chain reaction. Investors gradually moved from deposits to money market investments that paid higher interest. By March 2023, the bank had incurred losses on securities and was unable to raise more equity, prompting a massive run that led to its closure.
“The Federal Reserve is now providing liquidity support without restoring solvency, prolonging the agony and encouraging some banks to start gambling for resurrection as the S&Ls did in the 1980s.”
Admati, a Stanford professor, is an expert in finance and corporate governance. Hellwig, a German economist, has profoundly impacted banking regulation and financial crisis theory. Portes of the London Business School is a leading expert on international economics and European integration.
The article points out how SVB concealed its insolvency through accounting practices. Furthermore, it criticizes the Federal Reserve’s supervisory approach, citing that the bank received high regulatory ratings despite its insolvency. A similar case occurred with First Republic Bank, suggesting that these issues were not isolated events.
The problem of insolvency is not confined to SVB and First Republic Bank; the professors warn that other banks may face a similar fate due to their investments in fixed-income securities. According to Jiang et al. (2023), unrealized losses on securities in U.S. banks amount to around $2 trillion.
The Federal Reserve’s reaction to the crisis is described as a temporary fix, with its policy expansion doing nothing to alleviate the banks’ solvency problems. The professors argue that ignoring insolvencies while insuring deposits can lead to disastrous outcomes, as seen in the savings and loans (S&L) crisis of the 1980s.
The authors urge U.S. authorities to acknowledge the evident banking crisis and address the underlying solvency problems. They suggest immediate measures such as restricting executive compensation and payouts to shareholders for banks failing to meet equity capital standards under fair-value accounting.
The current crisis, they argue, provides an opportunity for long-overdue restructuring of the banking sector, ensuring that solvent banks survive while addressing the too-big-to-fail problem. They caution against mergers involving banks that are already too large, citing the takeover of First Republic Bank by JPMorgan Chase as an example.
Another Stanford Professor Forsees Trouble
Professor Amit Seru of the Stanford Graduate School of Business and the Hoover Institution has also been issuing serious warnings regarding the impending dangers in the U.S. banking sector.As interest rates rise, Seru suggests that banks are facing serious problems that could potentially lead to a significant financial crisis.
The professor, along with his team, conducted a mini stress test on U.S. banks, calculating the mark-to-market value of the banks’ assets based on monetary tightening over the past year. They found an alarming $2 trillion hole in the balance sheet of the aggregate banking sector. This loss is roughly equivalent to the equity in the banking system, suggesting that some banks could be in a precarious position.
Seru expressed concern not only about the rising interest rates but also about the potential for a credit crunch. The COVID-19 pandemic has drastically altered the economic landscape, and the possibility of a looming recession only compounds these issues. Particularly troubling is the commercial real estate sector, which has not recovered fully in the United States.
“If commercial real estate loans get depressed and there are defaults, [banks] have that much less buffer to act because [of] the mark-to-market assets or unrealized losses, which made them very weak,” Seru explained.
According to this logic, this could leave banks vulnerable to additional shocks.
The professor also highlighted the risks associated with the U.S. government’s decision to backstop deposits in an effort to reduce concerns. This move might prompt banks that are already underwater to take imprudent risks in an attempt to recover, a situation reminiscent of the savings and loans crisis of the 1980s.
‘Biden’s Inflation’
Peter Navarro, a former adviser to President Donald Trump, responded to these worries in a recent interview, attributing the crisis to the current administration’s financial policies.“The root cause of this impending banking crisis is Joe Biden’s inflation,” Navarro told The Epoch Times, criticizing the Federal Reserve’s abrupt increase in interest rates. “This, coupled with a bailout of unprecedented proportions, is set to generate further inflation, hindering efforts to solve the issue using Federal Reserve policy alone.”
Navarro suggested that the Fed should have urged Biden to rein in spending to counteract inflation. He voiced grave concerns about the commercial real estate market, which he sees as a “ticking economic time bomb.”
On the subject of the Federal Reserve’s current leadership and the planned implementation of a central digital currency, Navarro was no less critical. “Jerome Powell should not be Fed Chair, I opposed it when Trump appointed him. We’re stuck with a guy I just don’t trust to solve anything,” he said, pointing fingers at former Treasury Secretary Steve Minuchin for recommending Powell for the position.
With the Stanford professors’ warning and Navarro’s pointed critiques, the spotlight now falls squarely on the Federal Reserve and the Biden administration’s economic policies. As the debate continues, the future of the U.S. banking sector hangs in the balance.
