WASHINGTON — The federal government’s bailout of two bankrupt banks last month has drawn criticism from some lawmakers and investors, who accuse the Biden administration and the Federal Reserve of bailing out wealthy clients in California and New York and bank clients in Central America on to saddle with the bill.
But new data helps explain why government officials viewed the failures of Silicon Valley Bank and Signature Bank as a risk not only to their clients, but to the entire financial system. The numbers suggest that a run on deposits at those two banks could have sparked a succession of bank failures, paralyzing small businesses and economic activity across much of the country.
The geographic risk analysis of a banking crisis, commissioned by The New York Times, was conducted by economists from Stanford University, the University of Southern California, Columbia University and Northwestern University.
The results show the continued potential for widespread damage to the entire banking system, worsening the financial position of many banks as the Fed raised interest rates to curb inflation. Those rate hikes have lowered the value of some government bonds that many banks hold in their portfolios.
While the damage has been contained so far, the research shows that larger runs on banks vulnerable to rate hikes could lead to a significant drop in available credit for shop owners, home borrowers and more. Because so many counties rely on a relatively small number of financial institutions for deposits and loans, and because so many small businesses keep their money close to home, even a modest run on vulnerable banks can effectively hinder access to credit for entire communities.
That kind of credit paralysis, the researchers estimate, could affect nearly half of the counties in Missouri, Tennessee and Mississippi — and every county in Vermont, Maine and Hawaii.
The analysis supports the case made by government officials based on anecdotes and preliminary data they had as they orchestrated the bank rescues over that weekend in March. As fears of a wider financial crisis mounted, the Fed, the Treasury Department and the Federal Deposit Insurance Corporation banded together to ensure that depositors had access to all their money after the banks collapsed – even if their accounts were over the limit. Exceeded $250,000 on federally insured deposits. . Fed officials also announced they would offer attractive loans to banks that needed help to meet depositors’ demands.
The move allowed large companies — such as Roku — that kept all of their money with Silicon Valley Bank to be fully protected despite the bank’s collapse. That has drawn criticism from lawmakers and analysts who said the government was effectively encouraging risky behavior by bank managers and depositors alike.
Even with those steps, the analysts warn, regulators have not permanently addressed vulnerabilities in the banking system. These risks leave some of the country’s most economically disadvantaged areas susceptible to banking shocks, ranging from a slump in small business lending, which may already be underway, to a new run on deposits that threatens easy access to credit for people and businesses in provinces across the country.
Federal Reserve staff hinted at the risks of a broader banking-related blow to the US economy minutes after the Fed’s March meeting, released Wednesday. “If banking and financial conditions and their effects on macroeconomic conditions deteriorated more than assumed in the base scenario,” staff would say, “the risks surrounding the base scenario would be on the downside for both economic activity and inflation . ”
Administration and Fed officials say the measures they have taken to bail out depositors have stabilized the financial system — including banks that could be threatened by a run on depositors.
“The banking system is very healthy — it’s stable,” Lael Brainard, director of President Biden’s National Economic Council, said Wednesday at an event in Washington hosted by the Semafor media outlet. “The core of the banking system has a lot of capital.”
“What’s important is that banks have now seen, bank executives have now seen, some of the stress the failed banks were under, and they are strengthening their balance sheets,” she said.
But the researchers behind the new study warn that it has historically been difficult for banks to make major changes to their financial positions quickly. Their data does not take into account the efforts smaller banks have made in recent weeks to reduce their exposure to higher interest rates. But the researchers note that smaller and regional banks face new risks in the current economic climate, including a downturn in the commercial real estate market, which could spark another run on deposits.
“We have to be very careful,” said Amit Seru, an economist at the Stanford Graduate School of Business and an author of the study. “These communities are still quite vulnerable.”
Biden administration officials monitored a long list of regional banks in the hours after Silicon Valley Bank filed for bankruptcy on March 10. They became alarmed when data and anecdotes suggested depositors lined up to take money out of many of them.
The cost of the bailout they have planned will eventually be paid by other banks through a special fee levied by the government.
The moves drew criticism, especially from conservatives. “These losses are borne by the Deposit Insurance Fund,” Tennessee Senator Bill Hagerty said in a recent Banking Commission hearing on the bailouts. “That fund will be replenished by banks across the country that had nothing to do with Silicon Valley Bank’s mismanagement or regulatory failure here.”
Senator Josh Hawley, Republican of Missouri, wrote on Twitter that he would try to prevent banks from passing on the special fee to consumers. “Mo clients are definitely not paying for a wake-up bailout,” he said.
The researchers found that Silicon Valley Bank was more exposed than most banks to the risks of a rapid rise in interest rates, lowering the value of securities such as Treasury bills in its portfolios and paving the way for insolvency as depositors scrambled to get their money back. to pull. money from the bank.
But, drawing on 2022 federal regulator data, the team also found that hundreds of U.S. banks had experienced a dangerous deterioration in their balance sheets over the past year as the Fed quickly hiked rates.
To map the vulnerabilities of smaller banks across the country, the researchers calculated how much the Fed’s rate hikes have lowered the value of individual banks’ assets compared to the value of its deposits. They used that data to effectively assess the risk of a bank failing in the event of a run on its deposits, which would require bank officials to sell undervalued assets to raise money. They then calculated the proportion of banks at risk of bankruptcy for each province in the country.
Those banks are disproportionately located in low-income communities, areas with a high proportion of Black and Hispanic populations, and places where few residents have college degrees.
They also form the economic backbone of some of the nation’s most conservative states: Two-thirds of Texas counties and four-fifths of West Virginia counties could see a crippling number of their banks fail, even in the case of a medium -sized run on deposits, the researchers calculate.
In counties across the country, smaller banks are crucial engines of economic activity. Goldman Sachs researchers recently estimated that in 95 percent of counties, at least 70 percent of small business loans come from smaller and regional banks. Those banks, the Goldman researchers warned, are withdrawing from lending after the collapse of Silicon Valley Bank.
Analysts will get new indications of the extent to which banks are taking swift steps to pull back lending and capital accumulation when three major financial institutions report quarterly earnings on Friday: Citigroup, JPMorgan Chase and Wells Fargo.
Stanford’s Mr. Seru said the communities particularly vulnerable to both a credit slowdown and a potential regional bank run were also those most affected by the pandemic recession. He said larger financial institutions are unlikely to quickly fill a loan vacuum in those communities if smaller banks were to fail.
Mr Seru and his colleagues have urged the government to help address the vulnerabilities of those communities by requiring banks to raise more capital to strengthen their balance sheets.
“The recovery in these neighborhoods is not yet there,” he said. “And the last thing we want is disruption there.”
