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Not Buying Central Banks’ Favorite Excuse

Everyone has become so inured to massive central-bank interventions in markets that no one realizes just how unusual the latest banking crisis and response has been. But the time has come to consider whether monetary policy is the systemic force that created systemic vulnerability in the first place.

CHICAGO – As institutional mea culpas go, the US Federal Reserve’s recent report on the events leading up to Silicon Valley Bank’s failure is surprisingly self-critical, detailed, and informative. While pointing out that SVB did not manage its risks appropriately (when its own models showed that it was taking too much interest-rate risk, the bank changed the model’s assumptions), the report also castigates supervisors for failing to appreciate SVB’s growing vulnerabilities or pushing it to fix them. The Fed also flags regulatory changes that SVB exploited to avoid closer scrutiny. But the report does not address a crucial matter: the Fed’s monetary policy.

This is partly by design: the report was intended to review the Fed’s supervision and regulation. Yet by focusing only on these issues, it ultimately ignores one of the most important factors affecting financial-sector stability. SVB was not just one bad apple. Four US banks failed at around the same time, largely because they had invested in low-yielding fixed-rate long-term bonds and loans, financed with short-term runnable deposits.

In March, the US Federal Deposit Insurance Corporation estimated that banks were sitting on unacknowledged losses of around $600 billion on their securities holdings – a figure that rises well above $1 trillion if one includes losses on low-yielding loans. Worse, many of these banks also have significant levels of runnable uninsured deposits. Even though they are surviving for now, their profitability is being impaired and their long-term viability as independent entities questioned as depositors demand higher interest rates.