Fed Action Could Have Prevented SVB’s Collapse

A central function of the central bank is to act as the lender of last resort. Why did it fail to do so?

By Hal Scott. He is an emeritus professor at Harvard Law School and director of the Committee on Capital Markets Regulation. Excerpt:

"The Fed (along with the Treasury) must answer two key questions: Did it know there was or could be a run on SVB, and if so, why didn’t it lend enough to the bank to prevent such an outcome?

Some believe that SVB couldn’t borrow sufficient cash from the Fed to stem the run because it lacked collateral. But the fair-market value of its entire portfolio of government-backed securities was $102.2 billion as of Dec. 31. Even allowing for a significant decline in value by March 9, SVB would still have substantial collateral to borrow from the Fed to cover the run on its deposits. Moreover, the Fed had no credit risk taking government-backed securities, even at par rather than fair-market value, as it could itself hold them to maturity.

Further, under Section 10B of the Federal Reserve Act, loans at the discount window need to be secured only to the satisfaction of the Fed, giving the central bank plenty of leeway. During the 2008 crisis, the Fed used this same leeway (then also available under 13(3) of the act) to lend to nonbanks against unsecured commercial paper through a special-purpose vehicle—a much riskier proposition.

When SVB, the country’s 16th-largest bank before last week, was announced to be insolvent, depositors at other banks predictably began to panic. In response the Fed established its new Bank Term Funding Program to extend loans to eligible banks at longer terms (up to a year rather than 90 days) and with more favorable collateral valuation (par value rather than fair-market value minus margin) than would normally be available at its discount window. But by that point the Fed was playing catch-up."