In Today’s Banking Crisis, Echoes of the ’80s

Losses at SVB, Signature and other banks reflect the risk from borrowing short and lending long

By Charles W. Calomiris and Phil Gramm. Excerpts:

"In 1991, new legislation was enacted with the goal of ensuring accurate loss recognition and “prompt corrective action.” As recent events show, that reform failed. Securities holdings held under “hold-to-maturity accounting” weren’t marked to market at SVB, Signature or the roughly 200 other banks that appear to be in similarly perilous condition. Not only did accounting rules allow SVB and the others to avoid formally recognizing losses; supervisors—who have the authority to intervene and look beyond accounting measures to force banks to shore themselves up with new capital—chose to do nothing. It took runs by uninsured depositors at SVB and Signature to force regulators to act.

Why did supervisors fail to pursue prompt corrective action? Calculating a bank’s duration risk (its exposure to loss from asset-liability maturity mismatch) is part of every bank exam in the U.S., one of the legacies of the 1980s thrift bust. Notwithstanding the accounting fiction of SVB’s balance sheet, supervisors knew that its securities holdings were of long durations and therefore declining in value. SVB wasn’t just any bank. It and First Republic were the two largest banks for which the San Francisco Fed had primary supervisory responsibility.

SVB’s strategy was profiting from taking carry-trade risk, or borrowing short and investing long. Its balance sheet looked more like that of a money-market firm than a bank, with purportedly as much as 94% of its deposits over the insurance limit. It held much more in long-term securities than in loans. In December 2022, SVB total securities’ book value was more than $123 billion and loans were only $73.6 billion. It paid above market for wholesale deposits to fund its carry-trade strategy. In 2022, as interest rates rose and the market value of its assets fell, SVB’s deposits fell $16 billion and it borrowed $15 billion from the Federal Home Loan Bank at higher cost to replace lost deposits.

The composition of deposits also changed. Non-interest-bearing deposits fell $45 billion, and interest-bearing deposits rose $29 billion. The increased reliance on borrowed funds and the decline in retail deposits have been a red flag of rising failure risk for bank supervisors for at least 130 years. By December 2022, SVB had an unrecognized loss of $24 billion on its hold-to-maturity securities combined with a new reliance on hot money. In 2022, as interest rates rose, Fed supervisors must have known the bank was deeply under-capitalized and headed toward insolvency.

Instead of raising the deposit insurance limit or expanding supervisory powers, Congress should require all assets held by banks to be marked to market. It should also invite supervisors from the San Francisco Fed and other agencies to explain why they failed to act. Was there political pressure not to? If so, from whom? Congress should press supervisors to intervene immediately to address similar problems at the 200 or so banks that are to some degree suffering similar weaknesses, rather than allowing those problems to fester."