Discover more from BIG by Matt Stoller
Fire the Fed
Key bad guys in the Silicon Valley Bank saga are at the Federal Reserve. It's time to end the era of central bank supremacy and fire the Fed as our most important bank regulator.
Welcome to BIG, a newsletter on the politics of monopoly power. If you’re already signed up, great! If you’d like to sign up and receive issues over email, you can do so here.
In 1969, then-Citibank CEO Walter Wriston tried to radically upend more than a hundred years of banking law by offering to buy the large insurance company, the Chubb Corporation. He did so by using a loophole in banking law that allowed banks to form a holding company and diversify into non-banking industries. Such a purchase would entangle banking and commerce in a manner traditionally prohibited by the rules establishing the national banking system in the 1860s, and reinforced by the Glass-Steagall Act in the 1930s. And it was utterly shocking to the political establishment, from bank regulators all the way up to President Richard Nixon.
Citibank’s move was part of a wave of big banks and conglomerates, which were an early type of private equity fund, trying to break this barrier, and use the special government guarantees for cheap credit as a competitive advantage over industrial firms in the real economy. Smaller banks were unhappy, as were many businesses, about what Wriston was doing. Still, the banks had an immensely powerful lobby. Yet over the course of the next two years, populist Banking Committee Chair Democrat Wright Patman, and his allies in business, at Federal regulatory agencies and in the Nixon administration, fought back.
Patman held hearings to expose the problems, hearings that today show what it means when core infrastructural platforms - in this case banks - could exploit their market position. A Pennsylvania entrepreneur testified about pressure put on him by banks to buy alternative services when he needed financing. An Indianapolis travel agent, Othmar Grueninger, talked about how bank-owned travel agencies were driving independent agencies out of business because of their unparalleled access to data about who traveled and who was creditworthy. “Any time I deposited checks from my customers,” he said, “I was providing the banks with the names of my best clients.”
But the big banks were powerful, and controlled a majority of votes on the House Banking Committee, despite Patman’s Chairman position. So the committee passed a version of the bill that legalized what Wriston and various conglomerates were doing. Executives at the American Bankers Association, the lobbying group based in New York, celebrated. Then, lobbyists for insurance and travel agencies, data processors, and industry groups mobilized. On the floor of the House, Patman and his staff completely re-wrote the bill that had come out of committee, and passed it out of the House. Lobbyists at the American Bankers Association had stopped paying attention, and didn’t even learn what happened until the next day.
The fight went over to the Senate, where it became even more brutal, involving bribery, threats to campaign contributors, and shouting matches. The progressive National Farmers Union, in hock to a Denver bank that had been acquired by a conglomerate, persuaded liberals like Senator George McGovern to back a big bank-friendly amendment. The negotiations for the final bill between the House and Senate were, according to American Banker magazine, among “the most contentious ever held on banking legislation.”
In that conference committee, Patman pulled perhaps the pettiest yet most impactful political maneuver I’ve ever seen. Attached to the bill was a noncontroversial provision to coin 150 million commemorative Eisenhower dollars with 40% silver content. A major contractor for the silver jacketing material for the coins was a company owned by a contributor to a key Senator on the conference committee, New Jersey’s Harrison Williams, who had previously backed the banks and conglomerates. Patman threatened to strip the commemorative coin provision, and Williams quickly caved and dropped his support for the bank-friendly version of the bill. And thus a key protection of the middle class from financiers was preserved for another thirty years.
Ultimately, the 1970 Amendments to the Bank Holding Company Act empowered the Federal Reserve to prohibit banks from co-mingling with commerce through holding companies. In the next two years, the Fed broke up 89 conglomerates, and stopped big banks from buying their way into insurance, land development, data processing, and management consulting. Everyone who had formed a bank holding company starting in 1968, when the rush began, had to divest their non-bank assets. I went into more details of this episode in my book Goliath; suffice to say it was one of the most important political fights of the 1960s that most of us know nothing about.
What Is Federal Reserve Independence?
What was most striking to me about this episode, having worked on the financial crisis of 2008 as a Congressional staffer, was not the fights within Congress. That made sense, the pettiness, corruption, good faith and big decisions all in one wrapper. It was the behavior of the Federal Reserve. Fed officials in the 1960s and 1970s were hostile to consolidated banking power. “The rapid development of the one bank holding company movement,” said the NY Fed President Alfred Hayes in 1971, “raised not only issues of bank safety and competition, but also the issue of excessive economic power—the possibility that one-bank holding companies might become nuclei of industrial-financial conglomerates which could dominate economic life in the United States.” Fed officials remembered the fragility of banking that caused the Great Depression, and that the Nazi and Japanese regimes that fostered World War II were intertwined with financial centralization. They also remembered the period from 1935-1950, when the Federal Reserve made no independent decisions itself, and simply took orders on monetary policy directly from the President.
I preface my discussion of the collapse of Silicon Valley Bank with the story of a different regulatory regime, because I want to offer a sense of the kind of thinking that existed at the Federal Reserve before neoliberals took over our society. And to be clear, the Fed was *never* good, per se, it was always the most bank-friendly regulator. The Federal Reserve has 12 reserve bank branches, and these regulate the banks in their districts. Unlike any other regulator, these branches actually have bankers from the institutions they regulate on their boards. That was true then, and it’s true now. But that the most bank-friendly regulator used to see the emergence of concentrated economic power as a serious political threat should illustrate how far we have come since then.
So what happened? In the 1980s, as part of the neoliberal revolution that reshuffled antitrust and regulation, the Fed also changed. It became ‘independent,’ and explicitly argued it should not be subject to political control or influence. From 1987-2005, the Chair of the Fed was Alan Greenspan, a former consultant to Silverado Savings and Loan, one of the largest bank busts of the savings and loan crisis, and a Michael Milken pet bank. Greenspan restructured the Fed’s supervisory authority, deferring to banks, and ultimately ripping out the culture of aggressive regulation. By 2004, the Fed, though it had consumer protection regulatory authority, chose to do nothing in the face of what the FBI called an “epidemic of mortgage fraud.”
Those who Greenspan promoted were men like the Fed’s general counsel, Scott Alvarez, who responded with “I don’t know” or “I don’t recall” 17 times on the witness stand in the only major trial over the bank bailouts of 2008, where the Fed did whatever they could to hand over money to large banks like Goldman Sachs.
Today, regulators at the Fed believe the opposite of what they did in the 1960s. So what is their philosophy? American strength and power, they think, comes from the vitality of our large banks, vs the more feeble and less profitable European banks. A quick fact to contrast how the Fed broke up conglomerates in the 1970s makes the point. From 2006-2021, the Fed received over 3,500 merger applications from banks, and didn’t deny a single one. This record includes Silicon Valley Bank in 2021 buying Boston Private Bank and Trust, which the Fed board unanimously justified by noting that SVB would not “pose significant risk to the financial system in the event of financial distress."
Far from understanding finance as a supportive activity to commerce, Fed regulators see banking and finance as the keystone for our society. And some of this is institutional; the Fed organizes monetary policy through a few large banks, using them as the agents of increasing or lowering interest rates, or expanding or reducing its balance sheet. As I noted when discussing the Cantillon Effect, which is how money moves in the economy, the Fed works through capital markets, and it backstops hedge funds, big banks, and private equity firms, because it is linked to them institutionally.
The Arrogance of Central Bankers
And with all that in mind, what is very clear, and what most policymakers have come to understand, is that the collapse of Silicon Valley Bank is 100% the fault of the Federal Reserve. SVB was regulated by the San Francisco Federal Reserve Bank, and examiners at the SF Fed didn’t see serious problems until the fall of the bank was imminent. This is despite public reporting in the Wall Street Journal about the hole in the bank’s balance sheet months earlier. The incompetence of Fed examiners is married to supreme smugness by those same regulators.
Indeed, nearly all of my contacts in bank regulation are uniform in hating the Fed, which is composed of, as one of them told me, “arrogant patronizing fucks who are not any good at their jobs.”
The closer you get to the facts the worse it looks. Supervisors should never have allowed a bank funded with between 90-100% uninsured ‘hot money’ deposits by venture capitalists to bet on unhedged long-term bonds. And you didn’t need to be a genius to get this fact. Everyone in Silicon Valley knew that SVB was insolvent, it was pretty much an open secret. The piggishness of the place, and the social climbing, was legendary. Despite what should have been a prohibition of banks and commerce in reform legislation in 2010 known as the Volcker Rule, SVB owned stakes in over 3,000 firms, and those firms placed their deposits with the bank in return. SVB also gave below-cost loans to Silicon Valley elites in the form of ‘white glove’ service. But it went beyond just self-dealing, the social aspect was just as important. Tech titans would place $100 million in deposits to get things like invitations to famous venture capitalist Marc Andreesson’s house for drinks. Powerful financier Ron Conway had up to $200 million at the bank, probably because SVB CEO Greg Becker is, you know, a good guy.
And the collusiveness of the bank with the Fed itself was very clear. I mean, Becker was on the board of the San Francisco Fed until the day his bank collapsed, when the SF Fed quietly replaced him with a ‘vacant seat’ notice.
The reason the Fed screwed up is ideological. Regulators there simply do not believe in placing constraints over banks, for fear they will hinder American strength. The era of Fed independence occurred in part because of our national strategy; America in the 1980s shifted from a nation whose power came from its manufacturing base and towards a nation whose power came solely from its control over the global financial order, with the trade deficit that implied.
As such, today it is the strength of large banks, as well as ‘financial innovation,’ that matters to the Fed, not the underlying simple utility service of operating payments, making loans, and safekeeping cash. And let’s be clear, financial innovation is always, and I mean always, gambling with other people’s money, using new technology or a new instrument. There’s even the phrase “This time is different,” to describe the mentality of every stupid new mania in finance
For instance, the Fed crew pushed aggressively for intertwining cryptocurrencies into the banking system. It was “hand-to-hand combat” for 18 months among regulators, with the Fed and officials Nellie Liang and Janet Yellen at Treasury pushing a bill, along with the most bank-friendly Senator, Pat Toomey, that would have given access to Fed facilities to stablecoin issuers. Fortunately, they lost after Sam Bankman-Fried’s FTX blew up spectacularly, and the Fed finally flipped its position by issuing a statement opposing crypto coming into regulated banking. (Of course, the embarrassment never ends, some dingbat regulator at the Fed, supported by SF Fed President Mary Daly who also screwed up on SVB, had allowed FTX to buy a bank charter, and get access to the payments system and a Fed backstop.)
But to truly understand why the Fed allowed SVB to act like piggish fools, we have to start not with the shift by Greenspan in the 1980s, but with how the Fed approached the financial crisis in 2008, and what they learned from it.
BIG is a reader-supported newsletter focused on the politics of monopoly and finance. This is journalism and advocacy that challenges power, so please consider a paid subscription. You can always get lies for free. The truth costs a few bucks, but in the long run it’s much cheaper.
Stress Tests and Busywork
If you listen to people like former Fed Chair Ben Bernanke, he will explain that the cause of the financial crisis was not what bankers did, or failures of supervisors at the Fed to stop them, but ‘gaps’ in authority, a savings glut abroad distorting borrowing costs, and a necessary complexity of risk-taking in a modern economy. Basically, he pointed the finger at everything but the 20 years of ripping out a culture of prudence at the Fed, which both he and his predecessor, Greenspan, undertook.
Indeed, Fed officials never believed that the financial crisis was caused by large financial institutions they regulated or the reckless behavior of the bank executives they worked with. As such, they see regulation to constrain large banks as foolish and unfair.
The truth is, though banking policy fights seem really complicated, they are mostly a game of pretend. Before the financial crisis, the Fed had authority to regulate big banks, but it used this authority to facilitate consolidation, such as when Alan Greenspan allowed Citibank to buy Travelers in 1999. The post-crisis legislation, the Dodd-Frank reform bill, didn’t allow the Fed to do more than it could before, it grabbed the Fed by the collar and said ‘do a better job of regulating banks.’
Dodd-Frank gave the Fed a bunch of annoying homework. The Fed had to make sure large banks had enough cash on hand (liquidity), stop big banks from being too exposed to other banks (interconnectedness), and look at a variety of other possible areas of risk. Banks had to pass Fed ‘stress tests,’ which were scenario planning exercises where banks would explain how they could handle adverse situations like recessions, drops in housing prices, and bankruptcy of major partners. If they passed, the Fed would let them do share buybacks and dividends, which bankers love because getting money is great. Big banks also had to write ‘living wills,’ which are ways to let a bank wind down without a bailout if it ran into trouble.
Still, the stuff in Dodd-Frank was all pretend. The Fed could have done all of it prior to 2010, but didn’t want to. In the post-financial crisis era, from 2010 onward, the Fed still didn’t want to. It regulated, but in a half-hearted way. Despite the stress tests and living wills, and despite the constant ‘we’ve solved Too Big to Fail,’ no one believed the biggest banks would ever be allowed to fail.
And the kabuki continued. As distance from the crisis grew, bankers and Fed officials pretended they had it all solved. The Fed always hated being forced to pretend it might exercise authority over large banks it saw as its allies, so officials at the Fed, from Alvarez to Fed Governor Randy Quarles, pushed to get rid of these stress tests. As Quarles said in 2019, “I think we’ve moved not too quickly, but quite quickly, in adjusting — again, with an eye toward efficiency — some aspects of post-crisis regulation.” Finally, people started saying the quiet part out loud. One progressive, Daniel Tarullo, hardly a hawkish regulator, pronounced these tests as irrelevant ‘compliance’ checks done so that the Fed could justify allowing more share buybacks.
In 2018, the Fed, along with its regional bank allies, wrote and lobbied for a bill, S. 2155, that didn’t quite take away its regulatory authority so much as give it the political cover to relax regulatory requirements over large regional banks, like SVB. SVB lobbied for this legislation, but the prime actor here was the Fed itself. The general counsel of the Fed, Mark Van Der Weide, helped author S. 2155, and Fed Chair Jay Powell testified for it. Just a few months after Trump signed S. 2155 into law, SVB announced a $500 million stock buyback program. And a few months after that, SVB began taking in huge deposits and make the bets that would lead to its undoing.
In 2019, the Fed wrote aggressive rules rolling back obligations of large regional banks, leading to an unusual dissent by then-Fed governor Lael Brainaird. At the time, opponents of this bill predicted removing requirements would lead to a blow-up, but the world of Fed officials nonetheless condescended to everyone who warned of too much risk in the system. Liang who ran the Federal Reserve’s financial stability division for six years, responded to the bill by saying “meh,” and from her temporary perch at the Brookings Institution, “It’s fine.”
So where is Liang today? She’s at Treasury, working for Treasury Secretary Janet Yellen. At this point, the Fed and Treasury have merged intellectually. Yellen used to be the Chair of the Federal Reserve Board and before that, she was the President of the San Francisco Fed. Yellen has a long history of pushing for large banks. In the 1990s, she supported the repeal of Glass-Steagall, in the 2010s, she endorsed exempting banks below $250 billion in size from a variety of requirements, which ultimately became the 2018 deregulatory legislation. Her underlings, like Liang, and the powerful bank regulator at the Office of the Comptroller of the Currency, Michael Hsu, come from the Fed, and are similarly terrible.
Ultimately, we can blame that deregulatory legislation for the SVB blow-up, or we can choose otherwise. Senators who voted for S. 2155, like Senator Mark Warner and Tim Kaine, and every Republican Senator, certainly think it had little to do with the blow-up. It’s true, it wasn’t inherent in that bill that the Fed would engage in lax supervision and that banks like SVB wouldn’t be required to have enough cash on hand to manage a run, though that is what Warner and Kaine sought. But the Fed wanted to do that, and the bill gave the Fed the excuse it wanted. As Quarles noted, “Changing the supervision culture ‘will be the least visible thing I do and it will be the most consequential thing I do.’”
It’s not just regulation, which can seem vague and esoteric. Take something much easier to understand, a rule Congress implemented to claw back bank executive compensation. An executive compensation rule is the easiest banking practice to understand. It’s basically, if your bank blows up, you don’t get to keep all your yachts.
Executive compensation matters for a lot of reasons. If someone can get a bonus based on phantom profits of their bank, they will, even if there are substantial losses later. This short-term mindset was a fundamental causal factor in the 2008 crisis. It’s why bankers were trying to move so many crappy mortgages, because they got bonuses for booking immediate accounting profits on the volume of mortgages, not whether those loans were ever paid back.
But it also matters today. For instance, in 2020, when SVB employees told the management committee to stop taking so many risks, management refused, noting that they preferred higher profits and the bigger bonuses that came with them. It’s the classic ‘picking up nickels in front of a steamroller,’ or abuse of ‘other people’s money.’
Another reason is moral. SVB was simply looted as it went down the toilet, handing out bonuses hours before bank examiners came in to shut the place down. This money should be clawed back. So why wasn’t it?
As part of the post-crisis reforms, in 2010, Congress mandated that six financial regulators jointly come up with a rule to claw back banker pay, to make sure that bankers would personally lose money if their bank blew up. If a rule had been in place in 2011, as per the deadline in the legislation, it would have been. So what happened? In a word, the Fed.
The prime mover among regulators for this provision was crisis-era FDIC Chair Sheila Bair, but when her term expired in 2011, no one picked up the mantle. And after Bair left, the Fed opposed the rule, killing it. Fed Chair Jay Powell told Senator Bob Menendez as much in 2018, saying that even though he would not implement the rule he was statutorily mandated to implement, the Fed was constraining executive compensation through its supervisory authority. (I’d love someone to ask Powell about how SVB’s exec compensation was structured, because I suspect he’s lying.)
Silicon Valley Bank
And this gets to the last part of the Fed’s immense, incomparable record of failure on SVB and the broader banking system. The Federal Reserve has supervisory authority over big banks because it is in charge of monetary policy, which is how credit flows in the economy and affects price levels. That means the rules it sets for interest rates work through big banks, and then move into the real economy and change mortgage rates, credit card rates, corporate borrowing rates, and so forth. Similarly, the way it regulates big banks sets up how what is called a “monetary transmission channel” functions.
For thirteen years, from 2008 to 2021, the Fed kept interest rates at zero, and had bought eight trillion dollars of bonds to make money cheaper for banks. One can argue the wisdom of the Fed’s actions, but it happened. This zero interest rate policy (ZIRP) meant that banks like SVP got used to free deposits and very low returns on lending and bonds. In 2021, the Fed began encountering serious signs of inflation, and the Fed’s most important job, along with full employment, is to make sure that price levels are relatively stable. To address inflation, it had to tighten financial conditions.
Now, you’d think that the Fed would have thought about the impact of higher interest rates on the banks it regulated and supervised. That’s kind of the whole point of being the supervisor of big banks and the monetary authority. One might even think that the Fed would want to do some sort of, oh I don’t know, stress test, on how higher interest rates could affect banks. But it did not. The Fed did not prepare the banking system for normalizing interest rates, because that would have required constraining what big bank executives wanted to do.
And that brings me to the collapse of SVB, which was unlike the last time we had a bank blowup. In 2008, bank balance sheets were full of weird stuff with weird names, like synthetic derivatives, collateralized debt obligations, or off-balance sheet demands that could come due at unexpected moments. Today, yes there are losses among banks, but everything is pretty transparent. SVB made bets on plain vanilla Treasury bonds and mortgage-backed securities. Their values dropped, but it’s from 100 cents to 95 cents on something that is easily sellable in the open market. If you own a lot of it, as SVB did, a small decline in prices leads to a big loss in a portfolio. It’s not like 2008, when some crappy instrument might be worth 100 cents on the dollar or might be worth 0, and there’s no ready market for anything. So the Fed should have seen the insolvency of SVB coming, as many short-sellers did. But it did not. And then, when there were problems, it was Jay Powell and Janet Yellen pushing almost immediately, on Thursday evening, for a bailout of uninsured depositors.
Now, I don’t want to get too deep into the SVB fiasco, there are a lot of explainers elsewhere. (I wrote a report you can read here if you want mine.) I will just note that the FDIC was not panicking, and if it had been able to go through with its original plan, uninsured depositors would have gotten back 50% of their cash almost immediately, and the rest back shortly thereafter, with only a slight possibility of a haircut. If the Fed had opened up its discount window or a facility to discount good collateral, there might have been runs on mid-size banks, but those would have been contained. And if the Fed had actually broken up the Too Big to Fail banks - JP Morgan, Citigroup, Bank of America, Wells Fargo, and Morgan Stanley - there wouldn’t have been a run at all. The only reason people withdrew uninsured deposits is because they had de facto government banks.
But instead, Powell and Yellen, who run Biden’s financial policy, forced a bailout of all uninsured depositors, billionaires like Conway, and firms like Roku, which had $500 million sitting in a bank account. That’s utterly absurd. As one European bank regulator said in horror, “At the end of the day, this is a bailout paid for by the ordinary people and it’s a bailout of the rich venture capitalists which is really wrong.” And what it means is that a new class of banks, with $100 billion of assets, are now de facto government banks. The 5000 small community banks aren’t, so they will eventually get wiped out (as they are starting to notice. Little is as annoying as the solidarity that community bankers feel towards the Wall Street bankers trying to kill them.) More fundamentally, it shows that Dodd-Frank, with its homework for regulators, its stress tests, its living wills, its goal of ‘ending Too Big to Fail,’ is a conclusive failure.
Drop the Fed Independence Charade
So what now? A lot of people I respect, like Morgan Ricks, are arguing for unlimited FDIC insurance for all deposits, with a corresponding increase in banking regulation. This would hand the full faith and credit of the United States, officially, to every banker in America, in return for more public oversight. This is a reasonable proposal, given that large banks are unfairly backstopped by government, while smaller ones aren’t. Still, I don’t believe that is a good idea, at least not with our current banking system, because a lot of money will then flood into banks, and bankers will put that money to work in riskier assets. Do we really have any confidence that supervisors are on their game? Without an absolutely radical restructuring of banking to make it much simpler and more limited, this will backfire. I do not think there is the political consensus that banks should be more aggressively regulated and restructured, so we’ll see even more privatizing gains and socializing losses if we do what Ricks suggests.
It’s time to go back to first principles, and that means ending Federal Reserve independence, the presumption that the Fed should be able to make decisions independent of elected political leaders. Independence just means the Fed will do what the banks want, not just in bank regulation and supervision, but in organizing the entire economy through monetary policy. That era needs to end. As happened from 1935-1950, and what the Fed hates people remembering as a possibility, is either the President or a Congressional committee directly running monetary policy. There shouldn’t be an ‘independent’ central bank, the job of making decisions on money belongs to people we elect.
This means, at the very least, regular audits of monetary policy by third party authorities, and getting rid of bank representation on the reserve branches that regulate them. It means removing as much regulatory and supervisory authority over banks from the Fed as possible, and putting that authority in the hands of the FDIC. The FDIC has to clean up banking messes, so they have an institutional incentive not to let bankers make messes in the first place. And it means giving an unlimited backstop to non-interest business accounts that do lots of transactions, like payroll. Basically if you’re infrastructure, you get protection, if you’re just some rich guy with a lot of cash and want a return on your money, you don’t.
Finally, it means raising regulatory requirements on the largest banks so high that it becomes unprofitable to be a government-backed bank, or just breaking them up directly using provisions of Dodd-Frank that are intentionally gathering dust.
The Fed sees banking as ‘innovative,’ which is ridiculous and means we will always structure banks, and our economy, in unfair ways. The Fed should be fired from its role in organizing the banking system, and large numbers of Fed employees should be laid off. I would even go so far as to consider making the Fed subject to annual Congressional appropriations. I mean, this is an incompetent and delusional organization that has spent $3.5 billion on its own renovation.
Regardless, banking is a public utility service, and we have to start treating it that way. The Fed won’t. And it will destroy our economy and society rather than admit it.
Thanks for reading! Your tips make this newsletter what it is, so please send me tips on weird monopolies, stories I’ve missed, or other thoughts. And if you liked this issue of BIG, you can sign up here for more issues, a newsletter on how to restore fair commerce, innovation and democracy. And consider becoming a paying subscriber to support this work, or if you are a paying subscriber, giving a gift subscription to a friend, colleague, or family member.