WASHINGTON — The federal government’s bailout of two failing banks last month has drawn criticism from some lawmakers and investors, who accuse the Biden administration and Federal Reserve of bailing out wealthy customers in California and New York and banking customers in Central America with the bill to charge .
But new data helps explain why government officials declared the collapse of Silicon Valley Bank and Signature Bank a risk not just for their customers, but for the entire financial system. The numbers suggest that a rush for deposits at these two banks could have sparked a cascading series of bank failures that crippled small businesses and economic activity across much of the country.
The analysis of the geographical risks 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, which has caused many banks’ financial positions to deteriorate as the Fed hiked interest rates to tame inflation. These rate hikes have reduced the value of some government bonds that many banks hold in their portfolios.
Although 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 credit available to shopkeepers, home borrowers and others. Because so many counties rely on a relatively small number of financial institutions for deposits and lending, and because so many small businesses keep their money close to where they live, even a modest run on vulnerable banks could effectively choke access to credit for entire communities.
That kind of credit paralysis, the researchers estimate, could hit nearly half of the counties in Missouri, Tennessee and Mississippi — and every county in Vermont, Maine and Hawaii.
The analysis helps bolster the case that government officials made based on anecdotes and preliminary data they had while orchestrating the bank bailouts this weekend in March. As fears of a major financial crisis mounted, the Fed, Treasury Department and Federal Deposit Insurance Corporation acted together to ensure depositors have access to all their money after the banks collapse – even if their accounts exceed the $250,000 limit for government-insured deposits exceeded . Fed officials also announced that they would offer attractive loans to banks that needed help meeting depositors’ claims.
The moves allowed big companies — like Roku — that kept all their money with Silicon Valley Bank to be fully protected despite the bank’s collapse. This has drawn criticism from lawmakers and analysts, who said the government is effectively encouraging risky behavior from bank managers and depositors alike.
Even with these 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 vulnerable to bank shocks, ranging from a pullback in small business lending that may already be underway to a new rush of depositors that is effectively reducing easy access to credit for people could ban and businesses in counties across the country.
Federal Reserve officials hinted at the risks of a broader bank-related hit to the US economy in minutes from the Fed’s March meeting released on Wednesday. “If banking and financial conditions and their impact on macroeconomic conditions were to deteriorate more than assumed in the baseline,” the staff said, “then risks around the baseline would be skewed downward 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 have been threatened by a depositor run.
“The banking system is very solid — it’s stable,” Lael Brainard, director of President Biden’s National Economic Council, said Wednesday at an event in Washington hosted by media outlet Semafor. “The core of the banking system has a lot of capital.”
“What’s important is that the banks have now seen, the bank managers have now seen some of the stresses that the failed banks were facing and that they are supporting their balance sheets,” she said.
However, the researchers behind the new study warn that banks have historically found it difficult to make large changes to their financial holdings quickly. Their data doesn’t take into account the efforts smaller banks have made in recent weeks to reduce their exposure to higher interest rates. However, the researchers note that in the current economic climate, smaller and regional banks face new risks, including a downturn in the commercial real estate market that could trigger a further rush for deposits.
“We have to be very careful,” said Amit Seru, an economist at the Stanford Graduate School of Business and author of the study. “These communities are still quite vulnerable.”
Biden administration officials monitored a long list of regional banks in the hours following the March 10 collapse of the Silicon Valley bank. They were alarmed when data and anecdotes suggested depositors were lining up to siphon money from many of them.
The cost of the bailout they organize is ultimately borne by other banks via a special fee levied by the government.
The moves drew criticism, particularly from conservatives. “These losses will be borne by the deposit insurance fund,” Senator Bill Hagerty, a Tennessee Republican, said in a recent Banking Committee hearing on the bailout. “This fund is being filled by banks across the country that had nothing to do with the mismanagement of Silicon Valley Bank or the failure of regulators here.”
Senator Josh Hawley, a Missouri Republican, wrote on Twitter that he would try to stop banks from passing the extra fee on to consumers. “There’s no way MO customers are paying for a woke 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, which reduced the value of securities such as Treasury bills that it held in its portfolios and set the stage for bankruptcy when the depositors rushed to withdraw money from the bank.
But using data from federal regulators from 2022, the team also found that hundreds of US banks have seen their balance sheets dangerously deteriorate 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 reduced the value of individual banks’ asset holdings relative to the value of their deposits. They used this data to effectively assess the risk of a bank failing in the event of a run on its deposits, which would force bank officials to sell undervalued assets to raise money. Then they calculated the proportion of banks at risk of failure for each district of the country.
These banks are disproportionately located in low-income communities, areas with high black and Hispanic populations, and places where few residents have college degrees.
They’re also 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 in the event of a single mean-big run on deposits, the researchers calculate.
In counties across the country, smaller banks are key engines of economic activity. In 95 percent of counties, Goldman Sachs researchers recently estimated that at least 70 percent of small business lending comes from smaller and regional banks. These banks, the Goldman researchers warned, are “disproportionately” withdrawing from lending after the collapse of Silicon Valley Bank.
Analysts will get new clues about the extent to which banks are moving quickly to limit lending and capital accumulation when three major financial institutions report their quarterly results on Friday: Citigroup, JPMorgan Chase and Wells Fargo.
Stanford’s Seru said the communities most vulnerable to both a slowdown in lending and a possible run on regional banks are also those that have suffered the most from the pandemic recession. He said larger financial institutions are unlikely to fill a credit vacuum in these communities quickly if smaller banks fail.
Mr Seru and his colleagues have called on the government to address the vulnerabilities of these communities by requiring banks to raise more capital to shore up their balance sheets.
“The recovery in these neighborhoods isn’t there yet,” he said. “And the last thing we want is a disruption there.”