Whenever a major financial institution collapses and needs a bailout, it's easy to say, "Where were the regulators?" But that's only a useful question if you can pinpoint the specific regulatory choices that led to any particular situation. So what caused Silicon Valley Bank to implode? On this episode of the podcast, we speak with Columbia Law School professor Lev Menand, who discusses the defanging of bank supervisors in the run-up to this fiasco. With proper oversight, someone might have caught and put a stop to the unique set of risks the bank was taking. But without proper oversight, they were encouraged to go for all-out growth, regardless of the ultimate social cost. We also discuss legislative changes over time that led to this buildup of risk.
Hello, and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal and I'm Tracy Allow. So Tracy, we obviously, I think have a sense of why Silicon Valley Bank failed. We just published a really good episode with Dan Davis, like sort of like talking about where things went wrong on the sort of deposit side and failing to balance assets and liabilities and the issues of strengths and weaknesses of the business model. But then the other question, there are many, many more questions beyond just like why they failed. Yes, I mean some of the big ones that are emerging are where were the regulators right it? You know, people were already analyzing spb's balance sheet, you know, certainly the week before it collapsed and for some time before that, and you could see these vulnerabilities when it comes to duration exposure. And again that's something we talked about with Dan Davies. And then the other thing I guess just in general is it's not like bank failures are that unusual over the course of history. So this is the first big one, I guess since the two thousand and eight financial crisis. And so it's obviously garnering a lot of attention, But we do have bank failures throughout history from time to time, and it kind of begs the question of, well, if we're going to keep having them in different ways, and if the government or the Federal Reserve are going to keep coming in and rescuing them in various ways, should we maybe do something to the system to make it different. What were the failures and can we at least you know, we're always going to be fighting the last War cliche obviously, but what does it tell us about weaknesses in the system? And there may be things that we could do, And of course there's things that people are talking about on the sort of written law side, which is like, Okay, maybe we need more banks to have greater liquidity, ability to meet withdrawals, etc. I think some of the smaller, more regional banks don't have a stringent requirements on that front as the really large banks. And then people are talking about supervision, and I don't think supervision gets as much attention as the sort of written laws, but it's essentially, well, why did the supervisors the bank regulators allow the bank to create this confluence of risks, this big like sort of very specific mismatch between the nature of its assets, the nature of its deposit base that allowed it to unravel really quickly. Absolutely, and then of course, with the FED announcing this new facility, which is quite a dramatic one, you have a question of, Okay, if we're just going to guarantee all the US bank deposits out there, then should we maybe make a more fundamental change to the banking industry itself? Right? And actually, Matt Klein over at the Overshoot, I think he tweeted this, but he had that great first line in his most recent newsletter about how basically banks are these private investment funds that are grafted on top of critical infrastructure, and that structure is designed to extract subsidies from the rest of society by basically threatening people with banking crises whenever one of them is allowed to fail. And we saw that last week, right, We saw especially a bunch of vcs coming out and saying, if you don't rescue all the SVB depositors right now, this is going to happen to all the banks. And so you kick off that, you know, privatization of profits versus publicization of loss's argument over and over and over again. Well, that's been like really clear in this particular episode, like there's something about this story really raises some like uncomfortable days because it's not coming in like a wholesale financial collapse that's related to the collapse of the economy like in two thousand and eight or two thousand nine. It's like it's this very specific industry that sort of got it in trouble. Anyway, we could go on and on, but I'm excited. We do have the perfect guest for us to talk about the role of regulator, the role of regulatory failure, the role of the FED in all of this in the history of banking, and how we got here. We're gonna be speaking to a Levmanon Here's a professor at Columbia Law School written a lot about the FED and regulation. So Lev, thank you so much for joining us, Thank you so much for having me. So just you know, very top line view. You know, what would you say was the main regulatory failure with SIV with SVB, So yeah, yeah, we can distinguish between maybe regulation bright line rules yeah, put down in advance, and sort of supervision, yes, which is discretionary safety and soundness oversight by by examiners and federal federal regulators, federal officials, and both the sort of bright line rules and the sort of supervision failed here. Yeah, there was an overreliance on the bright line rules and a failure to do the discretionary oversight, the safety and soundness oversight effectively. So on the bright line rules side, SVB figured out a way to take additional risk without holding additional capital. Because of what's called the risk capital rules, treasury securities are risk weighted zero. That means that a bank has to hold zero equity against their treasury positions. And so SEP was able to go and buy a lot of long dated treasuries and actually build up quite a bit of interest rate risk without that being reflected in the capital that was required of them under the under the bright line rules, under the under the regulatory framework. Now we have a whole supervisory framework that's designed to deal with these sorts of holes in the rules. Everybody knows that the rules are insufficiently precise, and in fact, we didn't even have the rules until the nineteen eighties in meaningful sense. We used to just do discretionary safety and soundness oversight. And so the real question here in some sense is how come the supervisors didn't pick up on the fact that SVB had gamed the rules to take on a lot of interest rate risk without holding an adequate amount of capital against it. It's a pretty obvious maneuver. It's not nearly as complex as some of the maneuvers the gaming and it's not novel. It's not novel. Yeah, this is an old move. It's not like they camp with something new. You would think any seasoned supervisor looking at the balance sheet could pick up on this pretty quickly. So so what happened, I think is exactly the right question to be asking, and I think the answer requires maybe And this might just be my approach to these issues twenty thirty years worth of history to understand, because basically, I think contemporary supervision is broken in some sense and this is a manifestation of that. Okay, um, well, I'm I'm just gonna go ahead and buy and say, please, please give us the you know, thirty or forty years of banking history building up to those. Yeah, So let me. I'll say why I think it's broken, and then I'll tell you how we got sure, how it got so broken. So it's broken because outside of the stress testing framework, which I think we should definitely talk more about. Supervisors primarily now focus on process and procedures. Our insight into what actually goes on in supervision is very limited, and that's because supervisory materials are all confidential and can't be disclosed by the bank and aren't disclosed by by the regulators, and often never made public. So there's a lot of opacity into into what supervisors are actually doing. But it's it's fairly obvious, and I'll go through a few examples that what supervisors today tend to focus on is the process, and so they will look to see does the bank have a good risk management process, does it have the right board committees, does it have the right management committees looking at its risk decisions? Are there three lines of defense? And if the supervisors see the requisite process, they are very reluctant to make judgments about the actual decisions that are coming out of that process, and so they don't want to impose. They are reluctant to impose their own view. Oh, that is excessive risk, that is too much interest rate risk as opposed to we like the procedures that you're set up to manage interest rate risk. Just to be clear, though they certainly could under current law, they're allowed to say they're supposed to. Arguably, that's what current law is about, and the process approach being grafted onto this is an innovation. The purpose of safety and soundness law is really very much to address risk, and the process angle is born of the view that the best way to do that, the most efficient way to do that across a massive banking system, is just to make sure that the procedures are good. If the procedures are good, the problem will sort of take care of itself. So as long as you see the bank kind of debating its risk exposure internally, which you know seems to have been the case at SVB, and I know I brought this up in the previous episode, but you know, there were some internal documents which I've seen where they're talking about interest rate exposure and they're debating it, you know, with their asset liability committee and presumably with their risk specialists. But if they come to the conclusion that actually we're okay, the regulators are just going to look at that and take out on face value because the process is there, and they assume that, you know, the bank is kind of doing what it should be doing. Yeah, exactly, if you're not one of the big gesips, the global systemically important banks, and you're not in the stress testing route game, I think that is what tends to happen. It doesn't have to happen, As Joe said, they're certainly going to be examples where supervisors exercise them independent judgment. But there is a tendency still in the supervisory process to look at compliance with the rules, to check for processes, and if you see compliance with the rules and you see processes in place, to give the bank a clean bill of health, as it were. And so the question is how did we get to this place, because actually this was an innovation. At one point, we used to do safety and soundness substantive supervision without much bright line rules at all. Capital rules date only to the mid eighties, and this focus on process is really an innovation from the nineteen nineties. And so it's part of what I think is the toxic brew of regulatory supervisory policies that brought us the two thousand and eight crisis. And we still sort of have supervision guided by this nineties approach, and I think the SVB failure is one of several really significant examples of post two thousand and eight supervisory failure where the supervisors are still focused on process and too unwilling to make substantive judgments, reflecting the sort of approaches that were developed by primarily the greenspan fed but also the Ludwig occ in the nineties. Can you explain what it was or what happened in the nineties, was a directive that came down what caused this philosophical shift or just maybe mechanical shift in the approach to supervisory Let me start with the eighties, actually just with the birth of the capital rules. So what's the baseline. So supervision, safety and signed supervision dates all the way back to the nineteenth century, and so the way that the government's managed the incentive misalignment between bank shareholders and managers and bank depositors and the public has been through discretionary supervisory oversight safety and soundness oversight. That's been the bywords of federal law since the nineteen thirties. And the way that supervisors would do their job is they would make judgments about the riskiness of banks assets and the riskiness of banks leverage and the amount of capital and they would write letters, and they would job bone and they would take enforcement actions. They would issue cease and desist orders if they thought banks were under capitalized, or like in the case of Silicon Valley Bank, they would tell Silicon Valley Bank that it had to shorten its duration risk. That's what supervisors would do. In the eighties. You have a moment that's quite similar to today in that the banking system business model comes under a lot of pressure for macroeconomic reasons. Inflation goes up and then interest rates go way up because of the Vulker shock. This causes the yield curve to change in a way that's very ugly for a bank. Because a bank's business is a positive net interest margin. You earn more on your assets than you pay on your liabilities, and your liabilities are short duration, and so if interest rates go way up quickly, you can end up in a position where you are paying more on your liabilities than you are in your assets, which is which is going to run right through your capital. That's not a profitable business model. This happened in the eighties and a lot of banks became undercapitalized and supervisors were swamped with cease and desist orders and supervisory directives to banks all over the place to raise more capital. Some banks sued. One bank was able to prevail in the fifth Circuit, and Congress intervened and pass a new law authorizing forward looking, ex anti brightline capital rules for the first time and saying that capital judgments of supervisors can't be second guests by courts. And so, in a sort of accidental way, you have the birth of capital regulation. The supervisors are overwhelmed and there are laws, suits, and you have Congress saying, actually, just write a rule that the banks all have to comply with so that you don't have to get into litigation over whether this bank or that bank is undercapitalized. Fast forward a few years. You get these rules, and you get you get Basel one, you get an effort to align these rules internationally, and you get Alan Greenspan as fed share. Going into the nineties, the banking system starts to transform. You have the emergence of large, complex banking institutions, and you have a lot of soul searching in Washington and the Federal Reserve at the occ about whether supervisors are really up to the task of assessing the risk taking of these new large complex financial institutions, these large complex banking organizations that we never had in this country before through the traditional means, or whether we should actually embrace these new rules that have developed up and rely primarily on the rules and shift supervisors to a task that they are that they're more capable of performing. This is this is very self conscious for the policymakers at the time. You can go back and read some of Alan Greenspan's speeches about the changes that he's making, and he basically thinks that, especially for large banks, supervisors are just not going to be able to do it the way they used to. What we need are capital rules that require shareholders to have enough skin in the game, and then the shareholders will do it. The shareholders were supervised banks. And so Alan Greenspan says, it's not about needing net less regulation. It's about whether it should be public sector regulation or private sector regulation, and we need to reorient the banking system so that we have more private regulation. So that obviously goes terribly wrong in two thousand and eight. It's not funny, but this happens over and over and over it does, and so by two thousand and eight you have supervisors have more or less unilaterally disarmed. They have shifted to enforcing the capital rules. The banking agencies are relying almost entirely on the capital rules for making judgments about whether a bank has adequate capital for the risks that it's taking, and instead they are looking at processes. And there's a real theory behind this. The theory is, in order for market regulation to work, private regulation to work, there has to be disclosure, and so a bank has to be transparent about the risks that it's taken. A bank can't be transparent about the risks that it's taking if it doesn't have processes to monitor and disclose those risks. And so the job for supervisors is to make sure banks are monitoring their risks and disclosing them to the shareholders so that the shareholders can discipline the banks. And by two thousand and eight, supervisors have stopped bringing in cease into sists. There's no safety and soundness enforcement actions against any of the major banks, any of the major banks that take TART for years running up to two thousand and eight, because if they're in compliance with the rules and they're disclosing to the market, the judgment is that system is going to work. What goes wrong is that bank shareholders have an incentive to take much more risk than is in the interests of the government or depositors. It's sort of basic economic stuff. The shareholders have an incentive to extract wealth from the depositors and from the public. And so the shareholders is gonna be much more comfortable with a lot more risk than the public should be. And so if you're going to rely on them to monitor risk, cake and you're going to get a much riskier bank. And this is Silicon Valley Bank story. I mean, it's very much Silicon Valley Bank story. So you get two thousand and eight, and you get a modification after two thousand and eight, which is stress tests, but a lot of ordinary day to day supervision continues to be I think procedurally oriented. And you see this with the London whale, and you see this with the fake account scandal at Wells Fargo, both of which I think are really important data points for outside observers to think about how much did we fix supervision after two thousand and eight, how much do we move away from the green span nineties cocktail of bright line capital rules and procedural oversight oriented to shareholder discipline. And I think the answer is for the small banks that are not subject to stress tests, and even for the big banks that are subject to stress tests, outside of the stress testing regime, we still have a lot of procedural oversight. So this is actually a very quick mechanical question. But for a bank like Silicon Valley Bank, is it as supervisor? Is it a panel like hot Like what do you know? Do you have a sense of like how many people? I mean, because it's someone at the SFED presumably, Now assume there's thousands of banks in California probably or at least hundreds, Like what kind of just like human resources could even go currently to paying attention to Silicon Valley a bank like Silicon Valley Bank. So there are thousands of supervisors across the federal system. Okay, they're split across three agencies, the Federal Reserve, the Federal Deposit Insurance Corporation, and the Controller of the Currency. They split up responsibility for supervising bank. Silicon Valley Bank is a state chartered bank and it's a member of the Federal Reserve system. So as a result, as you say, it's the FED that would have responsibility at the federal level for primary responsibility for supervision if there's always overlap, So the FDIC has some ability to come in because it's insuring the deposits obviously, and then it's very involved now. But the day to day job here is FED personnel in San Francisco who are really actually exercising delegated authority of the Board of Governors, which is the federal agency with the power to supervise member banks. And the Reserve Bank of San Francisco is actually a federal bank of Federal corporation, and so it's it's facilitated, it's helping the board, and the board has supervisory staff that are supposed to sort of oversee what is going at the reserve banks. So is San Francisco doing a good job, And obviously at the top of that is Michael Barr, the Vice champer supervision. I'm going to have some more questions on the San Francisco FED and the fhlbs as well. But just going back to the evolution of bank capital rules. So one of the big things that happened, and you sort of outlined it in the lead up to the two thousand and eight crisis, but like it definitely hardened after two thousand and eight. Is this idea that banks should be holding more bonds in general, the safest bonds, so, you know, US treasuries in the case of US banks, maybe agency mortgage backed securities that are implicitly guaranteed by the US government, things like that for their regulatory capital and liquidity buffers. And it seems to me like that probably made a lot of sense in the low inflation environment of two thousand and eight, But now that you have the FED raising rates, you have a lot of volatility. It seems like these bonds might not be I don't think safe is the right word, but not as unproblematic as maybe we imagine them to once be. Could you talk a little bit more about basically how we built the modern banking system on top of a bedrock of bonds that are presumed to be somewhat stable in price. So I think that you're right to sort of highlight the appeal of treasuries and agencies to both bankers and supervisors in the wake of two and eight. Bank that loads up on treasury, that's, like, you know, very wholesome. It seems very wholesome for a bank to do right. The government likes that. The government is like banks that buy treasuries since the Civil War, and so it's gonna cut against even the most ambitious and confident, you know, safety and soundness overseas. It's going to cut against their their impulses to to sort of fault a bank for loading up on treasuries. I mean, that's that seems that seems that's a good thing, right, And so it's it that helps to explain part of what's happening here. And it's also true that banks do have the ability to weather usually a fair amount of interest rate losses on their assets. So many banks think of themselves as structurally hedged against interest rate increases because while their assets, if they have law assets like long dated treasuries, that's those are going to lose value when the interest interest rates rise, their liabilities or deposits, and their deposits are sticky, they don't pass through, and so actually their deposit funding becomes much more valuable when interest rates rise. So if in a zero interest rate environment, interest rates or zero deposit rates or zero deposits aren't that useful. You're getting a little benefit that you have deposit funding. But if interest rates go way up, you're not gonna if you're the bank, you're not actually going to be forced to raise your extracting rents right from the deposit public. But you're not going to be forced to raise your deposit rates. And this is actually strengthening your business. And Silicon Valley Bank is going to think, yeah, okay, so we take some we take some hits on our long assets, but actually our net interest margin is going to position, is going to main strong, our deposits are going to be much more valuable, and we're just gonna we're gonna work through, you know, year to eighteen month period and be totally fine, right, which it seems like they lose was sort of the assumption that they had, like they knew they it wasn't great and maybe even technical and solvent, but I mean, I think it was in this leek one of matt Leview's news and letters, he's like, this was actually like a very profitable time for them, like it did. It would have been fine if everyone's did. And presumably their expectation was, well, we're just making a lot of income right now. So the fact that we took it a hit on the asset side is not really well. They had they had a specific estimate in one of those internal documents where they said, we could shorten duration, but that would mean an eighteen million dollar hit to our net interest margin in one year alone, going up to like thirty six million over the next three years. So they knew that if they reduced duration, they would be sacrificing earnings to some extent. Yeah, I mean, I think it's fair to say that in twenty twenty one they were making huge profits because this strategy was really working. Interest rates went way up, and I think it would have impaired their profitability, but they were They weren't wrong to think that they were what structurally hedge, even though they had no interest rate hedges or anything, by virtue of the fact that they would slowly be able to replace their treasuries with much higher yielding treasuries while being able to pay depositors very little. And we also, you know, we talked about this deposit betas on a recent episode with Joe Batte and why they're off at low and what if His points was like, well, you know, you have a bank, you have an individual has an account at Chase or something like that they're providing a lot of services along with that. People are not that inclined to move their checker account just because the interest rate doesn't bump up a little bit. And I imagine for Silicon Valley depositors these companies, the whole story about Silicon Valley Bank was all of the products, the startup specific products that they are that they offered, which presumably to their mind, insulated them to some extent against losing deposits. Absolutely, and I mean in the case of SVB, there was also what an antitrust law we call tying, where accompany ties one product to another product. Yeah, so the bank would require that if you wanted to borrow from the bank, that you would have Is that unusual because people some people obviously some people are like, oh, that's weird, and some people are like no, of course, like any commercial loan. But is that unusual in your view? I don't think it is unusual. There are strict rules about bank tying in other areas. But my understanding is that banks are explicitly permitted to tie deposit account services to lending services. And historically it was core to the banking business that you were the depository institution for the for your borrowers that that went together, and you know, we've moved away from that technology lots of things have allowed people to borrow from banks that aren't the banks where they bank at. But a long time, the idea was that there's a lot of synergies between that no one's going to be in a better position to determine how much to lend to you than your own banker. I imagine like there was also a bit of a prestige element to banking at SVOB as well, given that, you know, it was so popular among a particular type of tech slash VC person. But you know, Joe touched on the episode we did on deposit betas with Joe Abode. But I'd love to hear from you, like why didn't people pull more deposits from a bank that was essentially paying them nothing? Because to some extent, this is the big question, like why did SVB have so many deposits? Well into twenty twenty two, at which point we started to see some of the I guess most interest rate sensitive parts of the economy, ie the tech industry lose a bunch of money and have to pull funds. But why why were people accepting of that for so long. So we mentioned a couple of the sort of rational explanations that you know, there's a strong brand, you want to they're they're lending to you, they've required you to keep deposit there. But you can't discount the fact here that a big piece of this was a lack of sophisticated financial management on the part of startup companies that maybe didn't have CFOs, didn't have anybody on their teams with any experience in managing cash. They're focused on their their business and it's very hard to justify five hundred million dollar bank account balance, and I think we have one example of that that just there's there's no reason for that's that's very bad management. No well run, mature company would operate in that way. Among other things, you you you have a huge uninsured deposit risk that we that we saw, but you're also just giving up lots of return. You could have that money invested in laddered treasury bills or something. And significantly more so, there's a huge amount of money that's just been left on the floor here there, and it's you know, it doesn't it doesn't really make sense. So we have to understand that these that these customers, despite having lots of money, are not actually very sophisticated. So I want to go back to the supervisory question and ask about it, kind of come at it from a different angle. You know. Obviously the two thousand and eight two thousand and nine crisis was very focused on the asset side of the business and were these really high quality assets? And then part of the reasonable bunch of banks failed is because the assets like weren't very good that they held. And as people have discussed with Silicon Value Bank, a lot of the issues. Yes, maybe they made a wrong bet on treasuries or they put too much, but is the flightiness of the deposits? Can you talk a little bit more. I know that regulators do bucket deposits from the most sticky to the least sticky, but could you talk a little bit about like how good supervisory in a sort of like active pre nineties way might have approached the uniformity of SVB deposits and the risk of them all leaving at once. Yeah, I mean I think that if you showed svb's balance sheet to supervisor brought up during the new deal system. So let's say it's nineteen seventy five, they would be horrified at the enormous concentration of uninsured deposits controlled by a group of businesses with very similar risks to their business and so all of your depositors, and this is something that and this is something that a new deal era supervisor would be familiar with from press experience. Well, I think I think it would have been. They would have been unfamiliar with it in the sense that it would have been so unusual back then everyone would have looked at it and said, WHOA, this bank has a very unstable deposit base. It would not have been novel to view this with concern. It would be it would be even more concerning because of how risk it would have been to operate a bank in this way at that point in time, when when, of course, people still remembered the bank runs of the thirties much more than they do than they do today. And you know, part of what went wrong at SVP is it's not just that they had ninety seven percent or something in uninsured deposits, but that all of their depositors were going to withdraw at the same time. And so there's sort of a classic issue in the banking business always is in what circumstances am I going to be subject to a deposit train? You know, you get to model your deposits as sticky if you're a bank, because over time, for the banking system, the deposit base is always sort of growing. I mean, with the exception of over the last year where monetary policy is trying to shrink the money supply, but you know, over time it's a constant growing base, and so deposits are really, in some simes a very long duration asset, except if you're the one bank that experiences a drain to the rest of the system where everyone withdraws from you, and so if your customers are all going to face hardship your depositories or depot it was hard. The same time, you really can't treat yourself as structurally hedged. You're the opposite of structurally head And that's what that's what Silicon Valley Bank found out, is it thought that, oh, you know, when when my assets lose value, my deposits will become more valuable. But actually all their depositors started to draw down their accounts and the opposite happened, and so they were just very very long low interest rates, silicon valuing. The whole business model was tied to low interest rates, I think to an extent that they did not appreciate, and to an extent supervisors clearly didn't depreciate, but maybe weren't even thinking as hard about as they might have in an earlier period where they were more empowered to make those sorts of judgments. Yeah, this is exactly what I said on our episode with Dan Davies. It was interest rate exposure kind of squared, but just on the deposit side. Because to me, this is kind of the most novel or interesting thing about all of this, because we know that a lot of banks have unrealized losses on bonds, and you know too. Seems like broadly they've been managing their interest rate risk so far. But with SVB, the big difference was that group of highly concentrated, extremely unreliable depositors who themselves had significant interest rate exposure. And we're pulling money over the past years. So what could regulation do on that front? So I guess instead of the asset side, looking more at the liability side. Yeah, So what you want to see is a coherent asset liability management strategy for a bank, and so a bank that anticipates deposit trains for a bank that has flighty deposits, and there are many banks that can fall into this category. This is something that regulator supervisors do think a lot about. If you're in that category, then you need to hold liquid assets that you can sell and that at their fair market value to cover the withdrawals. And so part of the problem here is that Silicon Valley Bank did not actually have available for sale securities at fair market values sufficient to cover the withdrawals, and so the fix for this would have been to have much less duration in the in the in the asset portfolio, or many many more reserves. This is the same problem, by the way, that took down silver Gate Bank and to some extent, Signature Bank. They had deposit bases that were flighty, that their depositors suffered and their deposit the banks experienced deposit drains because they were concentrated in a group of people that were exposed to interest rate hiking. I just realized I promised to ask about discount lending and the fhlb's the Federal Home Loan Bank. So you know, in theory, when you have this type of banking crisis or you know, some sort of liquidity issue with the financial institution. You would expect them to either go to the FED, to the discount window and for all blots listeners, we recorded an episode on this a month or two ago, or they can borrow from the FHLBS. And some of the talk out there is that SVB got cut off by FHLB. Why would that have happened and why wouldn't those two lenders of last resort do everything they can in order to step in and support the bank. Or is it the case that at some point, you know, maybe they're talking to the FDIC and they just say this is untenable and no matter how much money we provide, like the bank is not going to be able to get up and running again. So I'm speculating a bid here, and you might want to talk to the FHLB expert in the legal academy, K Judge, who's my colleague. But the FHLBS are not a lender of last resort in the way that the FRBs are. Right, the FHLBS they do provide sort of lender of second to last resort services to their members, but they are much more operated by their members, and they pay dividends to their members than the FRBs. So the FRBs were set up in a similar model, but today basically function as public banks, so they have no interest in profits or anything like that, and they're willing to sort of take one for the team in a way that the fhlbs are not. So I think it's a mistake to look at the FHLBS and say, oh, well, you really ought to have lent into an insolvent institution and took on that potential. Rik k. The FRBs are are are are wary of that for various reasons we could get into. But the flhol bes have even more reason to sort of to pull back. We definitely have to do an FHLB episode at some point with k Judge, because I don't know much about them at all, and it definitely it's been too long or it's far too long without having yeout having her on. I want to ask another dimension. You know, people pointing to the twenty eighteen law change to Dodd Frank that seemed to exempt banks like Silicon Valley Bank from some of these liquidity requirements that you were talking about, like do you have enough liquid assets? Hey? Could you sort of characterize the change that was made there in b had that not been in place, like is that is that change that was made in twenty eighteen? Does does that tell the story of the demise? Had the old Dodd Frank laws remained in place for a bank the size of Silicon Valley Bank, would they have been able to weather the storm? You can never know for sure, but I would suggests yes, that is decisive. And so this brings us back to how the government responded to the two thousand and eight failure of supervision regulation. And they responded with a set of tiered new requirements. And for the very biggest banks you had the CCR stress testing regime, and for all of the banks with more than fifty billion dollars of assets, you had stress testing as well as collection of other enhanced prudential standards. And this new cocktail of regulation and supervision was geared towards preventing a repeat of something on the scale of two thousand and eight. And so we weren't going to impose this on the whole banking system, on all of the sort of smaller banks. But the thinking was, if we could just really get back to serious government oversight of banks over fifty billion dollars that would really go a long way towards preventing another another calamity like two thousand and eight. And what happened was immediately there was litigation over the threshold for this new regulatory supervisory cocktail. And so this fifty billion dollars threshold came under a lot of political pressure from the banking agencies and from various people in Washington, and the bank lobby fought a battle over many years to raise the threshold. One of the important figures lobbying for raising the threshold was the CEO of Silicon Valley Bank. He was growing his bank and he did not want to grow his bank into additional regulatory and supervisory requirements. And in twenty eighteen, after winning over people in both parties to this cause of raising the threshold, Congress changed the law and the threshold moved up. A bunch of thresholds moved around, but the relevant threshold, I think, moved up to two hundred and fifty billion dollars. And the result was Silicon Valley Bank and its peers had successfully exempted themselves from the enhanced prudential standards that Congress had created. After two thousand and eight, and the result was you didn't have the stress testing, which is the primary means by which supervisors now exercise substantive judgment about risks, and so you had a much more I think light touch process focused oversight that allowed rule compliant balance sheet configurations like svbs to go relatively unchallenged. But if you had been in the in the Enhanced Prudential Standards bucket, I think that they would have been challenged. They would have been challenged through all of these additional rules and also supervisory programs. And it's unlikely. You can never know, but it's unlikely that they could have taken so much duration risk and not raised capital earlier, been permitted to go for so long in a position where their liquidation value was possibly negative. Yeah, since we're on the topic of the blame game, I mean, one of the things that you see people saying now is that, well, it's the Fed's fault. The FED kept interest rate slow for too long, and it basically forced people to assume additional duration risk in order to seek out yield. And I think, you know, financial repression is a real thing. But on the other hand, you cannot ignore the individual actions of one or a few specific banks, their managers, their shareholders, and their depositors. But how would you describe the overall monetary policies role in the current predicament. So overall monetary policy is of course central to the current predicament. But there's a sort of false dichotomy underline, the view that somehow it's like monetary policy happening up here at the FED that's then causing problems down here at the banking system. The whole thing is monetary policy. The whole reason we have banks is monetary policy. Banks are creating the money supply, and the question is how much money do we want to be created. So it would be the tail wagging the dog if we had to change our judgment about how much money should be created because like somehow the system couldn't create that amount of money safely and stably. We have a broken system if it can't create the amount of money that the FMC says is appropriate for macroeconomic conditions. And so I would not blame the FOMC for thinking that we need to adjust the amount of money that the banking system and the financial system are creating. I would blame the banking and financial system and the banking and financial laws. If they're incapable producing the amount of money and changing the amount of money they're producing overtime consistent with the fomc's directives and the needs of the economy, that's a really big problem. And it does look like we're facing that problem now, where in the coming months we could be in quite a predicament where the FOMC may make the judgment and we can brack it whether it would be the correct judgment that the economy needs less money and the banking system may be incapable of functioning properly under that directive. And that's the flip side of, you know, the suggestion that the banking system should also be able to function under the judgment that interest rate should be zero and function in a way that is sustainable over time. And so to the extent that is what's going on, I think it's a real indictment not of monetary policy, like the high level decision about how much money we need, but the structure being unable to follow through to execute on those decisions. Leveman on that was an amazing answer, That was an amazing conversation that was so helpful that was so helpful and so clear. I've said it every time we talked to I'm like, oh, I've finally had There's been a few more, but I so that was a that was very good. I'll just leave it there. I really I really appreciate that. So thank you so much for coming back on up. Thank you so much for having me that, Tracy. I love that whole conversation, starting from the very end, which I think is a really excellent way to sort of reconceptualize the monetary policy problem, which is that if the FED is going to be tasked with like the sort of like big sweep macro management, right, getting employment inflation at its targets and so forth, in theory, we want to have a financial system that can operate under any you know, operate relatively safely under whatever rates the FED deems to be appropriate. Absolutely, I mean, I do think there is a fundamental tension between monetary policy, which you know, like the big thing monetary policy does is basically impact the price of bonds and then having the financial system and banks specifically have to hold a bunch of bonds as part of their capital and liquidity mandates. Like that tension is there, but there are way is to manage it such that we can avoid failures and also provide for the effective implementation of monetary policy as a whole. The other thing that really struck me is this is kind of an incentives episode, right, And I thought Lev's point about basically outsourcing a lot of bank supervision to private shareholders and expecting them to you maybe press the brakes on risk when things start to get out of hand, that was a really interesting one. And SVB, I think, is going to end up as a classic case where you know, there was an acknowledgement that there was an issue here. There was the asset liability duration mismatch, and there was too much exposure to long bonds and too much of an assumption that deposits would be around forever or that they might even return or start growing again, and it was a conscious decision to pick up net interest margin, or at least it looks like that. I'm sure more will come out over the course of all of this, but for now, it certainly seems like it was a decision to do that. That's really interesting, like thinking about like, it's pretty fascinating that a lot of these like capital requirements and ratios and regulations that we think of as courtA how we manage the banking system are all pretty young, and that for the most part, for a long time in history it was like active super advisory people making judgments based on the operations of the bank, whether their decisions on loans and deposits were healthy. But it does make total sense that it is sort of like you know, I hate usually where it's like neoliberal, but that like that the role of supervisors would essentially transform to making sure that shareholders were getting adequate information. That you start with the assumption that the market is the best regulator, and then what is the role of the government well, and the role of the government, and that point is to make sure that market regulators get good information. Like that seems like a very like big theme that like you could like characterize across a lot of different industries, a lot of different government and then the failure of just like well, the problem is like shareholders can lose everything and not be accountable for the spill over when a bank fails. And so yeah, the need perhaps to get back to a type of supervisory that actually takes decisions into own hands and rather than just outsourcing it. You know, I realized we didn't even get into FED checking accounts, which is one of them. Now that's the next step. So then I think the series is if all deposits post SVB are presumed to be ensured, which almost seems like implicitly the case, now why do we have private deposit taking institution? So I kind of think that's the next one in this series to look at, Well, what does this tell us now about even the point of private deposit taking institutions? And should there be a point? I mean, that is what I was kind of hinting at in the intro. But we'll just have to leave that. You know, it was a trailer not for this episode but for the next one, so plenty more to come, but shall we leave it there? Let's leave it there. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe wisn't All. You can follow me on Twitter at the Stalwart, follow our guest Levmnond on Twitter at levmanand follow our producers Carmen Rodriguez at Carmen Arman and Dash Bennett at dashbot Check out Bloomberg's podcast son to the handle at podcasts, and for more Odd Lots content, go to bloomberg dot com slash odd Lots, where we post all the transcripts. Tracy and I have a blog and weekly newsletter that comes out every Friday. Go there and sign up. Thanks for listening.