Barn Door Economics and the Collapse of Silicon Valley Bank

On March 10, Silicon Valley Bank collapsed, causing a disturbance in the financial force. A little over a month and a half later, the Federal Reserve Board released a report detailing the bank’s shortcomings, as well as its own.

But instead of simply closing the barn door after the horses bolted, the Fed is making plans to build a new barn.

Calling the actions of Silicon Valley Bank’s board “a textbook case of mismanagement,” Michael S. Barr, Fed vice chair for supervision, called out Fed regulators as well as bank officials for the institution’s failure.

“Federal Reserve supervisors failed to take forceful enough action,” Barr said in a cover letter accompanying the 118-page report. “Silicon Valley Bank’s failure demonstrates that there are weaknesses in regulation and supervision that must be addressed.”

The bank’s failure also demonstrates that Fed policymakers have not forgotten the chain of events – including lack of sufficient oversight – that led to the near-collapse of the global financial system and the onset of the Great Recession in 2008.

While Fed staff detailed Silicon Valley Bank’s failure to oversee basic interest rate and liquidity risks and noted the board of directors’ failure to oversee the bank’s senior leadership, the report lays the groundwork for a new regulatory regime in Washington to “improve the speed, force and agility of supervision,” Barr said.

In the aftermath of the financial meltdown brought on by toxic mortgage-based securities in the mid-aughts, the mantra “too big to fail” took hold, legitimizing the extraordinary measures financial regulators took to shore up the banking system and calm investor and consumer fears.

The logic of “too big to fail” led in turn to the idea of “systemically important financial institutions,” defined as financial services entities whose failure might trigger a wider financial crisis. With that concept in hand, the Fed and other regulatory agencies pumped billions of dollars into the banking system to stabilize the industry.

The collapse of Silicon Valley Bank makes it clear that “too big to fail” is not enough. With advances in information technology which allowed for news of Silicon Valley Bank’s troubles to go viral on social media to its networked and connected depositors, news of the potential crisis dramatically increased the speed of the run on the bank that pushed it over the brink.

Rather than wait for a financial services company to grow large enough to become systemically important, the Fed report indicated a change in underlying assumptions about supervision and oversight are needed.

Specifically, the report said the collapse of Silicon Valley Bank “suggests an opportunity to shift the culture of supervision toward a greater focus on inherent risk” and “offers an opportunity for a broad assessment of how Federal Reserve oversight functions in theory and practice.”

This puts the Fed and other regulators in a delicate position of finding the right balance between stultifying the growth of financial companies through burdensome regulation or allowing them to grow out of control and imperil the banking system as a whole.

Either choice carries its own risks. Let’s just hope the new regulatory barn is strong enough to meet the challenge.