Fed Chairman Jerome Powell, starting in 2021, led the central bank and its monetary policy on an erratic path. The economy was booming in 2021 and Powell kept short-term interest rates near zero and injected $120 billion per month via quantitative easing on top of an already soaring economy.
In 2021 Powell said: “I’m not even thinking about shrinking the Fed’s balance sheet” or “I’m not even thinking about raising interest rates.” In the Q&A portion of his February 10, 2021 speech to the Economic Club of New York he managed to work in that phrasing a couple times.
Powell and others at the Federal Reserve kept talking about inflation as “transitory” in 2021. That was the exact opposite of what they should have been saying.
Powell like others before him, including former Fed Chairman Ben Bernanke, never understood that investors and top management of financial institutions might actually believe that Fed leaders have expertise and insight into market conditions. The sad aspect is that Powell and others likely believe that they do have this insight and so don’t issue warnings to not pay attention to what they say.
The Fed’s message in 2021: have a great time at the party, enjoy free money with lots of excess Fed-created reserves, since with that combination, nothing can go wrong. The management team at Silicon Valley Bank said: we hear you. The San Francisco Federal Reserve invited SVB CEO Gregory Becker to join their board in 2019. As such, Becker was tapped directly into Fed policy and was able to provide feedback to Fed leaders.
Deposits flowed into SVB from the free money available to private equity investors and startups in Silicon Valley.
SVB top management said, in effect, “great. We pay a near-zero interest rate to depositors, turn around and purchase long-dated Treasuries and MBS at higher yields. We can’t lose. Zero interest rates are here to stay, inflation is transitory, and Powell says he is not even thinking about raising rates. We don’t have to do anything, as we have our margin built in.”
The Fed employs over 20,000 people. But, apparently, it never dawned on anyone up the Fed’s food chain that inflation might be an issue and interest rates might increase. If that occurred, depositors at commercial banks might demand higher returns and/or withdraw their deposits.
Since bond prices and interest rates have an inverse relationship, this could mean banks might be stuck with capital losses from those longer-dated debt instruments as interest rates rose. But not to worry, since banks can report the face value or par value of that longer-dated debt.
So, no worries.
But the market said not so fast. The flaw in the bank’s logic was revealed after depositors at SVB decided to withdraw their deposits and SVB was forced to sell underwater debt securities. The market value of those securities of course didn’t cover the deposits.
The Fed and the many other regulators at the federal and state levels had not anticipated that depositors in commercial banks might decide to pull their deposits out. Regulators follow regulations and apparently don’t consider changing market conditions.
Commercial banks like SVB that followed Fed talking points, and not financial reality, became ticking time bombs.
SVB top management went all in on Powell’s talking points. After all, the Fed chief repeated many times that inflation was “transitory.” It apparently never occurred to him that he should not be preaching transitory inflation and not even thinking about raising interest rates since some bank CEO’s might believe him.
It is easy to blame the CEO of SVB, but he was on the board of the San Francisco Fed and may have heard the same there. Plus, it was the Fed’s own chairman suggesting to him that what he was doing was all OK. Fortunately, some other managements understood that Powell, like all politicians, has talking points.
Most people learn at an early age to disregard what politicians say. Chair Powell is a very good politician, just not a very good Fed chair.
The decision to backstop all deposits at SVB will go down as another monumental mistake by the Fed. But Powell is a politician. And when Treasury Secretary Janet Yellen and the FDIC likely talked about the clout of people in Silicon Valley and the importance of their political donations, Powell no doubt understood.
Mike Cosgrove, principal at Econoclast, a Dallas-based capital markets firm, is an emeritus professor at the University of Dallas.