All about bank(panic)s and the implications for policy

Crisis Characteristics and Causes

• The recent banking stress originated as a textbook bank run triggered by rising interest rates causing the value of long-term treasuries to plummet.
• Silicon Valley Bank (SVB) failed after selling these securities at a loss, failing to raise capital, and experiencing a rapid run on deposits driven by venture capital calls and social media.
• Gary Gorton notes that while uninsured deposits make up only about half of all deposits today (down from 75% in 1984), this shift to a wholesale system has made the banking sector significantly more vulnerable to runs.
• The speed of the SVB run was accelerated by digital communication, specifically venture capitalists contacting portfolio firms and social media, rather than the traditional physical queues seen in the 1920s and 30s.
• Uninsured deposits, now vulnerable to runs, are concentrated in "wholesale" forms of short-term debt that cannot be easily rolled over, creating systemic fragility across all market economies.

Attribution of Responsibility

• Dan Tarullo (Former Fed Supervisor): Identifies bank management as the primary cause due to inadequate handling of liabilities and rapid growth that outstripped risk management capacities.
• Tarullo argues there was a "supervisory failure" where the San Francisco Fed identified vulnerabilities but did not follow up quickly enough to force remedial action.
• Tom Honig (Former Fed President, FDIC Vice Chairman): Attributes primary blame to management but cites "monetary policy errors" as a major contributor, specifically the shift from near-zero rates to rapid rate hikes.
• Honig predicts that the rapid increase in interest rates by a factor of 20 or more after a decade of zero rates was a predictable error that created adverse consequences for the banking system.
• Gary Gorton rejects the narrative that blame lies solely with bank management, arguing instead that policymakers and academics lack a fundamental understanding of financial crises and the mechanics of short-term debt.
• Tarullo suggests a potential "softening" of the supervisory culture over the last four to five years by the Board of Governors may have contributed to the lack of intervention.

Regulatory Framework and S-2155

• Experts agree that the 2018 rollback of Dodd-Frank (Bill S-2155) was ill-advised for exempting banks with $100B–$250B in assets from stricter oversight, as they proved systemically important.
• Tarullo disputes a direct causal link between S-2155 and SVB's failure, noting that SVB's capital and liquidity ratios may have technically met the requirements that would have applied under full Dodd-Frank.
• Honig characterizes Dodd-Frank as "form over substance," arguing that stress tests and living wills created a false sense of security without ensuring the substantial equity capital necessary to absorb shocks.
• Gorton asserts that Dodd-Frank never had the capacity to prevent the crisis because it did not address the core mechanism of bank runs: the vulnerability of uninsured deposits.
• Tarullo notes that even if SVB had been subject to the 2022 stress test, the single scenario used (a reduction in interest rates) would not have uncovered the bank's vulnerability to rising rates.

Proposed Policy and Regulatory Solutions

• Tarullo advocates for mandating that all banks over $100 billion in assets participate in annual stress tests featuring multiple scenarios rather than a single fixed scenario.
• Tarullo supports requiring "mark-to-market" accounting for Available-for-Sale securities portfolios to ensure unrealized losses are visible to regulators and the market.
• Tarullo advises caution regarding marking "Hold-to-Maturity" portfolios, citing concerns that such rules could disincentivize banks from holding U.S. Treasuries and exacerbate market issues.
• Tom Honig recommends raising equity-to-asset capital requirements to 10–15% (preferably 15%) to replace the current 6% leverage, arguing this would better prepare banks for the "unexpected."
• Honig argues for focusing on simple leverage ratios rather than risk-weighted capital, as the latter misleads by assigning zero risk to government securities while underestimating duration risk.
• Gary Gorton argues that capital and liquidity requirements alone cannot solve the problem due to a shortage of safe assets to back short-term debt, suggesting the expansion of deposit insurance to cover uninsured transactional deposits.
• Gorton proposes three specific policy actions: insuring only the transactional component of uninsured deposits, bringing stablecoins under regulatory oversight, and developing a Central Bank Digital Currency (CBDC) to crowd out private money issuance.
• Gorton warns that without addressing the root cause of short-term debt runs, future crises involving stablecoins or new forms of short-term debt are inevitable.

Forward-Looking Outlook

• Tarullo warns that other bank portfolios holding longer-dated securities may face similar stress as rates remain elevated, posing a risk of "another shoe dropping."
• Tarullo highlights a strategic dilemma for policymakers regarding the business model viability of mid-sized banks ($50B–$250B), questioning whether to lower regulatory costs or ensure stability, potentially forcing consolidation.
• Tarullo suggests that ensuring financial stability may diminish the medium-term prospects of mid-sized banks, raising questions about the future of mergers and acquisitions in the sector.
• Honig emphasizes that $23 trillion in U.S. banking assets remains vulnerable, and the industry must strengthen capital to survive the unexpected shocks inherent in a highly leveraged system.
• Gorton predicts a cyclical return to financial crises, noting that knowledge in economics is not cumulative like physics, leading to repeated failures to recognize systemic vulnerabilities.
• Goldman Sachs analysts conclude that while the immediate crisis appears to have calmed, the fundamental questions regarding banking stress and policy responses remain unresolved.