Almost a year after the mini banking crisis in the United States, it is worth revisiting the episode. Was it just a tempest in a teacup? Was there really a systemic threat, or was it just a problem with a few banks? Should the interventions by the U.S. Federal Reserve and Treasury worry or comfort us?
When the Fed engages in quantitative easing , it buys bonds from financial institutions. Typically, those sellers then deposit the money in their bank, and this results in a large increase in uninsured deposits in the banking system. On the banks’ asset side, there is a corresponding increase in central-bank reserves. This is stable, since reserves are the most liquid asset on the planet and can be used to satisfy any impatient depositors who come for their money.
Thus, as the Fed raised interest rates, the economic value of these banks’ assets fell sharply. Some of the fall was hidden by accounting sleight of hand, but SVB’s sudden demise caused investors to scrutinize banks’ balance sheets more carefully. What they saw did not instill confidence. The KBW Nasdaq Bank Index duly fell by over 25%, and deposits started flowing out of a large number of banks, many of which lacked the liquidity to accommodate the sudden outflows.
The Fed opened a generous new facility that lent money for up to one year to banks against the par, or face value, of the securities they held on their balance sheets, without adjusting for the erosion in the value of these securities from higher interest rates. And the Federal Home Loan Banks — effectively an arm of the U.S.
Where does that leave us? Although the situation could have been much worse if the Treasury and the Fed had not stepped in, the seeming ease with which the panic was arrested allowed public attention to move on. Apart from die-hard libertarians, no one seems to care much about the extent of the intervention that was needed to rescue the smaller banks, nor has there been any broad inquiry into the circumstances that led to the vulnerabilities.