The Fed Faces Its Trilemma

Last Friday, after a demanding week tracking a bevy of risks related to the closure of Silicon Valley Bank (SVB), I needed to clear my mind. I waited for markets to close, then set out for a long run. The weather was fine, and tuning into non-financial podcasts was refreshing. Still, I couldn’t help but anxiously check my phone for news alerts.

Fortunately, the weekend brought no further bad news from the U.S. banking system. But even if the acute phase of this crisis is short-lived, uncertainty will persist. The failure of Silicon Valley Bank and Signature Bank could weigh on financial and economic activity for a long time to come.

The business of banking is conceptually simple. Long ago, bankers joked of the “3-6-3” rule: Pay 3% on deposits, charge 6% on loans, and take your clients out for a 3:00 tee time. But if it was ever really that easy, those days are long in the past. Interest rate surges of the late 1970s proved costly; some institutions took on extra risk to offset their rising funding costs, but often found more trouble than relief, spurring the savings and loan crisis. Nearly 3,000 American financial institutions failed between 1980 and 1994.

The decades-long run of falling interest rates that followed, along with greater competition from private investors, reduced bank margins. Some strategies aimed at arresting the decline in profits created kindling for the global financial crisis of 2008.

Given the importance of the sector, banks are subject to a wide range of rules and review by a bevy of regulatory bodies. Many have therefore wondered how a firm the size of SVB could have failed. We have since learned that the Federal Reserve issued the bank serial findings of risk management deficiencies. But the firm apparently did not heed the warnings, and supervisors may not have pressed the issues aggressively enough.