Priorities

One of the sad things about priorities is that all of the things you value can’t be your #1 priority. Just to take one notable example, I think that U. S. national security has a higher priority to us than Ukrainian sovereignty does.

Having too many priorities is a particular problem for the Federal Reserve. By statute it has multiple priorities: maximum employment, stable prices, moderate long-term interest rates, and a sound banking system. Today the editors of the Wall Street Journal claim that Silicon Valley Bank’s weaknesses were allowed to undermine the bank’s solvency by a Federal Reserve Bank that had priorities other than their statutory ones:

The San Francisco Fed is responsible for regulating banks in the Western U.S., and one of those was Silicon Valley Bank (SVB) that failed two weeks ago.

The problems at midsize banks appear most acute in the SF Fed district. See failed Silvergate Bank, and First Republic and PacWest Bancorp, which have scrambled to raise cash. What did the Fed’s examiners miss, and why?

Judging by her public presentations, San Francisco Fed President Mary Daly has been focused more on the progressive priorities of climate change and equity. In June 2021, she touted the regional Fed’s work cataloguing climate risks, including “formal surveys, listening sessions, and targeted meetings with CEOs to better understand how climate risk affects decision making and resiliency planning.” She added: “Consistent with our history, we have assembled a team to study how these issues are likely to impact the Federal Reserve’s mandates in the future.”

Climate change “including the frequency and magnitude of severe weather events—affects each of our three core roles,” the bank’s website says. For instance, climate change may “challenge the resiliency” of banks and “low-and moderate-income communities and communities of color.” What about the resiliency of banks to runs on deposits or rising interest rates?

A San Francisco Fed memo last October noted that its “Supervision + Credit (S+C) group” has been working with Federal Reserve Board Vice Chair for Supervision Michael Barr to “inform his agenda and priorities”—namely, financial risks to banks from climate change, cryptocurrency, financial fairness and the Community Reinvestment Act. None of these contributed to SVB’s failure.

SVB was required under the Dodd-Frank Act to conduct quarterly stress tests to ensure it could withstand financial shocks and other adverse events. It’s not clear if the bank evaluated a scenario in which rapidly rising interest rates led to an outflow of deposits and losses on sales of fixed-income assets, but it should have.

The San Francisco Fed’s job is to ensure that banks model economic and financial scenarios that could materially impact its balance sheet. News reports say examiners flagged problems at SVB as early as 2019 in its risk controls and uncovered more last summer. But why didn’t they take corrective actions—for instance, by limiting the bank’s ability to grow?

Perhaps because SVB was fulfilling the SF Fed’s social and climate agenda. SVB noted in its 2022 annual investor report that it received its first “outstanding” rating from examiners on its Community Reinvestment Act plan, which included billions of dollars for low-income housing and initiatives to promote “a green economy and green communities that build wealth in communities of color.”

I have no ability to evaluate that claim.

I think that the Federal Reserve has a broader problem. Note what’s not in its list of priorities: running the economy and minimizing unemployment. Which of the Fed’s statutory priorities have they managed successfully? I would argue none of them. This

does not look like they’re maximizing employment. This

does not look like they’re maintaining stable prices. This

doesn’t look like they’re maintaining moderate interest rates. It looks like they kept interest rates too low too long.

Whether they’re maintaining a stable banking system is what’s being tested now but it doesn’t look to me as though the Fed has succeeded in anything it’s supposed to do.