Regulators Race to Contain Silicon Valley Bank Fallout

Federal regulators rushed on Sunday to contain fallout from the collapse of Silicon Valley Bank, with the government holding an auction to try and sell the failed institution and policymakers considering other options to ensure that depositors would get their money back.

The Federal Deposit Insurance Corp. took over the institution Friday, putting nearly $175 billion in customer deposits under the regulator’s control. The bank’s failure, the largest since the depths of the financial crisis in 2008, has raised concerns that other financial firms could suffer similar fates as rising interest rates put pressure on the banking sector and as nervous depositors consider pulling out their money.

While customers with deposits of up to $250,000 — the maximum covered by FDIC insurance — will be made whole, there’s no guarantee that depositors with larger amounts in their accounts will be repaid in full.

That reality sent tremors through the banking industry over the weekend. Government officials and economists worried that people with big bank accounts at other regional banks might begin to fear for the safety of their own deposits — which could prompt them to pull their money out and rush toward the perceived security of even bigger banks. That, some warned, could turn what might otherwise be a one-off bank failure into a sweeping crisis.

The key question is “is this going to be handled in a way that alleviates concerns and prevents runs elsewhere?” said Kristin J. Forbes, an economist at Massachusetts Institute of Technology.

While Treasury Secretary Janet Yellen tried to reassure Americans — saying on the CBS program “Face the Nation” that the banking system was “safe and well capitalized” — regulators were racing behind the scenes to find a way to insulate the system before U.S. markets opened for the week on Monday morning.

The FDIC on Saturday started an auction for Silicon Valley Bank that was set to wrap up Sunday afternoon, according to a person familiar with the matter. Bloomberg earlier reported the news of the auction.

And if that push to find a buyer were to fail, the government was considering safeguarding uninsured deposits at the bank, another person said. But no decision had been made.

As the Treasury, Federal Reserve, FDIC and White House pushed for a solution, economists and politicians worried that companies that have big and uninsured bank deposits might grow nervous as they watched some Silicon Valley Bank customers face down losses — prompting them to pull their own deposits out of other regional banks.

“The risk is to regional banks, having their assets flee,” said Rep. Ro Khanna, D-Calif.

He and other members of the state’s congressional delegation joined a call with officials from the FDIC on Saturday night around 11 p.m. in Washington to discuss the situation.

Khanna said that the regulator was focused on finding a buyer for the bank. But if that failed, he said the government needed to find a way to promise that all depositors would be paid back in full by the time markets opened Monday morning. As of Saturday night, the FDIC was willing to commit only to partially paying back depositors, he said.

“We said that wasn’t going to be enough,” Khanna said in an interview. “There’s been too much buck passing between FDIC, Treasury and the Fed — the reality is that these things happen by consensus.”

Throughout the day Sunday, government officials tried to determine what tools the government had at its disposal to cushion the impact from Silicon Valley Bank’s failure. The first choice appeared to be a sale: Kevin McCarthy, the House speaker, said that the “best outcome” would be for someone to acquire the failed bank.

“I’m hopeful something can be announced today,” McCarthy, who said he had spoken with Fed Chair Jerome Powell and Yellen, said on Fox News’ “Sunday Morning Futures With Maria Bartiromo.”

But selling Silicon Valley Bank was not guaranteed to be successful — nor the only possible route the government could take.

The main backup plan being floated by analysts was the possibility that the FDIC could find a way to pay back depositors in full. While the regulator is typically required to unravel failed banks in the cheapest way possible — which means leaving the private sector on the hook for losses on uninsured deposits — it can get around that using what is called a “systemic risk exception.”

The rule, which was used repeatedly during the 2008 crisis, essentially allows the government to pay back uninsured depositors if failing to do so would have serious adverse consequences for the economy or financial stability.

But invoking the exception requires jumping a number of hurdles: The Treasury secretary in consultation with the president, the FDIC and the Federal Reserve Board must sign off on the decision to use it.

Getting the necessary two-thirds of the Fed’s six sitting board members to agree to such a plan could be a challenge, experts said.

“If the Fed signs off, I would think the Fed really sees it as systemic,” said Steven Kelly, a senior research associate at the Yale Program on Financial Stability, explaining that it was not clear that Silicon Valley Bank’s failure is in fact a threat to the stability of the broader financial system at this point. “They tend to take the determinations really seriously.”

Some economists suggested that the Fed could also try to help contain any trouble with some sort of emergency backstop program, which the central bank can use to funnel short-term cash to borrowers in need during unusual moments of market disruption, with the approval of the Treasury secretary.

But a central bank program might not be attractive in the current situation: Emergency lending programs from the Fed provide loans, not payouts. There are limitations on such programs that insist they must be broad-based, and which prevent their use for insolvent companies.

And even if depositors are not paid back in full, there are other steps that regulators could take to reassure investors in the safety of the system.

“I think the more urgent task is to reassure uninsured depositors more broadly,” said Daleep Singh, chief global economist at PGIM Fixed Income and a former economic official from both the Biden administration and the New York Fed.

To do that, the Fed could emphasize that banks can tap the Fed’s so-called discount window. That program allows commercial banks to take investment-grade securities — including Treasury bonds — and pledge them to the Fed in exchange for cash to meet short-term liquidity needs.

Banks often shy away from the discount window because they think that using it could signal that they are in a weak position. But in 2020, as the coronavirus shut down much of the economy, the Fed tried to encourage institutions to use it by making its terms more attractive. Back then, a group of large banks tapped it in concert to try to underline that using it was not a sign of weakness.

The Fed should be “putting the discount window in neon flashing lights,” Singh said.

This article originally appeared in The New York Times .