A Fed tale as old as time ...

Source: Getty Images. Bank run during a stock market crash in 1929.

The tale of Silicon Valley Bank and its fallout is still being written, and yet, it’s a story we know all too well. In fact, banking crises are at the heart of the Fed’s origin story. We may talk endlessly about monetary policy. And I can assure you that 25 versus 50 basis points and the terminal rate are not on the minds of Fed officials this week.

Why? The Fed’s founding mission is as a “lender of last resort.” The announcement Sunday night of a new lending facility for banks—the Bank Term Funding Program—in the aftermath of the meltdown at what was the 8th largest bank, Silicon Valley Bank, is par for the course.

The Panic of 1907

The Fed wasn’t always there to step in. Here’s the last banking crisis before the Fed was created in 1913.

The Panic of 1907 was a financial crisis set off by a series of bad banking decisions and a frenzy of withdrawals caused by public distrust of the banking system. J.P. Morgan and other wealthy Wall Street bankers lent their own funds to save the country from a severe financial crisis.

Sound familiar? Now: “Bad banking decisions.” Check. “A frenzy of withdrawals.” Check. “Public distrust.” Check, though it remains to be seen to what extent. Even J.P. Morgan is on the scene again to help. Unlike in 1907, the Fed is on the scene too. The Fed should have been on the scene overseeing SVB before it melted down. Ahem.

Continental Illinois National Bank and Trust in 1984

You wanted Volcker. Be careful what you wish for.

Several people, myself included, have argued for months that the Fed’s large and rapid rate hikes during the past year were going to break something in financial markets. The meltdown at SVB and the possible contagion effects fit the bill. Banks and others in financial markets were blindsided by the Fed’s actions and did not have time to adjust. And bad decision-makers at SVB made mistakes and paid dearly.

Here’s me last fall in The New York Times: as the Fed was racking up 75 basis point hikes and creating instabilities:

“The Fed has pushed financial markets in one direction really fast,” said Claudia Sahm, the founder of Sahm Consulting and a former economist at the Federal Reserve. “Markets need time to adjust.”

And on here also:

Hopeful-me expects 50 basis points at the Fed’s next meeting in early November. Realistic-me expects 75. Even so, big, new trouble overseas and any seizing up in U.S. financial markets will get you 50 or maybe even 0. I want the Fed to stop and be patient, but I don’t want to see the world events that would make it happen.

The hike numbers are smaller now: 25 basis points—before SVB—was my preference for the FOMC meeting next week, though 50 had been starting to look more likely. But unless things get back to normal really fast, 0 it is. And even then, 50 is off the table entirely. SVB is one of those “world events” I worried about in October last year. It was as clear then as it is now: the Fed is playing fire. We all got burned.

And again, this is nothing new. Going Volcker has been a popular battle cry. I know we were told that workers were the collateral damage. But we should have talked more about how his big and rapid hikes created crises in financial markets.

And here it is:

When Continental Illinois National Bank and Trust Company failed in 1984, it was the largest bank failure in U.S. history, and it remained so until the global financial crisis of 2007-08. The Chicago-based bank was the seventh-largest bank in the United States and the largest in the Midwest, with approximately $40 billion in assets (Federal Deposit Insurance Corporation 1997, 255).

Look at that. We are only off by about one half. SVB was the 16th largest bank, and Continental Illinois the 7th.

Continental Illinois had also invested in developing countries, which experienced a debt crisis brought on by Mexico’s default in August 1982. These events caused investors to reexamine the bank’s risk-pricing and lending practices during its high-growth period.

So again, we have mismanagement. And the rapid rate increases in the early 1980s were tied to the Volcker rate hikes: they wrecked economies in Latin America. And that came back to hit us too.

Now, in that case, the Fed, FDIC, and Treasury got it under control back. It bailed out that bank. The failure of Continental Illinois did not spread to other banks. That’s what the Fed, FDIC, and Treasury are aiming for now. Fingers crossed.

Let’s avoid The Techie Meltdown of 2023

Ever since the FDIC shuttered SVB on Friday, it’s been a truly wild ride. This weekend, Sunday night, and Monday morning were scary.

Yesterday I saw someone on Twitter remark that March 13, 2023, would be the day the recession began. Yesterday was also my birthday. I will be extremely displeased if the NBER does, in fact, date my birthday at the recession starts. [Technically, if this blows everything up, they will date the month, and if they did days, the peak—the start of a recession —would be sometime last week before the run on SVB. But still, ugh!]

More seriously, this week is a crucial one. Contagion is as much about psychology as it is about the balance sheets of the banks. There will be plenty of time to figure out what the heck happened. Now is not the moment. Now is the time to calm fears.

On that note, I have a few pleas: Exempt Powell from the communication blackout. And do it immediately. We need him at the podium, not a bunch of press releases. It’s crucial to calm financial markets and the public. It’s crucial to pull uncertainty and panic out of the air. Powell can help. Time is of the essence.

And please, no Summary of Economic Projections next week. The Fed delayed one early in the pandemic when markets were in turmoil. The world does not need the dot plot right now. Forward guidance has done enough damage. It’s not the time or place.

In closing

This is not a drill. And all is not lost.

The Fed knows what it’s doing. It knows how important its role is now. The Fed is in triage mode. Inflation is a problem, and the Fed will not forget that. But keeping the financial system out of tailspin is the top priority. It has work to do. Setting up the lending facility was the easy step; now it’s time to restore calm. Or at least dial down the panic. The Fed cannot do it alone. We can do it together.