Investigate the Bank Failures
A presidential commission can determine where the banks, the auditors, and the Federal Reserve erred.
In a speech last week, President Biden reassured the public that those responsible for the failure of Silicon Valley Bank (SVB) and Signature Bank will be held accountable. In the 2008–09 Financial Crisis, this did not happen. For Biden’s promise to be more than rhetoric, his administration must take a proactive role. As the last crisis showed, the normal mechanisms of accountability are broken. Banks paid billions of dollars in fees, but no CEO, board member, auditor, or regulator went to jail. Aside from a few CEOs, nobody even paid a fine out of his own pocket.
Firing the CEOs of Silicon Valley Bank and Signature Bank, especially if these do not involve a claw-back of bonuses and trading profits made with inside information, would be insufficient. That punishment would be too little, not just because it does not satisfy the public thirst for justice but also because it does not create the right incentives to avoid similar crises in the future. Resilient institutions cannot be brought down by the failure of just one individual, even the CEO. In fact, banks have a number of important gatekeepers. The failure of these banks suggests that all these gatekeepers failed together. If we want to restore trust in the system, we need to understand why. Only an authoritative presidential commission can do so.
The first gatekeepers to be investigated are the boards of SVB and Signature Bank, which are responsible for ensuring that bank risks are properly managed. They were not. In June 2019, Delaware’s supreme court held that the board members of Blue Bell Creameries should be personally liable for losses the company suffered following a deadly listeria outbreak because they did not create a board-level process to oversee mission-critical risks for the company. Why should the same not happen to bank board members when the bank they supervise fails to adopt such basic risk-management techniques as hedging interest-rate risk?
The second gatekeeper to be investigated should be the auditors. On February 24, KPMG signed the audit report of Silicon Valley Bank. On March 1, it signed the audit report for Signature Bank. By law, auditors must state whether they have any doubt about a company’s ability to survive over the next year. In both cases, KPMG expressed no doubts. Within two weeks, both banks failed. If auditors are unable to detect fraud or risk, what are they paid for?
The last and most important gatekeeper to be investigated is the Fed. The knee-jerk reaction of many liberal commentators was to blame former president Donald Trump for these bank failures. Under Trump’s administration, midsize banks like SVB were exempted from the duty to conduct a stress test. If this relaxation did not occur, the claim goes, SVB’s risk would have been identified much sooner. This claim is false, however. As Nobel laureate Douglas Diamond clearly stated in the latest episode of Capitalisn’t, a podcast that I co-host, SVB would have passed the stress test with flying colors. The 2022 stress test did not evaluate banks’ exposure to the possibility of significant interest-rate increases. If the Fed did not fail in its role as regulator for lack of instruments, then why did it fail?
We don’t know what regulatory actions the Fed might have taken against the two failed banks in the last few years since these actions are confidential. Yet, we do know that 20 months ago, when SVB acquired Boston Private Bank and Trust, the Fed Board unanimously authorized this acquisition, stating that SVB would not “pose significant risk to the financial system in the event of financial distress”—exactly the opposite of the Fed’s March 13 statement to justify its intervention to save the bank’s depositors.
We also know that on Tuesday, March 7, three days before SVB failed, Fed chairman Jay Powell stated in his Senate hearings that “American banks are strongly capitalized.” Asked about potential exposure to real estate, he added, “But the question is, what’s the financial stability risk? It’s—it’s not great for the largest institutions [that] don’t tend to have a lot of direct exposure to that, some smaller banks actually do, medium- and small-size banks do. We carefully monitor it. We agree that that’s an area that requires a lot of monitoring. And, you know, I’d say we’re on the case.”
After last week’s bank failures, the Fed promised to conduct an internal review. Internal reviews, however, are toothless. They are bound to absolve the very parties who commission them. After the Challenger explosion in 1986, the investigation of the causes of the disaster was not left to NASA’s internal review but to a presidential commission led by William P. Rogers, a former U.S. attorney general. The Rogers Commission was a top-notch group that counted among its members Richard Feynman (Nobel Prize in physics), Neil Armstrong (the first man to walk on the moon), and two Air Force generals. Precisely because it was independent and authoritative, the commission was able to identify the root cause of the Challenger disaster (including NASA’s responsibilities) and propose some remedies to avoid similar disasters in the future.
Of course, the 2023 banking crisis differs from the Challenger tragedy, which killed seven people. Nevertheless, there are many similarities. After succeeding in taking a man to the moon and bringing him back to earth safely, NASA was the pride of the nation, the pinnacle of American technology and organizational capability. The Challenger explosion undermined that confidence. Only a presidential investigation could expose how NASA, sitting on its laurels, had become complacent and inefficient.
The same can be said for the Federal Reserve. Handling the 2008 crisis might not have been like taking a man to the moon, but it was probably more important for human welfare. Ben Bernanke, who steered the Fed during the crisis, was even awarded the Nobel Prize in economics. In a world where most institutions are plagued by partisan divisions, the Fed appeared until recently as the only bipartisan institution run by highly skilled technocrats who could do no wrong.
No longer. In the last two years, the Fed has failed twice. It has failed to see inflation coming, and it has failed to see the banking crisis coming. The nation needs a trustworthy Fed to combat inflation. The only way to recover this trust is through a transparent, independent, and authoritative commission whose findings are believable. President Biden should appoint such a commission without delay.
Photo Illustration by Avishek Das/SOPA Images/LightRocket via Getty Images
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