Special Episode: Richard Squire on the Collapse of Silicon Valley Bank

During this special episode, Richard Squire joins us to discuss the collapse of Silicon Valley Bank. Richard is a Professor of law at Fordham University School of Law, where he teaches corporate, business, and bankruptcy law, and he is here today to provide an overview of what has happened at Silicon Valley Bank, and analyze the elements that have led to this point. Join us to hear his perspective on the Federal Reserve’s failures, the role of moral hazard, and how middle class tax is redistributed to the wealthy. We discuss fractional reserve banking, Dodd-Frank, and interest rates, before we theorize about what the world would look like without inflation from money printing. Hear why Richard doesn’t advocate for lifting the insurance cap on deposits, which program is working in tandem with deposits, and why deflation is undesirable for the Federal Reserve with money multiplication and division in mind. Join us today to hear all this and more from today’s highly knowledgeable guest. Thanks for tuning in!

Key Points From This Episode:

• An introduction to today’s guest, Professor Richard Squire.
• Richard’s rundown on the bank run at Silicon Valley Bank.
• What Richard means by bad practices: a failure of risk management.
• The two main problems that caused the bank to fall into bankruptcy. 
• How the social media component fueled the panic around this crisis.
• The Federal Reserve’s failure to monitor interest rates at Silicon Valley Bank.
• Moral hazard at various scales.
• The redistribution of middle class tax to the wealthy in Silicon Valley.
• The cost of money printing.
• Fractional reserve banking.
• How different our approach to banking would be without inflation from money printing.
• Where Dodd-Frank fell short in addressing risk.
• Why Richard doesn’t advocate for lifting the insurance cap on deposits.
• The program that is working in tandem with deposits.
• Why deflation is in conflict with what the Federal Reserve wants.
• Money multiplication and money division.
• The impact of having no risk officer at SVB.
• A note that the insurance limit has not been limited for other banks.
• Why there is global interest in the Federal Reserve’s interest rates.

Links Mentioned in Today’s Episode:

Richard Squire on LinkedIn

Silicon Valley Bank

Dodd-Frank Wall Street Reform and Consumer Protection Act

Fordham University School of Law Corporate Law Center

Transcript

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SPEAKER_02 0:00

Now, they weren't seaworthy because of bad practices at those banks in particular, but the underlying volatility in the market, I think we can lay at the feet of the Federal Reserve.

SPEAKER_00 0:13

You're listening to Bite-sized business law, where we discuss big issues in small doses. This podcast is sponsored by the Fordham University School of Law Corporate Law Center, which is run by Fordham Law Professor Richard Squire and me, your host Amy Martella. Okay, let's get down to business. Welcome to a special episode of Bite-sized business law, where we will be discussing none other than the collapse of Silicon Valley Bank. You might remember Professor Richard Squire from our very first episode, where we discussed another crisis, the crypto bankruptcies. And he's graciously agreed to return to talk to us today about SVB. Richard is a professor of law at Fordham Law School where he teaches corporations, business, and bankruptcy law. And he's my co-director here at the Corporate Law Center. Richard, welcome back.

SPEAKER_02 1:01

It's nice to be back. Whenever there's a crisis, I want you to think of me.

SPEAKER_00 1:06

In fact, when we got the news on Friday that SVB had collapsed and gone into FDAIC receivership, the first thing I thought was, I've got to hear what Richard has to say about this.

SPEAKER_02 1:15

Good, good.

SPEAKER_00 1:16

So thank you for coming. I know you've been very busy. Different media outlets have been asking for your time and your thoughts. So thank you so much for being here today.

SPEAKER_02 1:22

This is the place I want to be the most. Great. Yeah, no, I told them they all have to take a number because you called me and wanted to do a podcast.

SPEAKER_00 1:29

That's right. That's right. Okay, so when we last spoke, we were talking about a different crisis, the crypto bankruptcies. And now we have another one to discotch, which of course is the collapse of Silicon Valley Bank on Friday, March 10th. Unlike other financial crises, this was not a crisis of credit. It was nothing necessarily nefarious afoot. It was just a good old-fashioned bank run. So can you just quickly give us a little background on what exactly happened? And then we'll get into more of the meat.

SPEAKER_02 1:57

Sure. You're right that there was a good old-fashioned bank run going on, primarily at Silicon Valley Bank, certainly. Also, Signature Bank failed recently or was seized recently. But I can't take your rosy view that nothing nefarious is going on here. I think there are actors who are responsible for this for not behaving properly, both at the government level and then at the banking level as well. So the way I think about what's happened here is that essentially we have stormy financial seas. We have liquidity levels going up and down due to Federal Reserve policy. Initially, money was pumped into the economy in 2020 and 2021 to pay for deficit spending, to convert that deficit spending to cash. A lot of that deficit spending was COVID relief. And so that increased the amount of money in circulation, increased the amount of the money that were on bank balance sheets, and banks lent a lot of that out. Then we had inflation as a natural result of all that money being injected into the economy. So we had this great tide kind of of money going out into the economy. And then the Fed said, well, wait a minute, we have to reverse course and try to start pulling the tide back in. This buffets everybody in the economy, the liquidity levels moving up and down, but it especially buffets banks. And there were a couple of banks that it turned out that just weren't seaworthy. So they couldn't survive the buffeting that happened. And so they failed. Now they weren't seaworthy because of bad practices at those banks in particular. But the underlying volatility in the market, I think we can lay at the feet of the Federal Reserve.

SPEAKER_00 3:32

Okay. And when you say bad practices, I know there's been some talk about the DOJ and the SEC investigating the CFO and the CEO of Silicon Valley Bank. Are you talking about those types of practices where they may have unloaded stocks improperly? Or are you talking more about just a failure of risk management?

SPEAKER_02 3:50

Aaron Powell Mainly the failure of risk management. If they unloaded stocks and therefore engaged in insider trading, they may have broken the law. But that's not what caused SVB ultimately to run out of cash and fail. What caused it was two different problems. So we know that what a bank does, a typical bank, a standard commercial bank like SVB, is take money from depositors, which they can withdraw at any time. So it's considered to be short-term credit. It's actually on-demand credit. But then the bank turns around and invests that in longer-term investment. So it could buy US Treasury bonds, for example, which is SVB did. It can make loans to businesses. SVB also did that. And a problem can arise when all the depositors want their money back at the same time, and the money is tied up in long-term investments. Now, if a depositor came to SVB and said, look, I have a million dollars here in my checking account, I'd like it back. And SVB said, You know, I don't have the cash right now. But here is a US Treasury bond that we bought, and you can just take that instead. And if the depositor accepted that, then there wouldn't be a problem. But the depositor wants cash, and that's not what the bank has because it's invested the cash in these investments. Now, that's an inherently rickety or uh unstable structure. The government has created policies such as, or programs I should say, such as FDIC insurance, and then also the lender of last resort function played by the Federal Reserve to try to backstop that rickety structure, to make it a little bit less rickety. But it is inherently fragile. And so if the bank, for example, fails to make diversified investments, and SVB failed to do that, invested large amounts in mortgage-backed securities, and especially it looks like US Treasury bonds. And those bonds, when they were purchased, didn't pay much interest, which was fine when interest rates were low, when the Fed was pumping money into the economy. When the Fed reversed course and started trying to fight inflation by reducing the money in the economy, the natural consequences, interest rates go up, those investments suddenly are less valuable. Perceptive depositors saw that this was happening and started pulling their money out. Now, and kind of then the ball was rolling down the hill and ultimately it couldn't be stopped. There was a snowballing effect as SVB started then selling those long-term investments to try to raise the cash to pay for the depositors. But once depositors heard that the bank was selling those investments at a loss, that just made things worse. So, what did SVB do wrong? Well, there are the risk management people didn't diversify the investments, and they also did not hedge inflation-related interest rate risk. So they should have known that if interest rates were going to rise because the Fed was going to start fighting inflation, that the value of the treasury bonds on the portfolio would fall. There are ways to hedge that risk. You can buy interest rate swaps and other things like that. SVB didn't do that. And so it was left just suffering these kind of unhedged, undiversified losses. In addition, it had a concentrated depositor base. Most of its deposits were from not what they call retail deposits. They weren't from households. These were from Silicon Valley companies, a few startups, maybe also some long-standing software companies, biotech companies, and they had huge balances at SVB that had grown recently. The last three years or two and a half years, they had grown by several hundred percent. So there was a lot of money that came in. Just like money can come in quickly, it can leave quickly, especially when it's all from one industry. If there's a shock to that industry and the tech has been suffering some difficulties lately, that money's all going to go out. And that's exactly what happened. SVP was not diversified on that side either. A basic rule of investing is you're not supposed to put all your eggs in one basket. SVP did that two times over, put most of it investment assets or investment eggs, I should say, in the basket of treasury bonds that are interest rate sensitive. And then on its deposit side, most of the eggs that were coming in were from one basket, namely Silicon Valley.

SPEAKER_00 7:41

What I thought was extra interesting about this go-around was unlike in 2008 with Lehman Brothers, 2023, the social media component made the panic that much more. So these tech industries, you know, they got right on their slacks and their platforms where they speak to each other. And within 24 hours, this 40-year-old bank was just unraveled because these messages pinged across the world and it really added to the panic.

SPEAKER_02 8:07

So I think that's right. With Lehman Brothers, we did have the internet back then, and we even have rudimentary text. I think in those days, I was texting on my flip phone. Or I actually didn't have a full keyboard, I just had numbers, but they have letters associated with that. And you have to hold it down three times. Right, hold it down, and then the phone would start figuring out which letter you want. But there was email. That also was a run when it did happen, and it was several financial institutions that were run on. That largely did not happen on street corners, like in the old days, where depositors lining up to pull their money out, but happened online. And that's certainly what happened with SVB as well. But yes, the amount of interconnectedness and the speed with which people can communicate with each other at all hours by social media or otherwise, especially the tech savvy depositors of that particular bank, made it kind of Hussein bolts speed kind of run. You know what I mean? I mean it was a sprint for the doors in a way that's hard would be harder to do in older days.

SPEAKER_00 9:00

Some are even saying that the Fed didn't tune into what was happening with SVP. It was actually Twitter that raised the red flag.

SPEAKER_02 9:08

There's no doubt about that. In almost any crisis that we see where a financial firm turns out to be insolvent, the federal regulators are, and the state regulators as well, are often the last ones to know. We saw this with the collapse of the Madoff Ponzi scheme, where many people in the private sector knew for years, tried to tell the SEC it was happening. The SEC investigated incompetently, and it was not ultimately the SEC that brought Madoff down. It was the market in the end. And then the SEC came in after the fact and the DOJ and started prosecuting people. So, no, there is no indication that regulators saw this coming at SVB or at signature. Now, they are looking more closely at other banks this week to see if they have similar unhedged exposure because that will influence the capacity for the Federal Reserve to continue to raise interest rates to try to fight inflation. Inflation is still well above the 2% target. It's easing a bit, whereas a few months ago it was 10% or 9%, now it's only 6%, but that's still well above where the Fed wants it. The Fed would like to keep raising interest rates, but that reduces the amount of money in circulation and puts pressure on banks. And if other banks are going to be proved to be or would prove to be not seaworthy because of the same inherent problems, the Fed's now gonna want to know that before raising interest rates again.

SPEAKER_00 10:27

Okay, so that brings us to another important failure that we have to discuss, which is the Fed's failure to monitor the effect of their interest rates. And as we just spoke about, you know, they didn't notice the red flag until Twitter put it up. But you have to think that any sort of rapid growth, the way SVB was experiencing rapid growth in the last two years, as you mentioned, they went from some deposits worth 60 billion to over 200 billion, that that in and of itself is a huge red flag. And when I first heard about this last Friday, you know, I kind of gave the Fed the benefit of the doubt. I thought, well, they've been so busy and trying to ease inflation. But then I was reminded that actually what's much more important than inflation is financial stability. And that is really one of their core mandates. So do you think that they were too preoccupied with the rate hikes and easing inflation to even notice or to care about the rapid growth of a bank like this? And how it was probably not a great indicator of health.

SPEAKER_02 11:23

So what's remarkable about your description of all of the Fed's responsibilities, and I agree we have put all this on the Fed's shoulders, is that that's a lot to do for a small group of relatively small group of people, even if they're very smart and they hire and employ many of the PhD economists in the country. The Fed is charged with stimulating the economy when growth is sluggish, but then fighting inflation when the stimulus that it uses, which is essentially money printing, leads inevitably to higher prices. And then on top of that, also regulating banks, and that is especially difficult because there's a trade-off between the two. When you fight inflation, you put greater pressure on banks. Banks do better in easy money times, they do better in the inflationary environment, but then when it's the opposite, banks have pressure on them. Now, is it the Fed's fault, the regulators' fault, ultimately, not to notice that SVB in particular, and maybe signature as well, did not have competent internal risk managers? I mean, that's a lot to ask. Some people out in Washington, D.C., or well, there's the San Francisco branch. I take that back. The Fed does have a brand in California as well. But to know about the competence of the internal, the risk managers at these particular banks, I think that's a lot to ask of the Fed. Maybe a better approach would be that when a bank does prove to have incompetent management, it should just be allowed to fail. It's an interesting question whether we think that the banking system should be such in the United States and our regulators should try to achieve a banking system so that banks never fail or that banks over a certain size never fail. If that is going to be the goal, then I think you are putting unrealistic expectations on regulators. And you're also taking away a lot of the discipline of the market and encouraging a lot of moral hazard. Now, why is it that in the banking sector, we seem to be moving in the direction whereby we really don't want any of them to fail? Or as soon as one fails, we engage in quasi-bailout-like behavior rather than just letting the losses lie where they fell. It's because the federal government has already given promises to the American people suggesting that their money is compl is either mostly safe or completely safe when they put it into these commercial banks. And it's very hard, once there's that political expectation that depositors are protected, to then let the market do its work and weed out the incompetently run banks.

SPEAKER_00 13:37

Aaron Powell You're saying that Americans believe that their money is protected, but don't we all have the understanding that it's only protected to a certain point? And why shouldn't we here have let all the depositors get their $250,000 back? But above and beyond that, let the market do what it will.

SPEAKER_02 13:51

Right. So what the average American understands about how FDIC insurance works is something I can't speak to with a great deal of confidence. I do think that Americans, most Americans know that their money is insured. They may not know the exact amount. They also may not know how it works in terms of if you have a checking and a savings account at the same bank, you can't add those two together and then get $500,000 in insurance. It's only $250,000. However, if you're married, you can have an individual account that's up to $250. Your spouse can have an individual account that's up to $250, and then the two of you can have a joint account that's up to $500. So then you can have a million. Did you know that? I actually didn't eventually. I didn't know until I looked up recently, right? So there's some complexity here. And if you and I, we're lawyers and we're interested in banking law and corporate law, if these aren't things that we uh are at our fingertips, I don't think it's at the fingertips of most Americans. I also think most Americans reasonably expect that even if a bank does fail and those people have deposits that exceed the FDIC limit, well, there's a chance they'll be made whole anyway, because the government will bail out the bank or at least bail out the depositors. And this has happened with SVB, it happened with signature, it happened on a broader scale in 2008. So I think, yes, Americans do have expectations that at least 250,000 or at least some large amount of money is protected, and maybe all of it is. And the government is responsible for creating those expectations, and it doesn't want to pay the political price when those expectations are disappointed. Can you explain to us what you mean by moral hazard? So moral hazard occurs when people who engage in risk don't bear the losses when that risk manifests. It actually comes from the insurance industry. So the idea would be if homeowners insurance that covers you in case of fire. You might be more likely in the old days of smoke in bed. That was the great hazard that people talked about. When I was a kid, I saw advertisements that said, don't smoke in bed. Now it's don't smoke at all. But maybe we'll start seeing them don't smoke marijuana in bed. That's what people will start saying now. But anyway, but the concern would be that, well, if your house is insured, you may be less likely to be careful about fires, you may be less likely to buy a smoke detector and so on. Because, hey, if there's a fire, you're covered. You may even be likely to set your house on fire to try to collect the insurance money, which is the ultimate manifestation of moral hazard. So it happens when people who engage in risk behavior don't bear the costs when the risk manifests, but rather the cost is shifted to third parties. So certainly FDIC insurance has this effect. The banks and the depositors are the ones who are engaging in potentially risky behavior by putting their money in a bank that's going to turn around and then lend it out and make investments with it, investments that could lose money. But with the insurance here, we say, oh no, no, you don't have to worry, you depositors. Your losses will be shifted. Essentially, they'll be socialized, shifted to the taxpayer, which is where ultimately where all of this money comes from with these bailouts. Now, the higher the insurance amount, the greater the moral hazard. With SVB, we're seeing companies that had over $40 million, at least one company, Roku, the streaming service, out of $40 million in accounts, just regular transactional corporate checking accounts, essentially, at Silicon Valley Bank. And that's going to be paid off in full. Probably already has by now. So that is moral hazard on a multi-million dollar scale.

SPEAKER_00 17:09

Well, it sounds like the depositors aren't the one taking a risk, right? When you deposit your cash in a bank, you're just depositing your money in an account. So the risk here sounds like you've got a bank who is taking positions, failing to manage the risk appropriately. Right. And then the FDIC is saying, don't worry about all that. We're going to come and make sure, make every one of your customers whole. So it sounds like what you're saying is with moral hazard, you're encouraging the bank, you're kind of insulating them from the consequences of the R.

SPEAKER_02 17:40

Well, you're insulating the depositors too. And the bank then benefits from that because it gets more deposits than it would otherwise. It's interesting what you said about how when a depositor puts money in a bank, the depositor is not really taking any risk. I feel like we have created an environment in which that's the expectation. Now, if the bank turned around and put the money, so if you deposited a $100 bill in your checking account or your savings account, and the bank said, okay, we're going to take this $100 bill and we're going to put it in our vault, then the risk would be much less. But I think you know, no, I'm sure you know, and I think I hope most Americans know, that the bank doesn't do that. It turns around and lends the money out. And so to say that the depositor isn't taking any risk is to say that we don't expect or we don't want to require the depositor to have any responsibility for selecting sound banks versus unsound banks or for just engaging in basic diversification. Don't put all your eggs in one basket, is also maybe something that the depositors should know. But if we want to say, no, no, no, from the depositor's perspective, it's just like it's in a vault, in a safe deposit box, that's fine. But it does remove one potential market check on risky bank behavior.

SPEAKER_00 18:48

Aaron Powell But it also gives Americans confidence that they can continue to bank, because I think that was the big concern here. I mean, most Americans don't have money in Silicon Valley Bank. So, the concern here, right, was that there would be this ripple effect throughout the whole system if we didn't swoop in and save them.

SPEAKER_02 19:06

That's one potential uh interpretation. If President Biden immediately gotten on television and said, look, if you have deposits that are not for more than $250,000 per person per FDIC bank, you are fine to reassure Americans generally and to prevent a bank run done by people at the household or what do they call the retail level. And if he said if it's above that, there are additional mechanisms. By the way, this is something else I've been learning about recently. There are now services whereby if you have more than $250,000 in your account, your bank can then pass that money onto an account at a different bank. It can insure people ultimately for well into the tens of millions of dollars, and it's a service that's just provided. And so President Biden could have said, look, there are banks out there that provide this service. When they do that, it's spread out to different banks, and each bank is insured up $250,000. So you will be protected if you do that. Would that have stopped the run? I think it would have been effective to stop retail level running. Like you said though, SVP was not a retail level run. It was a run by business depositors, by businesses and corporations. And do we want to prevent them from running? They are in an excellent position, unlike the typical household, to monitor risk at particular banks. This is what they do, they're risk managers. Silicon Valley companies have risk managers. They also are in a very good position to learn these basic facts that you and I are reminding ourselves about of the $250,000 limit per deposit, the ability to spread your deposits among multiple banks, or have a service that does that. And so if they have failed to do that and therefore suffer losses, it's not clear to me why they shouldn't bear the losses in that situation. Now, there's a potentially political explanation, a potential political explanation here, which is Silicon Valley in particular. It's a US government policy for the tech industry to be one of our competitive leaders, especially vis-a-vis China. And so losses being suffered into that industry may be seen to have certain political or strategic costs. In addition, Silicon Valley is known for donating large amounts of money to the Democratic Party in particular. I don't think politicians are above such considerations. And so this could be cynically interpreted as a bailout for a particular industry, even though that industry was reckless in its banking practices.

SPEAKER_00 21:25

Yeah, there it definitely sounds like it was a concentrated in the tech industry. And we've been talking about SVV a lot, and which is fine.

SPEAKER_02 21:32

With signature, a lot of the investments were in the crypto industry. So again, uh there as well, you did have a lack of diversification on the investment side. That's right. And another high tech industry that was receiving a lot of the bank investments.

SPEAKER_00 21:45

Yeah. I mean, I get it. We don't want to be squashing innovation in any way. And of course, our tech companies, you know, we want to emerge as leaders. However, I think it's important to acknowledge that there is some sense rumbling around out there of injustice in that. You know, we're bailing out some tech bros who went to MIT simply because they are rich and because they support this billionaire economy in Silicon Valley. And we don't do the same thing for people who suffer economic hardships in other ways. So what do you have to say to that, to people who are feeling a little sense of injustice right now?

SPEAKER_02 22:19

I think that it is true that this is a rich man's and rich woman's bailout, especially with SVB again. I think most of those tech firms that had their deposits repaid immediately and in full are employed by and receive investments from some of the wealthiest individuals in America. This will be paid for ultimately by taxpayers when it is said, oh, the taxpayer won't pay any price for this. That's simply not true. Oh so? Well, okay, so I'm glad we're talking about this because we live now in a world, I think, of euphemisms. So one euphemism that the government's trying to use to say this is not a bailout? Well, it's not a bailout of the equity holders and managers of SVB, but certainly it is a bailout of their depositors, same true thing that you can say at signature. And then also to say, well, this won't be borne by the taxpayer. Well, how where's all this money going to come from for these depositors, these companies that had these multimillion dollar accounts at SVB? It's going to come, first of all, from the FDIC's insurance fund, but that will have to be replenished. The way it's replenished is by what the government calls an assessment on other banks. An assessment is just another term for a tax. That is a euphemism. And there's two things that are notable about that particular way of raising the money. First of all, it means that other banks will have lower profits. That means that the shareholders of those banks will take the hit. Now you may think, well, bank shareholders, why do I care about them? If you have a 401k or savings account, and I'm sure you do, and millions of Americans do, I'm sure that there are stocks in there, maybe in an index fund, and a lot of it is the banking industry. So the average American will pay for this out of his or her retirement fund and investment portfolio. And so that's one thing that's interesting about this. It will ultimately be borne by, it's not the average person in the sense that in order to have some money in the stock market, even through your retirement fund, you're probably not amongst the poorest Americans. But it's a middle class tax. There's no doubt about that. So it's a redistribution from the middle class to these wealthy people out in Silicon Valley. There's no doubt about that. Second of all, think about the perverse incentives, the moral hazard, if you will, of saying, okay, banks that did manage themselves responsibly, that did hedge interest rate risk or inflation risk, that did manage to re-usher their depositors so that the depositors wouldn't run. They have to pay into the FDIC assurance fund to replenish the losses caused by the irresponsible risk managers and loan officers at SVB and signature. So certainly there is tremendous moral hazard there as well. And that is every reason. That's two reasons I've given you. One is the regressive redistribution of the nature of this assessment or tax. And then also the moral hazard. Now, when people say, well, we're bailing out the rich, but we're not, we don't similarly spend money for people who are more needy in our economy. I do think that it is true that the Federal Reserve, one of its main functions, is to subsidize both Wall Street and also the banking industry, the commercial banking industry. And it's no doubt that that is regressive. It is notable, however, it's interesting, that all of this started, this last round, as I was talking earlier, about lots of money flowing into the economy and then money being pulled out after it was proven to be inevitably inflationary. Why was all that money pumped into the economy in 2020? Well, because there was blowout spending going on by the federal government, a lot of which was for COVID relief. And a lot of that COVID relief was intended to, and I think in many instances it did, help the average American. It wasn't just rich people who were receiving that money by a long shot. But that had to be paid for somehow. We tried to pay for it just by printing the money, but that turned out to be unsustainable. And so we have this ripple effect. And so I think that government spending is going on here at kind of all levels of the income hierarchy, if you will. We had blowout spending mainly targeted toward poorer or middle class people, workers back in 2020 and 2021, caused inflation, caused a reversal of monetary policy, caused some banks to fail, and therefore caused some bailouts that are now going primarily to rich people. So I think there are a lot of different snouts at this trough.

SPEAKER_00 26:32

How do we avoid this? I know you once described it to me as boiling a pot where you pour the water in the money, and then you realize that you've got to turn up the heat on the uh rates, and you know, you're trying to keep the lid on. And how do you escape this cycle of we have money, we print money, it causes inflation, we hike the rates up, causes banks to suffer. You know, how do we get out of this cycle?

SPEAKER_02 26:54

One way that we would get out of this cycle, and the question would be, is it politically feasible, is to stop using the Federal Reserve as a way to pay for government spending. Stop. Now, the technical term is monetize the debt, but all that means is that the Treasury pretends that it's borrowing money to pay for federal spending, but then the Federal Reserve immediately comes back and pays the people who have lent the money to the Treasury in full with newly printed money. So essentially we're paying for it with printed money. And why do we have money printing going on? Well, the American voter, and this is maybe a problem with democracy in modern economies and modern systems, wants two different things from Congress. It wants, first of all, lots of spending on social uh programs and other safety net programs, Social Security, Medicare, all kinds of things that people like. But people also don't want to pay for those with taxes. So we want the money coming out of Washington, but not money going into Washington. Now, that gap can be bridged to a certain extent for a limited time by borrowing. But the borrowing ultimately has to be paid for as well with interest. And so taxes are looming there at the end. So the other way to do it is money printing. If you print the money, then you can spend without having to tax or borrow. But there's a cost there as well. There's actually two big costs. One is inflation, and then the other is greater instability in the banking system than we have already. So I think one way we would start is to say, look, we're not gonna do this anymore with the banking system. We're gonna put back to have a stable currency that's backed by gold or some other real commodity so that we can't just create more out of thin air. And we're gonna have to bite the bullet politically and say, if you want certain levels of government spending, you have to pay for it with taxes. The other way, more specific to banking, is for the US government to get out of the business of trying to support this banking structure, whereby the technical term is fractional reserve banking. But it's really just taking money on short-term credit, deposits that can go away at any time, and then letting the banks lend it out long-term. We subsidize that, we try to hold it up, but because it's inherently rickety, you can only hold it up for so long.

SPEAKER_00 29:04

I think you're right. I think that approach to taking short-term credit and wanting to reach for that long-term yield is it's not good, as we saw here.

SPEAKER_02 29:12

No, no, it's not good. And if the government weren't subsidizing it, people will be a lot more careful with their money. It's also worth noting that if we didn't have inflation from money printing, people would be more comfortable going to a bank that was just a vault that says, I will keep your money in a bank account, I won't lend it back out. So it is much safer. Now you may say, well, you don't get any interest on that. Well, first of all, you don't get much interest now on your deposits. But second of all, if there isn't inflation going on all the time because of money printing, actually not getting a return on your savings isn't so bad. If there's slight deflation over time, which is what we had in the 19th century before we had a central bank that printed money, actually your money just sitting there tends to grow in value over time. So part of the demand for these risky banking services, also demand for Wall Street for stocks and bonds and so on, which are complicated investments, and the average person isn't in a great position to know whether he or she is being swindled or not. In the 19th century, people didn't have to do that. Investing in Wall Street was seen as something for people with a lot of money to spend and a high tolerance for risk. The average person, I think, intelligently said, I'm not going to give my money to strangers. I could be swindled. The person would put it in a vault and would grow in value over time. That was a perfectly legitimate way of saving money. So I'm glad I persuaded at least you that we should stop subsidizing the maturity transformation, is another term for describing our banking system. Maturity meaning that your deposits are short term, so they have a short-term maturity when they can become due. But your assets, which is the bank's loans, have a long term. So you're taking short-term credit into long-term credit, which is inherently risky.

SPEAKER_00 30:45

Even though it was the safest bet for SVP, they thought, you know, it's a safe asset.

SPEAKER_02 30:50

The deposit, you mean up to 250.

SPEAKER_00 30:52

To put it in treasuries and to put it in bonds and government-backed mortgage securities. It's safe, right?

SPEAKER_02 30:58

I mean, don't you feel like that's a safe. Why do we call it safe? You're right. There is a certain safeness in that. There's no doubt about it. One reason we think it's safe, call it safe, is because with a few technical exceptions, the United States Treasury has never defaulted on the debt in the sense that it says, okay, I, Amy, you have a 100, that would be a big one, a $10,000 bond and it's due on this date, and then you don't get the money on that date. So that would be a payment default. And generally payment defaults don't occur on US Treasury debt. Unlike if you buy a bond at a corporation and then it goes bankrupt, there may be a default there. Now, we do know, however, that there's another risk associated with treasury debt, which doesn't go away just because there's no payment default risk, which is inflation risk. And that's what SVP was facing. Or maybe more concretely here, the risk that interest rates will be jacked up by the Federal Reserve to fight inflation. And so the bonds can still fluctuate in value, in their market value, based on interest rates in the economy. And so there is some risk there as well. So it's not a perfectly safe investment.

SPEAKER_00 32:00

Okay. So lest we forget that we are lawyers, let's talk a little bit about the role of the law in all of this. Sure. What does the SVB collapse say about the efficacy of Dodd-Frank or the rollback of Dodd-Frank during the previous administration?

SPEAKER_02 32:14

So Dodd-Frank was supposed to shore up the banking sector in a couple of different ways in order to make bailouts uh less necessary going forward. At the same time, it did create certain bailout mechanisms that we didn't have before, just in case those regulations ultimately proved to be unsuccessful. So, one of the things that we see is that specific risks that cause a previous crisis may not manifest again. Regulators may be doing a pretty good job to prevent that. So, for example, in the old days, most banks, when they would lend out your deposit money, they would lend it out in the form of mortgages. They wouldn't use it to enable people to buy houses with it. Now, we saw that a mortgage crisis, a housing crisis, and specifically a subprime uh mortgage crisis really drove the 2007, 2009 is often the the years that are uh mentioned for the crisis. I say 2006 in my head because that's when the Federal Reserve started tightening the money supply, which we're gonna do.

SPEAKER_00 33:14

And you saw it coming, of course.

SPEAKER_02 33:18

Oh, yes, absolutely. I immediately so the you've seen the movie The Big Short, right? Of course. Yeah, no, that was really about me. I just use a different name and so on. Uh yeah, but they had uh Christian Bale playing me or somebody similarly handsome. No, I didn't see it coming at all. I'm trying to be smarter going forward. I had a lot of confidence in our regulators that I have since re-considered. Uh so yes, but starting in 2006, there was tightening in the um the money supply. But anyway, the 2007-2008 crisis, it was mortgage-backed security specific. Now banks don't, they may originate mortgages, but then they immediately turn around and repackage them into securities and then get them off their balance sheets. And then they are held by other investment vehicles, by uh hedge funds or by pension funds and so on. And so the regulator said, okay, this particular problem we have addressed to a certain extent, but new risks will always manifest. That is the nature of any profit-making enterprise. And so Dodd-Frank didn't do much to address the risk that manifested here with respect to SVB in particular, signature to some extent as well, which is unhedged interest rate risk. That just wasn't the particular problem that was perceived in the last crisis. So regulators are kind of always chasing the last crisis, like they say, generals are always fighting the last war, that old cliche. And so Dodd-Frank didn't put in mechanisms that were particularly good at dealing with this particular risk that manifested. Now, with that said, Dodd-Frank did create a mechanism whereby government could very rapidly declare that all of the depositors would be insured at a particular failed bank or two if those banks were deemed to be systemically significant or there was systemic risk. It's called the systemic risk exception. That rapid increase in insurance mechanism is in Dodd-Frank. It was created then and then it was used in here. Did it reduce the likelihood of runs at other banks? I think that there's a there's a good argument that it did. There's another facility that's also been rolled out by the Fed that's also backstopping banks. We haven't talked about that yet. But it's also targeted at this specific risk that the market value of your treasury bond holdings will and mortgage-backed security holdings will fall. So, in that sense, Dodd-Frank did create a mechanism that may have been helped temporarily at least to limit or confine this crisis. But it has the consequence of that bailout, which we've talked about is maybe both distributionally unfair and also creates moral hazard.

SPEAKER_00 35:47

Well, talk to us about wasn't Dodd-Frank also aiming to require banks to keep a certain amount on reserve to prevent the bank run that occurred, you know, with Lehman Brothers. And then subsequent to that, smaller banks, regional banks like Silicon Valley Bank, appealed to Congress and said, we're not systemically important enough. We're not these so-called SIFI, systemically important financial institutions. We shouldn't be subject to all of these regulations. And then they ended up rolling back those requirements.

SPEAKER_02 36:19

Right, right. So I think the government can't have it both ways. It can't simultaneously agree that these banks are not systemically important. And then when they do fail to say, oh no, you're systemically important after all, engage in these bailouts. That's right. I am not as confident as maybe other people are in the ability of such regulations to uh uh prevent uh failures from occurring simply because I think that banks try to find ways to get around uh regulations. For example, they were rewarded for investing in U.S. Treasury debt mortgage-backed securities because regulators considered that to be the safest of all assets, as you were describing. So, in that sense, SVB was doing exactly what the regulators would want it to do, but we saw that that risk manifested there as well. So I'm not as confident that the regulators and regulations can prevent this kind of thing. But to the extent that we're at least going to try that, we do have to be consistent. And it does mean that we have to take seriously that some banks will fail if they're not systemically important. SVB is was big in the sense that it's one of the top, it was one of the top 20 banks in the United States in terms of deposits. But it was an order of magnitude smaller than what are the big four that have multiple trillions of dollars in assets. Bank of America, Citigroup, Chase, and Wells Fargo between you and me. I don't know why anybody would have his or her check in your savings account anywhere else, given that they're certainly too big to fail. I thought the same thing.

SPEAKER_00 37:43

I mean, I understand the convenience of a regional bank, but these companies like Roku should have had money, all of their money at one of the big four.

SPEAKER_02 37:51

Yeah, or should have diversified across money. That's right. Well, these regional banks try to compete with the too big to fail banks by offering higher interest rates and other sweeteners. But then to do that, they sometimes have to take greater risks. So uh there's a logic to it, a perverse logic again. But if we say, look, even if you are one-twentieth the size of Citigroup and the other, the big four, you're still systemically uh important. Then I think we have to give up the game on trying to make these distinctions. I would not support this for a moment, but one way to say it is to say, look, we're just gonna say, yeah, bank deposits um are fully insured, you know, lift the insurance cap. I don't advocate that, but then what why do I not advocate that? Well, because it would create an incentive for banks simply then to fund all of their operations with deposits. So if you look at a typical bank balance sheet, where does it get its money that it's then gonna turn around and lend out or invest? There are three main sources. There are deposits, there are then long-term lenders, bondholders, for example. People, I'm not talking about the bonds that the bank holds, I'm talking about bonds that it issues, and then people buy them. And then finally, there are equity holders, there are shareholders. Now, at least with SVB and with signature bank, the long-term creditors and the equity holders took losses. That means that that part of the balance sheet imposes a certain amount of market discipline on a bank, right? We don't want to take losses, so we're gonna monitor you whether you're making risky and reckless decisions or not. But if you make all deposits fully insured, then why would any bank issue bonds again? The bondholders are gonna say, we're gonna monitor you for risk. Say, yeah, forget it. Bondholder, just open up a checking account for the same amount, $10 billion, or no, that's exaggeration, $10 million or $40 million, like Roku did. We'll call it a deposit account. The interest rate will be lower, but you won't mind that because it'll be perfectly safe. We'll only raise a very small amount of money from equity holders. And so then the market discipline, which the regulators have to rely upon to a certain extent, unless we're just gonna give up the game altogether and socialize the entire banking system and have all banks owned entirely by the government, that market discipline mechanism will evaporate altogether. So that's why we shouldn't do it. But this inconsistency creates its own instability and it also creates moral hazard.

SPEAKER_00 40:06

Tell us about the program you mentioned that's working in tandem with everyone's deposits. There's also a program where every bank who's holding these types of assets.

SPEAKER_02 40:13

Yes, yes, it's open to all banks. It's a term lending facilities, what it's called. A term loan just means it's something that banks like to receive because there's you can't run on it. It's the opposite of a demand deposit where the creditor or the depositor can take it back at any time. Whereas a term loan means you have the money for a term before you have to pay it back. So banks can get loans from the Federal Reserve for up to a term of a year, although, for all I know, the Federal Reserve will allow them to roll that over later. These mechanisms, once they get put in place, usually exist for a long time, if not forever. Now, when the Federal Reserve lends to banks, which it already does through its discount window, through that's its lender of last resort function traditionally, it demands collateral. So it's not making an unsecured loan. The bank has to take some assets and pledge them to the Fed so that if the loan fails, the Fed can then at least seize the assets to cover the losses, to seize the collateral. Now, traditionally, with the old discount window, the Fed would look to the market value of the collateral and say, okay, you're giving me, let's say, bonds that have a market value of $100. I'll apply a standard haircut just to protect the Fed against additional risk above maybe 10%. And then I can I'll lend you $90 against that. Well, the problem is that these bonds that are on these balance sheets have lost a lot of market value because of the direction of interest rates caused by the Fed itself. Of course, the Fed is kind of, you know, it's operating kind of with both hands here, squeezing banks from the left and the right. And then a third hand emerges, a helping hand, and try to help them when they get into too much trouble. It's an extraordinary amount of power and responsibility in one institution. But anyway, but that was a little rantish. But going back to your point about how this term loan facility will work, with this facility, the Fed is saying you can post collateral such as treasury bonds, and we will value them at par, which means basically 100 cents on the dollar rather than a lower market price. So if this had been available to SVB a month ago or just a couple weeks ago, SVB would not have had to sell its treasury bonds at a loss in order to cover its depositor run. Once it was announced it was doing that, the depositor said, oh my goodness, uh it didn't hedge this risk, and so we better pull out more money. So it backfired. Instead, SVB could have just taken those bonds, put them to the Fed, and borrowed 100 cents on the dollar of them, then it would have the cash it would need to pay the depositors. Once the depositors saw that the money was being paid back in full on demand, and there was no losses being reported by SVB, probably the run would have stopped them. So that particular scenario is now less likely because this facility is in place. Again, what we have here is regulators reacting to a manifestation of market risk and trying to opt that down. Sometimes it works, but will they be ready for the next risk manifestation? But anyway, that is the facility that has been put in place to try to prevent other banks from suffering the same fate.

SPEAKER_00 42:55

And do you think most banks will take advantage of it?

SPEAKER_02 42:57

To the extent that they need to, yes. They do have to pay interest on it. It's not a gift of cash. It's not the same as the Fed buying those bonds at par, where then you just have the cash. That's what the Fed does when it's lowering interest rates. That's called quantitative easing. This is kind of like quantitative easing by different terms, by another name. Now you may think, well, certainly it needs another name because quantitative easing is the least intuitive term anyway. I mean, I would like that sounds like extremely unpleasant or whatever it is, but it has a similar effect. The Federal Reserve is, for the short run, taking treasure reserve debt, taking it onto the Fed in exchange for cash that's going out there. So to the extent that other banks are facing similar pressure, certainly they will do that, use the facility rather than liquidate positions. We don't have data yet on how many banks are taking advantage of this and in what numbers. There's a final irony here. Of course, to the extent that banks do that, it's inflationary because now more money is being put into the economy in exchange for a pledge of collateral of treasury bonds. And the Fed has been trying to fight inflation recently. And so there's some sense of where. You know, the Fed can only fight inflation until banks start breaking and then it has to stop.

SPEAKER_00 44:05

And I I've heard a lot of commentators say this whole debacle will be deflationary, deflationary. But it sounds like maybe some of the measures the Fed is putting in place won't be so.

SPEAKER_02 44:13

It's definitely true that a widespread bank run is deflationary to the extent that does occur. As people pull their money out of banks, if this were happening on a broad scale, which it doesn't seem to be happening now, then banks would have less money to lend out. And so they would not renew loans or they would call them in loans to the extent that the loans they could call in loans. So the ability for banks to effectively increase the money supply, the amount of money that's available. So when a bank, for example, this is how banks create money. When a bank makes you a loan, usually you don't ask the bank for the cash. Usually the bank says, here, open up a checking account and we'll just credit it, right? And let's say they make it makes you a loan of $1,000. The bank doesn't then add $1,000 to its reserves. It may keep a small amount of that in reserve, but the rest is just there in a checking account, which also could be run upon. And so it's called the money multiplier. Banks can pyramid additional, what's called banking money on top of central bank money. Central bank money or Federal Reserve money is cash, currency, and also deposits at the Federal Reserve. But then banks add additional amount by creating checking and savings deposits that are in excess of those amounts. When they are making loans, when money is plentiful and depositors are safe, that tends to even more increase the amount of the money supply. But then when depositors start pulling money out, the money multiplier starts working in reverse. It's called the money divisor rather than the multiplier. Things are getting smaller very rapidly. That certainly is deflationary. It causes prices to fall because there's less money in circulation. The Fed also doesn't want deflation because deflation would greatly increase the interest rates that the federal government has to pay on its treasury debt. And we already know that there is more than that than probably will ever be repaid in full. So deflation is a nightmare for the Fed. So it's doing everything it can to stop that. It right now wants disinflation, meaning get inflation down from high levels like 10% and 6% to maybe a more politically acceptable level like 2%, but it doesn't want that number to go negative. And certainly widespread bank runs could push it into negative territory.

SPEAKER_00 46:18

Okay, so deflationary means we're going into negative territory. Disflation means we're getting to a number that we're disinflated.

SPEAKER_02 46:24

Disinflation. Yes, yes, yes. Well, strictly speaking, deflation refers to falling prices. Now, when you say something is deflationary, you simply mean that it's pushing prices down. But sometimes people want to distinguish between deflation, a situation of falling prices, and a situation of disinflation, where inflation is still occurring but at a lower rate than it was before. Got it. So that's technical kind of Fed speech.

SPEAKER_00 46:50

A lot of jargon.

SPEAKER_02 46:51

A lot of jargon. That's right.

SPEAKER_00 46:53

All right. So you spoke before about how the equity holders of these banks will be left out to dry. They're not going to be saved by Uncle Sam.

SPEAKER_02 47:00

There's no indication that they're going to get anything.

SPEAKER_00 47:02

Are we going to see shareholder lawsuits? And if so, on what basis?

SPEAKER_02 47:06

Yeah, we might. I think that's entirely possible. Now it's going to be a little bit tricky, but there is a corporate law, uh, and it also applies over into banking law to a certain extent, doctrine whereby a board of directors is supposed to monitor a company or a bank, its operations for risk. The main risk that monitoring is supposed to prevent, and the type that if the risk manifests because of a lack of monitoring, it can lead to a shareholder lawsuit alleging that the directors of the company failed to they breach their fiduciary duties, is for risk of from illegal activity. So let's say that people in the bowels of the bank were engaged in outright fraud, and then that caused the bank to suffer losses. Yeah, then shareholders might be able to bring successful lawsuits against the board of directors to saying, look, you're supposed to monitor to prevent fraud and other criminal activity in the bank. To the extent that you didn't do that, you have to compensate the bank or the corporation, depending on what we're talking about, for those losses. A wrinkle here is that it may not be that SVB was doing anything that was illegal. We'll have to see. It looks to me that most of what was going on was just stupid, not illegal, a failure to monitor risk. If there was a nine-month period last year where SVB did not have a risk management officer at all, the position was vacant, right? Now, maybe an argument could be made. This is actually kind of, you know, you got my corporate law uh professor juices kind of flowing. I've been thinking so much from the finance and banking side, but maybe an argument could be made that having no risk manager in place. It's in and of itself. Well, right, it's so egregious that it's in bad faith and so is a breach of fiduciary duties. That is entirely possible. Courts might entertain that. Uh, so we could see some creativity there. So whenever you're talking about businesses and boards of directors specifically making decisions, there's a general protection of the business judgment rule. It's hard to overcome, as the plaintiff, the business judgment rule, which is a deferential rule that favors directors and lawsuits in the absence of egregious or illegal activity. That may not be able to be shown here, but you never know. We're going to learn more about what was going on at SVB and also signature in the in the weeks and months ahead. I know there's already been lawsuits filed against parent company of SVB, alleging, I think false disclosures, false disclosures are fraud. Uh, that is actionable. Also to the extent that there was insider trading going on.

SPEAKER_00 49:24

Yeah, what do you make of that? Do you think there is anything there?

SPEAKER_02 49:27

I think that it's possible. It's something you have to look into, right? If a company's senior managers see that the company is going down or is in trouble and start dumping the stock, that is trading based on inside information. Now we have to be careful. People noted that in the weeks leading up to the failure, the the officers were selling stock, but officers of companies sell stock all the time. There are certain mechanisms that are in place under SEC-issued rules that make that permissible. So just because they were selling doesn't mean they were selling in an illegal way or selling in anticipation of a failure. They are allowed to periodically sell off their holdings in order just to raise cash and diversify their own portfolios. So it's certainly something worth looking into. Whether it will rise to the level of illegal activity, we will find out. But will there be litigation here? Definitely. Will it be successful? Let's see.

SPEAKER_00 50:12

What about claims against KPMG, which apparently gave both SVB and signature clean bill of health weeks before the collapse?

SPEAKER_02 50:22

Yes. So so far, this type of lawsuit has never been successful. So we saw the rating agencies back in 2008 giving triple-A ratings to subprime mortgage bonds that ended up being completely, I don't want to say completely worthless, but they were not AAA. They were risky, and for a while they were effectively worthless because there was no market for them. The whole market froze up. So, and there were no lawsuits brought successfully against those rating agencies. For the law to let rating entities, and it could be a rating agency like Moody's, or it could be someone who's a bank and stock analyst, like people maybe at KPMG, to make them liable for inaccurately uh rating companies, I actually don't think is a great way to go here. It stifles communications. For all we know, people there honestly thought what they were saying was true. And so they weren't engaged in any deliberate fraud. They may be incompetent or they may have made a mistake. And by the way, that's not the same thing, right? Sometimes you miss something. It doesn't mean you're generally incompetent. At least I hope not, because I miss things all the time. And so then you will probably just end up in the future not getting ratings at all if they can be held liable. Because remember, if they're right, it's not like they get a lot of profit on the upside. You know what I mean? It's not like the investor say, oh, you were right. You said this was a buy. So I bought based on your advice, KPMG. I made a million dollars, and here I'll share it with you, right? So to say that the investor keeps all the money when the rating proves to be accurate, but the rating agency is the insurer of the investor when the rating turns out to be too rosy is a recipe for bankrupt in an industry, and they'll just go out of business. So I think there the law will continue to apply the normal rules of fraud, which is unless you are intentionally misleading people and they're relying upon what you're saying, and their reliance is reasonable, then otherwise you basically have a right to say what you want. It's a kind of uh ultimately a free speech principle.

SPEAKER_00 52:11

So I want to hear what you think will happen to Silicon Valley Bank and to signature. We saw last week HSBC buy the UK arm of SVB for one pound. Yes. So I'm wondering if you think that there will be someone who will come in and buy SVB. And I know there are considerations about making giant banks and things like that.

SPEAKER_02 52:30

So do you think making giant banks?

SPEAKER_00 52:32

Yeah, yeah. Oh, about consolidation. Consolidating, yeah, exactly. Emerging with a much bigger bank.

SPEAKER_02 52:37

Right. So just to be clear, the purchase that you saw in England for one pound of the SVB subsidiary, that price is so low because the buyer is also assuming the responsibility for the liability, for the deposits and the other liabilities as well. And so that's basically saying we think the equity value is a dollar. Now, if it turns out to be more than a dollar, that's a great investment, right? But the SVB, it's a little bit different because there, most of the liabilities are going to be taken care of by the government. And so we're not now just talking about somebody buying just the assets of the company. So it will be a lot more money than that. But of course, if you're buying assets that are not connected to liabilities, they're worth more. So you're willing to pay more. And yes, there are already people looking at the balance sheet of SVB and saying, well, there is some value here. There are business loans, some of which are good, maybe many of which are good. There are US Treasury bonds here, which, as you said, are risk-free in terms of payment default, right? So there is some price at which those assets are going to be a good buy, a good deal, and they will be purchased at that price. Whether we will have consolidation in the banking industry is not depends on what happens more with the deposits. Will the buyer be required to take on the deposits as well? I think the answer probably is no. You take it, you walk away, you know, you don't have any liabilities associated with it. But the notion that that's not going to, if going to lead to consolidation in the banking industry, I think is ultimately something that isn't true. And it's going to happen anyway, because all of these depositors are going to start banking somewhere else now, even if they are not banking with whoever buys SVB, the SVB successor entity, right? So if you are Roku, for example, now you have your $40 million out of your checking account or your corporate transaction account paid back, well, you're going to put that in another bank, right? So the bank's going to pick up that anyway. We will have one fewer banks. And I would think that Roku would not only put it with, would do two things. First of all, would put it in a big bank that is too big to fail, so they don't run this risk again, and also spread it out amongst many big banks. The too big to fail phenomenon tends to lead toward market consolidation naturally. Of course, you're going to have fewer banks if the big ones are at a competitive advantage to the small ones. So again, our government policy is kind of of two minds. We create these backstops that do favor the larger banks. If SVB had been one-tenth the size that it is, it probably would not have been enjoyed this type of bailout. So that puts pressure on the market to consolidate and get bigger. And then we have the FTC and the Department of Justice Antitrust division saying, no, no, mergers are bad. We want to keep things small and so on. Again, this is a squeeze on the banking industry with two contradictory or countervailing signals, pressures coming from the government.

SPEAKER_00 55:24

Very true. Very astute observation.

SPEAKER_02 55:26

Oh, thank you. I convinced you earlier that we need to stop subsidizing fractional reserve banking. And that's one more vote. I know that you're a diligent voter. So the next time, you know, find some politician. Good luck with this, by the way, that wants to eliminate federal subsidy for uh fractional reserve banking and vote for that politician. Trevor Burrus, Jr.

SPEAKER_00 55:44

Right. Or that can explain it in an exciting way every time he gets on the uh behind the podium. Yes. Okay. Impossible to do. No, of course. You can't even say it without the reason. Fractional reserve. No, no, it's narcolepsy mid-phrase. That's right. Yeah. Okay. Million dollar question. Contagion. That's so much money these days. Well, all right. Let's make it $202 billion question. Which wasn't that how much SVB had in the deposits? Okay. Yeah. $202 billion question. Contained versus contagion. Is SVB the canary in the coal mine, or is this going to be contained? What is happening abroad? Okay.

SPEAKER_02 56:20

So there's a couple of different factors here. So far this week, we haven't seen contagion. So there was on Monday the stocks of other regional banks. First Republic was the one that seemed to have its kind of that laser pointer dot on its forehead when you know you're about to be assassinated in the movie. You know what I mean? It seemed the market had kind of, you know, or the crosshairs is the old way to do it, but now it's just that pinpoint dot on your forehead. You don't even see it. So the market had one of those on First Republic's forehead, but it didn't pull the trigger. The stock fell, but then the depositors didn't run on First Republic.

SPEAKER_00 56:53

And so the And tell us about halting trading. That happened also last week. They halted trading in a lot of people.

SPEAKER_02 56:58

Yeah, so there's two ways that trading can get halted. One is just a very temporary for a few minutes because there's a mismatch between people who want to sell and people want to buy. And so the market makers, the people who just work in the exchanges and they match buyers with sellers, they can't do their jobs. So some confusion and mistakes can be made in a situation of a mismatch. So they'll say, let's suspend trading for five minutes or maybe up to an hour in a critical situation. Yes, that can happen when there are big swings in value, usually downward. Then there's can be a permanent suspension of trading when you file for bankruptcy. So because otherwise people may not know that they're buying the stock of a bankrupt company. And by the way, sometimes the stocks of bankrupt companies turn out to have some value. It's hard to get on the exchange. So certainly SVB, anybody else who ends up receivership or bankruptcy, that's a permanent suspension of trading. Some of these regional banks may have experienced, I didn't notice this actually, but I'm taking because you're asking that it would happen and it makes sense that when they have these precipitous drops in value in a day, there are temporary suspensions of trading. It helps the market makers and sometimes regulators also think it's a little bit of a speed bump, just giving people five minutes to catch their breath. It's just full-blown panic, full-throated panic that's going on. But the market recovered a bit for these regional banks. The depositor runs did not show up at these banks on Monday. It seems like it's continuing to have a certain amount of stability. Will the new regime hold, right? Or will the dam hold, or will it burst somewhere else and water start flowing out again? There's a couple of reasons to think that that is still a risk. First of all, the Fed is going to go back to raising interest rates. Inflation is still too high. And so we are going to continue to have pressure on banks. Also, it's worth noting that this bailout for the depositors at SVB and Signature has not been offered yet to the banking system as a whole. So some people think, oh, and I've even heard some people say this, some commentators, and it may have just been a shorthand, they say, oh, the Fed lifted the FDIC or the FDIC lifted the insurance limit. That's true for the depositors of those banks. For all of the rest of us with our money elsewhere, it's still in place. And so if you have a lot more money in a bank and you think the bank is in trouble, you're going to say, well, I'll just leave it there because probably the federal government will give me the same deal in case this bank fails. Do you want to run that risk? Even if you're 90% sure that the government will do it, why take that 10% chance when you could get wiped out? And so because uh we still have for everybody else the old insurance limits in place, and because the underlying pressures from a shrinking money supply to try to fight inflation are still there, I think it could happen again. Banks are certainly now looking at their diversification, they're buying swaps to try to interest rate swaps to try to protect themselves. So it's probably less likely, but we're not completely out of the woods. Whether this is going to spread overseas, is that the other thing you want to talk about?

SPEAKER_00 59:43

Or just I don't know if you have a sense of how people abroad are looking at and thinking about what happened here last week.

SPEAKER_02 59:48

Yeah, so people abroad are very interested in this. I did an interview this morning, Al Jazeera English. It's not called English because it's based in England. It's actually basic guitar, but it's in the English language. And I was the only American there, even though all they wanted to talk about was the American banking failures. There is the another person who was an Englishwoman on the call or on the interview, and then a third person was German. Why do they care? Well, they care because they know that their central banks, the Bank of England in the United Kingdom or the European central bank in the Eurozone, they follow the Fed's lead on interest rates very much. So when the Fed raises interest rates, they often feel pressure to do the same thing. Otherwise, you have an imbalance and all the money is sucked out of Europe and England and into the United States, and that creates inflation in those zones. So often their central banks have to follow the Fed's lead. And so if they say, well, if it was Fed policy in raising interest rates that caused these banks to become rickety, or maybe they were already rickety and then ultimately caused them to capsize, and then our central banks are going to, and already have been to a certain extent, but will continue to follow the Fed's lead in fighting inflation by shrinking the money supply and raising interest rates, something similar could happen here if we have banks that have similar portfolios that aren't fully diversified. So I'm sure that all in those countries as well, people are looking at the banks where they have their money and say, are you hedged against um interest rate risk? Are you overexposed to long-dated, they're called bonds, that's just bonds that mature in a long time, that are particularly sensitive to interest rate increases. So yes, it could happen there because central banks they don't explicitly coordinate all the time. Sometimes they do in a crisis. There's a follow-the-leader effect, and the leader continues to be the US Federal Reserve.

SPEAKER_00 1:01:30

Well, I do hope that next time we meet, we do not have to talk about a crisis or a catastrophe or calamity or anything like that. Really?

SPEAKER_02 1:01:38

Yes. This stuff pumps me up. Also, I don't have anything positive to say in those situations. You know what I mean? Yeah. I'm one of these vultures, basically. Like, you know, so I'd be out of work if it was nothing. Okay. You know, but yeah, so right.

SPEAKER_00 1:01:50

So we'll think of something. There's always something in this country.

SPEAKER_02 1:01:53

Yeah, there's something that's where there's something that kind of uh some people are panicking, and I can always come in and tell a story about how it's the Fed's fault. Exactly.

SPEAKER_00 1:02:01

Well, they do say people bond more easily over a shared hatred than they do over a shared like Yes, and a crisis and something that scares people brings them together.

SPEAKER_02 1:02:10

Were you in New York in 2001?

SPEAKER_00 1:02:12

No, I was not. I was in Boston.

SPEAKER_02 1:02:14

Oh, you were in college then, is that right? You were in Boston College. So I don't know to what happened to extended there, but New York City was never more friendly than right after 9-11. The sense of that we're all in this together. So there was, I mean, obviously that's a very dark cloud in American history a day, but there was a little bit that silver lining. You know, New Yorkers actually would say, Hey, how you doing to total strangers. And it didn't feel creepy like it would now, right? Like if that happened now, you would call the police. You would whip out your phone and tape the person and post it to TikTok and say, look at this creeper, right? Right. Back then, normal people were doing it. So it did bring people together. I'm not saying that I want massive bank runs and contagion just so that people on the street will be friendlier to me, but it would be a but it would be a silver lining.

SPEAKER_00 1:02:54

Well, there's no one better suited to come and talk to us and answer all of our burning questions. So I know you've been busy, you've been on TV and print and all that. So thank you again so much for coming and talking to us today. It's my pleasure. Anytime, maybe. All right, thank you. Thanks to everyone at Fordham Law School, especially the Dean's Office and our corporate law center donors for supporting this podcast. Bite-sized Business Law is produced by We Edit Podcasts. Listen and subscribe to Bite Size Business Law on Spotify, Apple, or wherever you get your podcasts. The information in this podcast is for educational, informational, and entertainment purposes only and does not constitute legal advice, nor is it intended to promote the organizations with which our guests are affiliated. For more information, check out our show notes, and thanks for listening.