The Fed needs to stop raising rates now, former FDIC chair says after Silicon Valley Bank failure

Before Friday, investors were anticipating a major interest rate hike of a half percentage point at the Fed’s March 21-22 meeting. Bair said a hike of that size would not be “well advised” given the Silicon Valley Bank collapse.

Similarly, Goldman Sachs told clients late Sunday that “in light of the stress in the banking system,” the bank no longer expects the Federal Reserve to deliver a rate hike next week. Goldman, however, still expects rate hikes of a quarter point in the Fed’s May, June and July meetings, though it added there is “considerable uncertainty about the path.”

To fight inflation, the Fed has aggressively lifted interest rates at a pace unseen since the early 1980s.

Those interest rate hikes have contributed to the collapse of Silicon Valley Bank in at least two key ways.

First, higher borrowing costs rocked the frothy parts of the US economy, especially the tech industry that Silicon Valley Bank catered to. Secondly, the Fed’s rate hikes undermined the value of the Treasury bonds that banks rely on as a central source of capital.

“When money gets tighter, financial assets lose value. That has to be carefully managed,” said Bair, who led the FDIC during a wave of bank failures during the 2008 global financial crisis.

As of the end of last year, US banks were sitting on $620 billion in unrealized losses (assets that have lost value but haven’t been sold yet), according to FDIC data. Those assets could lose further value if the Fed keeps raising rates.

Silicon Valley locked $1.8 billion of losses on bonds it held last week as it rushed to sell securities in a bid to shore up its balance sheet.

But news of the need to raise cash spooked customers, many of them tech startups. They panicked, yanking $42 billion last Thursday alone when Silicon Valley Bank’s stock crashed by 60%, according to filings by California regulators. By the close of business that day, Silicon Valley Bank had a negative cash balance of about $958 million.

“This was a bank run,” said Bair. “From what I can tell, the assets are good quality, if held to maturity. But, humans are humans.”

The worry is that bank customers and investors could start to back away from other banks perceived to be the next weakest links. That’s why the US government stepped in with an extraordinary rescue plan Sunday to ensure customers were made whole.