Silicon Valley has been dominating the news this week. The obscenely badly managed Silicon Valley Bank went belly-up, its hundreds of billions of dollars of deposits, much of it banked by start-up companies, put at risk. As a result, California’s tech industry, already retrenching as the economic climate has shifted, suddenly faced the real possibility that many of its most creative young companies would be unable to pay their workers come mid-month and would accelerate rounds of lay-offs that are already causing havoc in the industry. In the last year, the tech industry has shed over 200,000 jobs, with layoff rates accelerating in 2023. Meta alone has, in a series of layoff announcements, now slashed more than 20,000 people from its payrolls.
So worried was the Biden administration that SVB’s malfeasance would create a cascading series of bank runs that could upend the global economy that over the weekend it crafted a rescue package to fully guarantee, above and beyond the FDIC limits, all deposits at the failed bank. This didn’t really work: After a short market rally on Tuesday, bank stocks began sliding again on Wednesday, with such large declines in major European banks that stock market tripwires temporarily stopped trading in their shares. There’s now a real risk that market insecurity and a collapse in confidence in the banks will trigger credit flow problems, as banks hoard cash to weather potential bank runs that could create the sort of deep recession that policy makers have worked to avoid since inflation began rocketing upward two years ago.
There is, of course, as always happens when large financial institutions fail, more than enough blame to go around.
One can blame politicians, of both parties, who succumbed to the lure of the bank lobby and weakened the guardrails put in place after the 2008 debacle precisely to limit the possibility of banks taking on more risky investments than they could safely handle. Scandalously, one of the biggest advocates for weakening the regulations for midsize banks was Democratic ex-Representative Barney Frank, who apparently went from being the principled coauthor of the Dodd-Frank regulations, which sought to hem in banks after 2008, to being a shill for Signature Bank—the other financial institution to go under this past week.
One can blame SVB’s grotesquely well-remunerated board members, who seem to have taken the unfathomably stupid decision to invest most of the bank’s money in bonds that if interest rates were ever to rise, would instantly lose a large part of their value. It’s hardly rocket science to understand the importance of hedging investments so that if one set of economic conditions shifts, your entire bank doesn’t suddenly keel over. Yet, apparently, no one at SVB—none of those executives paid millions of dollars per year, and given huge bonuses for the short-term profits they were able to accrue—caught the flaw in their strategy until it was too late to do anything about it.
One can blame the Biden administration for turning a deliberately blind eye to the inflationary pressures building within the economy in 2021, hoping that it would magically cure itself before painful economic interventions became necessary.
But perhaps above all, one can blame the Federal Reserve, the leadership of which, after 2008, kept pumping cheap money into the economy for years beyond, when they should have gradually eased back on the process. As a result, interest rates tumbled to historic lows and house prices, buoyed by the low interest payments on mortgages, rose to historic highs—creating an unsustainable bubble that nobody wanted to risk bursting. Then, after ignoring inflation for more than a year during the supply-chain disruptions unleashed by Covid, the Feds suddenly went into reverse, desperately using the one main weapon they have against inflation—interest rates—to try to tamp down an overheated economy.
Suddenly, Federal Reserve Chair Jerome Powell and his team, who had done nothing to ease inflation back when it was a more manageable problem, decided that the hoped-for 2 percent annual inflation rate was a rigid number that had to be achieved, at speed, no matter what the collateral consequences were. With one historically large interest rate hike after the next, the Feds have tilted at this particular windmill; no matter that today’s inflation rate is at least in part a psychological reaction to the unprecedented two years of lockdown the world experienced—to people wanting to spend, spend, spend, as a way to obliterate the memories of despair and isolation.
Powell and his colleagues, so single-mindedly focused on their 2 percent target, are unfortunately fighting the last war rather than the present one, using weapons that might have worked once upon a time but really aren’t particularly effective today. Their strategy assumes that, as interest rates rise, people pull back on spending. Instead, there seems to be such a psychological need to bury the memories of pandemic-era pain under mountains of consumer goods that the public is ignoring the higher interest rates and continuing to party like it’s 2019. Determined to beat sense into the thankless multitudes, Powell et al. just keep on raising interest rates further.
Last week, Senator Elizabeth Warren lambasted Powell for his publicly stated willingness to inflict pain on the economy, sacrificing what Warren estimated could be 2 million jobs, to achieve his 2 percent target. She might also have lambasted Powell for putting unsustainable pressure on the housing market—making it far harder for homeowners to sell homes, for buyers to buy homes, and for the construction industry to build homes; this in a country short more than 6 million homes, according to the latest estimates, and with hundreds of thousands of people homeless. She might, too, have called Powell out for such a relentless focus on inflation that he neglected to pay attention to the damage being done to the banking sector, where banks cumulatively holding trillions of dollars of deposits were caught holding long-term bonds, which they had been encouraged to buy during more than a decade of easy-money policies but which were suddenly devalued by the Fed’s relentless emphasis on increasing interest rates. Again, had the Feds begun raising interest rates sooner but done so at a slower, more manageable pace, this would have given banks far more time to unwind these investments, or at least to better diversify their holdings.
It’s unfashionable to criticize the Federal Reserve, which is, quite rightly, an independent institution intended to be walled off from political decisions and pressures. Yet time and again the Fed has shown itself to be peculiarly blinkered. Its awful decisions in the years leading up to 2008 created the worst meltdown in the housing markets, and, by extension, the financial system, since the Great Depression. Now, Powell’s ham-handed approach to inflation risks triggering a largely avoidable banking, market, and employment meltdown.
Warren was right to be scathing about Powell’s performance. Like Silicon Valley’s technology whiz kids, who have been so focused on unleashing superintelligent chatbots onto the world that they haven’t paid the slightest attention to the ethical consequences and the vast potential collateral damage that could be unleashed by ChatGPT and its ilk, so the Federal Reserve has developed tunnel vision when it comes to inflation.
Maybe we’re due to call a time-out. Take a break on developing artificially intelligent machines such as ChatGPT-4, released to such fanfare this week, that could render huge swaths of the workforce unemployed, and could end up turning malignant in their interactions with humans. And take a break in the efforts to, at all costs, achieve 2 percent inflation.
If the United States had hyperinflation, then yes, it would be worth all the pain to rein it in. But it doesn’t. The country currently has 6 percent inflation, with the core rates falling off again as post-pandemic glitches in the supply chain continue to ease up. Given that, is it really worth breaking the banking system, creating massive stock market insecurity, freezing the housing market, and creating high levels of unemployment simply to follow Powell’s diktat of once more reaching 2 percent?