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Four Questions about Failing Banks for WTO Chief Economist Robert Koopman

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Investors and regular people alike have become alarmed by recent banking failures and bailouts that feel eerily reminiscent of the subprime mortgage-sparked financial crisis of 2007-08. The twin failures of US regional banks on both coasts, Silicon Valley Bank in California and Signature Bank in New York, coupled with the fast-moving troubles of Credit Suisse, a global investment bank in Switzerland, have caused tremors in global markets and jangled nerves already frayed by persistent inflation.

To help sort out the facts from feelings, we turned to SIS distinguished practitioner in residence Robert Koopman. Koopman is the chief economic counselor and informal advisor on strategic and operational issues to the director general of WTO. Before joining WTO, he was the chief operating officer and director of the office of operations of the United States International Trade Commission.

The Biden Administration has taken pains to differentiate its moves to guarantee deposits at Silicon Valley Bank and Signature Bank from the 2008 bank bailout. Clearly, the scale is different, but what else distinguishes what we’ve seen over the last week from 2008?
The 2008 crisis was driven by poor quality, risky mortgage loans bundled into financial instruments whose real underlying riskiness was not well understood. Large amounts of these instruments were created and sold, and when their underlying values turned out to be much less than purchasers expected, it undermined the global banking system. The current crisis is not about poor loans being widely marketed and mispriced but about a number of small- to medium-size banks being caught holding relatively safe long-term bonds whose current market value fell because interest rates rose as the Fed aimed to slow inflation. As the value of those bonds fell, a number of banks that did not take precautions against interest rate increases found they did not have the required assets to meet withdrawal demands from depositors.
There’s been disagreement among Democrats about what or who bears responsibility for the failure of Silicon Valley Bank and Signature Bank. Some, like Senator Elizabeth Warren, say the 2018 rollback of Dodd-Frank opened the door for this, and others, like former Representative Barney Frank—the “Frank” in Dodd-Frank—say that a toxic narrative about cryptocurrency is to blame. In your opinion, what action or circumstance bears the preponderance of the blame for the failures of these two regional US banks?
The rollback of some of the Dodd-Frank regulations definitely contributed, as banks the size of Silicon Valley Bank and Signature Bank would have been subject to higher reserve standards and closer scrutiny. In the case of Silicon Valley Bank, the combination of their holdings of relatively safe long-term bonds, whose values fell as interest rates rose, and a sudden surge in unexpected withdrawal demands from large uninsured depositors—largely as a result of a panicked and perhaps unnecessary urging from certain depositors—caused the bank to stop allowing withdrawals and further spread panic across the banking sector.  
Credit Suisse saw plummeting prices for its shares last Wednesday, and the bank was planning to borrow $54 billion from the Swiss central bank to shore itself up. Swiss authorities ultimately arranged a fast-tracked takeover of Credit Suisse by Union Bank of Switzerland (UBS) on Sunday, March 19. In what key ways is the situation with Credit Suisse different from that of the two American banks that just failed?
Credit Suisse has had a long run of bad management decisions over the past few years, including fines and penalties from regulators for making illegal transactions. It recently had to announce that there were material weaknesses in its most recent financial reporting, further undermining confidence in the bank’s financial health. Silicon Valley Bank had a pretty solid record over the past few years. In addition, Credit Suisse had experienced a long-term decline in deposits as wealthy Chinese and Russian nationals withdrew large sums when Western sanctions were introduced on Russia for its invasion of Ukraine, while Silicon Valley Bank’s withdrawals were sudden. And while Silicon Valley Bank was a large regional bank, Credit Suisse is a large, global bank with operations around the world. Credit Suisse was adversely affected by the attention and potential panic caused by Silicon Valley Bank’s circumstances, but that was really a change in how critically investors and regulators were looking at bank weaknesses in general as opposed to a sudden change in Credit Suisse’s financial operations.
As a non-economist, it’s easy to see all this bad news about banking happening simultaneously and start to really worry. From your perspective as an economist, when you look at what has happened to these banks over the past couple of weeks, what, if any, immediate concerns do you have about the global financial system?
My main concern relates to what that famous economist John Maynard Keynes once described as “animal spirits,” referring to the emotional and psychological factors that drive human behavior, such as confidence, optimism, and fear, and how those spirits are hard for economists to predict and model. In fact, we often assume that people are perfectly rational and can make good financial decisions consistent with long-term outcomes. But as we see from things like banking runs and financial crises, even if the underlying economics are not that bad, people’s reactions to those circumstances can make the outcomes worse. This is why governments and regulators often feel the need to step in and intervene to calm those animal spirits. The irony is that those animal spirit-type reactions can cause businesses to behave in less risky ways, which is useful for the market. A number of observers are worried that recent regulatory responses to fix the banking system will create what economists call “moral hazard”: that it will convince businesses and investors that they can behave in overly risky ways because they will be “bailed out.”