Zongyuan Zoe Liu
Bank failures in the United States happen more often than one might think. According to the Federal Deposit Insurance Corporation, there have been 563 bank failures in the United States between 2001-March 2023, or about 25 per year. The fall of the sixteenth largest bank, the Silicon Valley Bank (SVB), is another piece of evidence for Minsky’s financial instability thesis—more about that in a bit. However, the timing of SVB’s collapse could not be worse. As the Joe Biden Administration focuses on winning the great power competition between major strategic rivals, the last thing America needs is the perception of a weakening U.S. financial system.
About fifteen years ago, Washington Mutual’s implosion and Lehman Brothers’ collapse sent shock waves across the global financial system. As economists and investors worldwide tried to make sense of the market turmoil, they discovered the work by Hyman Minsky, a financial economist described by his colleagues as “radical as radical, if not crackpot.” Minsky disbelieved the mainstream efficient market theory and devoted much of his career to developing the Financial Instability Hypothesis. According to Minsky, financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crisis.
The fall of SVB is not exactly a “Minsky Moment” in the U.S. financial system because the bank’s forced asset sales were caused by the flight of depositors rather than the bank being over-leveraged. However, the affair sends a clear reminder that the combination of a lack of risk management and weak regulatory oversight is a toxic brew that can overflow quickly. Still, much information is needed for the general public to understand why SVB’s management made such fundamental mistakes. SVB failed to reduce its enormous interest rate risk while the Federal Reserve loudly communicated that rates were on an upward trajectory. The collapse of SVB is a sobering reminder that during the low-interest rate environment of the last decade, there has been a buildup of asset-liability mismatch and duration mismatch on the books of many U.S. financial institutions. For U.S. policymakers, the fall of SVB is a reminder that the erosion of financial oversight and the resultant financial instability has the potential to decrease the attractiveness of U.S. financial markets, which may eventually cost the United States its privileged position in the global financial system.
The timing of SVB’s implosion complicates the Fed’s fight against inflation by straining the market’s belief in the Fed’s commitment to tame inflation by hiking interest rate hikes much further. The fall of SVB adds to a series of recent financial scandals, such as fraud at FTX and misused PPP loans. These events diminish the image of the U.S. financial system when there are already big doubts about America’s financial governance capacity at home and its ability to wage financial statecraft internationally.
The fall of SVB has much to do with its astonishing lack of risk management as the collective lobbying of the financial services industry to erode financial regulators’ supervision capacity. A 2011 paper published by the National Bureau of Economic Research found that lobbying activities by financial institutions played a role in the accumulation of risks and contributed to the 2008 global financial crisis. Under the Donald Trump Administration, some of the most hard-fought rules meant to prevent another spate of bank collapses were rolled back, marking a significant victory for the intense lobbying efforts of the financial industry. Under the Dodd-Frank Act, the tighter capital and liquidity requirements known as “enhanced prudential standards” were applied to all banks with consolidated assets of $50 billion or more. Almost as soon as the rules came into effect, smaller banks began to lobby for an exemption. In 2015, SVB President Greg Becker submitted a statement to a Senate panel pushing legislators to exempt more banks — including SVB — from the tighter oversight rule. In 2018, the lobbying paid off, with former President Donald Trump signing into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), which raised the asset threshold for enhanced oversight to $250 billion. Such regulatory loosening due to lobbying was why Sen. Elizabeth Warren (D-MA) drew a straight line from the 2018 deregulation effort to the 2023 failure of SVB.
While the U.S. government under the Trump Administration focused on easing financial regulation, China was engaged in exactly the opposite. Chinese leaders have become highly aware of the importance of financial security to national security since the 1997 Asian Financial Crisis. President Xi Jinping, in particular, has prioritized financial security and has vowed to strengthen the party-state’s financial governance and regulatory capacity. Since he came to power in 2012, he has implemented a series of policies aimed at tightening the state’s supervision over China’s financial markets and institutions. Most recently, the state launched a new State Administration of Financial Supervision (SAFS) to strengthen state oversight of the nation’s financial system and reduce risk at subnational levels. Creating a centralized SAFS is the latest evidence that Chinese leaders are committed to strengthening financial regulation to safeguard China’s financial stability in defense of volatility in global markets and international geopolitical tensions.
A healthy and stable U.S. financial system is a prerequisite for the Biden Administration to realize its proposed industrial policies. Recently, U.S. lawmakers have expended both their time and energy devising a new outbound investment screening regime and improving the existing inbound investment screening effort. These aim to prevent U.S. capital from funding foreign research and development in strategic competitor countries while also denying those countries the ability to invest in strategic industries in America. However, an investment screening regime is rendered obsolete if U.S. financial markets lose their attraction due to the perception of not being safe due to excessive financial deregulation. Not all deregulation is bad, and it should be welcomed when it means improving market efficiency and strengthening financial stability and security. However, if deregulation means debilitating financial regulators, creating market inefficiency, and debasing U.S. financial stability, then the Biden Administration and U.S. lawmakers should strongly guard against it. Another round of financial crisis brought about by deregulation will severely lessen the appeal of U.S. financial markets and assets, including Treasury debt. The weakening of U.S. financial leadership will decrease the ability of the United States to exercise financial statecraft. The fastest way for the United States to cede ground in the present era of great power competition is to debase its domestic financial system and relinquish its global financial leadership position.
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