The recent collapse of two midsize banks changed the Federal Reserve’s course of action on tightening monetary policy, but not necessarily in the way some market participants and observers expected.
Following its Federal Open Market Committee meeting Wednesday afternoon, the Fed raised its benchmark interest rate by a quarter percentage point, a more modest hike than was expected before the failures of Silicon Valley Bank and Signature Bank earlier this month. It also indicated that it would stop raising rates sooner than it previously projected.
Yet, Fed Chair Jerome Powell made clear that this slight change of course was not the result of financial stability concerns. Instead, he said, the committee felt it could pull back because the banking sector volatility that followed the failures served as its own check on inflation.
“The events of the last two weeks are likely to result in some tightening of credit conditions for households and businesses and, thereby, weigh on demand in the labor market and inflation,” Powell said. “Such a tightening of financial conditions, which would work in the same direction as rates, in principle … you can think of it as being the equivalent of a rate hike, or perhaps more than that.”
He noted that the precise impact of the episode will not be known for some time, and said the Fed will monitor the fallout and respond accordingly.
Powell reiterated the Fed’s belief that the banking system is “sound and resilient with strong capital.” He also emphasized that the two banks failed as a result of their own mismanagement, and were not emblematic of broader issues in the banking system.
“At a basic level, Silicon Valley Bank management failed badly,” Powell said. “As they grew the bank very quickly, they exposed the bank to significant liquidity risk and interest rate risk, [they] didn’t hedge that risk.”
He added that Silicon Valley Bank also experienced an “unprecedented” bank run of $42 billion in less than two days, which contributed to the uniqueness of its situation. And he noted that the Santa Clara, California-based bank had a concentration of depositors in the venture capital and tech worlds, saying that the coordination of those depositors in exiting the firm contributed to the institution’s downfall in a way that was not likely to be repeated.
Still, Powell said, the Fed and other federal regulators opted to take drastic measures in response to the two bank failures — including covering all depositor losses at the banks, even those above the Federal Deposit Insurance Corp.’s $250,000 cap, and rolling out a new lending facility for underwater government-backed securities — to prevent spillover into otherwise healthy banks.
“History has shown that isolated banking problems, if left unaddressed, can undermine confidence in healthy banks and threaten the ability of the banking system as a whole to play its vital role in supporting the savings and credit needs of households and businesses,” Powell said.
As he and other government officials have done repeatedly during the crisis, Powell committed to taking further action to quell concerns in and around the banking sector, if need be.
During the press conference, Powell briefly discussed the Fed’s ongoing internal review of its supervisory actions around Silicon Valley Bank, noting that his primary interest is in determining “what went wrong and why.” He declined to comment on what findings he expected to emerge from the review, which is being led by Fed Vice Chair for Supervision Michael Barr.
Powell did acknowledge that the episode was likely to lead to some reforms in how banks are monitored and capitalized, and said he will support whatever recommendations emerge from Barr’s review.
“I assume that there’ll be recommendations coming out of the report, and I plan on supporting them and supporting their implementation,” Powell said.
The Fed’s latest rate hike raises its target range to between 4.75% and 5%. The decision to hike was unanimous among the FOMC’s 11 voting members.
In its statement on the increase, the committee changed its forward-looking guidance from “ongoing rate increases will be appropriate to quell inflation” to an anticipation that “some additional policy firming may be appropriate.”
“We were trying to reflect the uncertainty about what will happen,” Powell explained. “It’s possible that this [crisis] will turn out to have very modest effects … on the economy, in which case, inflation will continue to be strong, in which case the path forward might look different.
“It’s also possible that this will contribute significantly to tightening credit conditions over time and, in principle, that means that monetary policy may have less work to do,” he added. “We simply don’t know.”