[Prefatory Note: This post questions the ability of the Fed, the bankers, and the regulators to understand what they are doing. As a caveat, lest there be any mistake, it is conceded they are far smarter and know much more than I do. So, this post should be understood as a question and not as an answer]
Banks take in deposits and lend them to make money. The spread between what they pay for the deposits and what they charge for the loans is one component of their profit and financial/capitalization status. Another component of their profit and financial status is the investments they make on the revenues and deposits they receive. Supposedly not wanting to take undue risk, the regional banks invested a substantial portion of their revenues in treasury bills. Well that's not quite right: They certainly were not taking any default risk but they were taking on interest rate risk, i.e., if interest rates went up on their holdings, the market value of their holdings would decline (even to the point of cratering). In retrospect, these bankers either did not know or did not care about the interest rate risk their holdings were subject to. In either event, these bankers had no business running the banks.
The Fed has a dual mandate of maximum employment and price stability. When inflation becomes a problem, price stability becomes the Fed's primary focus. The major tool they have is to raise interest rates, which has the effect of raising the cost of borrowing and thereby reduces borrowing and depresses demand, which tends to cause a recession that cools inflation. In retrospect, the Fed either did not understand the regional banking system's reliance on treasuries for their capitalization and hence did not understand what raising interest rates would do or they did not care. In either event, once it became clear to the Fed and everyone else that the banks would be taking over the Fed's burden of tightening credit which would reduce borrowing and depress demand, the Fed appears on the verge of changing the "higher interest rates for longer" course it announced just a week before the regional banks began collapsing.
The regulators' job is to see bank problems before they become crises. Again, in retrospect, they either did not understand the interest rate risk regional banks were taking on their capitalization or they did not care. In either event, one has to wonder what the regulators think their job was or whether they even showed up for their job.
Finally, what is so amazing about what's happening is that interest rate risk is not some esoteric, arcane, black swanish thing. It's something everyone who holds a bond or a bond fund or a cd or any fixed income asset knows about. As Holmes would say, it's elementary. What also is elementary is how little it takes to have a run on a bank (or all banks). What would you do with your money in a bank if you thought it did not have the capital to give it back to you if you waited to ask for it? When the Fed and Treasury lifted the FDIC limits for SVB depositors, and are now considering upping the FDIC limit across the board, you can be certain they understood exactly what a run on a bank is.
[EOP]
