BU Today: Are circumstances materially different from the 2008 financial meltdown, such that we’ll avoid a broader financial crisis?

Guren: Yes. They’ve weakened Dodd-Frank, but one of the things Dodd-Frank did is, all the banks have living wills, so that the federal government can take them over [if necessary] and unwind them. I like to think of 2008 as a run on the shadow banking system [financial institutions that acted like banks but without banks’ regulation]. In 2008, we didn’t have the information on this stuff. Now the Fed has a lot more information and can unwind things. 

I also think the main difference is the collateral that the banks are holding is US Treasuries, and [in 2008] it was mortgages that were foreclosing. I don’t think we need to worry about US Treasuries not being fundamentally good collateral. The person who essentially created the field of central banking, Walter Bagehot, an editor for The Economist in the 1860s and 1870s, had this dictum: [central banks] should lend freely at a high rate of interest, on fundamentally good collateral, to banks. That’s been the guiding light for central bankers in these sorts of crises. In this case, the collateral is fundamentally good: it’s US Treasuries.

Hurley: Yes, I think so. Number one, the banking industry itself—that’s why I think this was overkill—is materially better off today in terms of capital, liquidity, and stress tests. Point two is that the crisis of ’08 was largely a credit crisis. This is a balance sheet crisis. [The 2008 crisis] was all about subprime [mortgages] and shadow banking and not being able to determine the value of subprime assets [banks held]. That was more systemic. This, I believe, could be more contained. Silicon was an outlier. They had well over $100 billion of uninsured deposits that they turned around and bought 10-year Treasuries with. There aren’t many banks as vulnerable as Silicon was.

Williams: Yes. The big difference is that banks failed [in 2008] because of bad loans and poor credit underwriting. By the time the Great Recession ended, over 600 banks failed. Today’s banking crisis was triggered by bad risk management practices around deposit management and interest rates. Each of the failed banks focused on a risky, concentrated customer segment, quickly grew deposits, converted these funds into loans and bonds when interest rates were low, and assumed interest rates would not quickly rise.

Based on this array of flawed assumptions and mismanagement, each bank put billions of funds to work, some in loans and others in bonds. Most of these investments were made at lower interest rates. As inflation increased, by 2022, interest rates skyrocketed and these longer-term loans and bonds lost market value. The Achilles’ heel was that these banks never thought their concentrated customer base would ever fall on hard times or as depositors stampede for the door. It was also as if they took it as fact that depositors would always keep their monies at the bank, even if in excess of FDIC insurance limits.

BU Today: Are the reforms made back then, like the Dodd-Frank Act, and the Biden administration’s current efforts enough to address this problem?

Guren: I think yes. There’s a chance that everybody still freaks out and pulls their money out of these banks, despite essentially guaranteeing deposits. But if a lot of businesses pull their money out, I think [the government] is going to step in and allow the banking system to consolidate [into fewer, bigger banks]. There’s a big policy question, which is, “Do we want the banking system to consolidate?” I don’t have an answer right now, but regulators and politicians need to ask themselves, is that something they’re OK with?

What am I concerned about? One, if this does get out of hand, can the US Treasury do what it needs to do if it’s backed up against the debt limit [which some House Republicans are opposed to raising]. I am not underestimating the ability of Congress to do this under the gun, but that’s one concern. The other concern is we still have an inflation problem; does this give the Fed concern about raising rates? My sense is probably not, but maybe it does. 

We need to figure out what went wrong with the regulators here and increase deposit insurance. Because obviously, $250,000 just isn’t cutting it. The areas in which [Dodd-Frank] has been watered down is to limit the extent of regulation on small to medium banks. To the extent that everybody’s concerned about the contagion to smaller banks, those are precisely the banks that we’re not regulating as toughly.

Williams: The 2008 financial crisis demonstrated the need for stronger regulation to prevent banks from engaging in excessive risk-taking. After Dodd-Frank was passed, it was watered down under the Trump administration. One area that changed was in defining what banks would receive the highest oversight, designated as Systemically Important Financial Institutions. This important threshold was eventually moved up to only include the biggest banks, with assets of $250 billion and above. 
 
In 2023 it is clear that watering down Dodd-Frank was a bad policy decision, as Silicon Valley Bank, at $210 billion, and Signature Bank, at $110 billion, clearly were systemically significant banks that should have been more closely scrutinized.
 
The Biden administration policy of adding additional [government lending to] banks to buffer against future bank runs is a helpful first step. As is charging banks higher FDIC fees to pay for insurance needed to help defer the cost of those banks that fail. Hearings to better understand why these banks failed so rapidly will also help in developing future preventative measures. Most importantly, the president made it clear that stronger bank regulation over risky bank behavior would be put in place. In essence, some of the holes in Dodd-Frank would be sealed up.
 
One additional reform idea—banks should be required to maintain greater capital levels, not just based on the amount of credit risk, but also on the amount of interest rate risk they are willing to take.

Hurley: They weakened the Dodd-Frank regulations in 2013, ’14, ’15 that allowed this to go on. I think we need to read those regulations and where they need to be strengthened. The problems were there lurking in plain sight, and it was a problem of the regulators more than a problem of the regulations. I’ll give you a concrete example: There’s an agency I’ve been writing about, the Federal Home Loan Bank system. It loans to banks and insurance companies. Silicon Valley, at the time that it failed, had $20 billion in advances from the Home Loan Bank of San Francisco. That’s crazy high. It was the largest borrower from the Home Loan Bank of San Francisco at the time that it failed. It also was the largest borrower six months ago. That was a canary in the coal mine. What the regulators should have done is look at that level of borrowing back last summer, go into the bank, slap a cease and desist on them, fire many of the executives, and say, look, you have 90 days to raise capital. If you can’t, find a merger partner.