Jill On Money: Bank failures put Fed in the hot seat

Federal Reserve officials were under fire as they convened their two-day policy meeting, during which they decided to raise short-term rates by a quarter of a percentage point to a peak benchmark range of 4.75% to 5%. Despite uncertainty in the banking sector, the Fed said that still-high inflation required action.

The rate decision, along with events of the previous two weeks at Silicon Valley Bank, Signature Bank and Credit Suisse, have put the Fed's policies and oversight in the hot seat.

Although many of the problems at these banks were unique to them, the broader issue may be that the Fed and other global central banks kept interest rates too low for too long. Low or zero percent interest rates can help fuel growth but can also lead to outsized risk taking, both among individuals and businesses.

An example of this mindset occurred during the pandemic. With a lot of cash on hand and interest rates low, many were lured into risky investments. After all, why keep your stimulus check in a zero percent savings account when you could buy a meme stock or crypto?

Similarly, if you are a venture capital firm and your clients have handed over money so that you can invest in the next big thing, you may cast your net a little wider for ideas, perhaps throwing money at companies whose business premise was based on pandemic conditions persisting forever.

And if you are a bank that is sitting atop a mound of deposits, perhaps from those very companies that were handed VC money, why keep all of those deposits in easily accessible money that is paying zero when you can purchase a "safe," longer-dated treasury or mortgage-backed security that will increase the amount of interest you can earn?

While some decisions made during a low-interest environment can be awesome (i.e., a 30-year fixed-rate mortgage for under 3%), others can catch you flat-footed and bite back when rates rise.

The Fed's aggressive inflation-fighting rate-hike campaign of the past year hurt high-growth sectors like tech and also banks like Silicon Valley, which held longer-dated bonds. The lesson here is when the Fed hits the brakes on the economy, certain parts of the banking sector went flying through the windshield.

In addition to its role as "lender of last resort" and manager of monetary policy, the Federal Reserve is the prudential regulator of the U.S. banking system. That means that it strives to ensure the safety and soundness of individual institutions and maintains overall financial stability. To do so, it, along with the Office of the Comptroller of the Currency and state regulators, oversees and supervises the nation's banks.

In this role, there are likely to be many questions. Silicon Valley Bank was subject to scrutiny by the state of California and the Federal Reserve Bank of San Francisco. Presumably, regulators understand that when a bank relies on a higher-than-average uninsured deposit base (more than $250,000), it creates risk.

The reason is that uninsured depositors are usually the first to leave a bank when there is a problem because they understand they are not protected by FDIC insurance. Silicon Valley Bank had a much higher-than-average amount of uninsured deposits, which should have been a warning. Additionally, regulators knew Silicon Valley Bank had purchased long-dated Treasury securities when interest rates were low, which resulted in unrealized losses on the bank's balance sheet. Although the San Francisco Fed warned about Silicon Valley Bank's governance and controls, it may not have focused on the bank's liquidity, which ultimately led to its demise.

Although we are still in the eye of the storm, these and other questions will be debated among regulators, legislators and banks themselves.

Jill Schlesinger, CFP, is a CBS News business analyst. She welcomes comments and questions at <!--p:BC TAG Body Copy Tagline-->[email protected].<!--p:BC TAG Body Copy Tagline-->