Fed criticized for missing bank red flagsFed criticized for missing red flags before bank collapse

WASHINGTON - The Federal Reserve faces stinging criticism for missing what observers say were clear signs that Silicon Valley Bank was at high risk of collapsing in the second-largest bank failure in U.S. history.

Critics point to many red flags surrounding the bank, including its rapid growth since the COVID-19 pandemic, its unusually high level of uninsured deposits and its many investments in long-term government bonds and mortgage-backed securities, which tumbled in value as interest rates rose.

"It's inexplicable how the Federal Reserve supervisors could not see this clear threat to the safety and soundness of banks and to financial stability," said Dennis Kelleher, chief executive of Better Markets, an advocacy group.

Wall Street traders and industry analysts "have been publicly screaming about these very issues for many, many months going back to last fall," he added.

A class-action lawsuit was filed against the parent company of Silicon Valley Bank, its CEO and its chief financial officer, saying the company didn't disclose risks that future interest rate increases would have on its business. The lawsuit was filed in the U.S. district court for the Northern district of California and seeks unspecified damages to be awarded to those who invested in SVB between June 16, 2021, and March 10, 2023.

The Fed was the primary federal supervisor of the bank based in Santa Clara, California, that failed last week. The bank also was overseen by the California Department of Financial Protection and Innovation.

Now the consequences of the fall of Silicon Valley Bank, along with New York-based Signature Bank, which failed over the weekend, are complicating the Fed's upcoming decisions about how high to raise its benchmark interest rate in the fight against high inflation.

Many economists said the central bank policymakers at their meeting next week likely would have raised rates by an aggressive half-point and raise their projection for future rates to 5.6%. Its rate stands now at about 4.6%, the highest level in 15 years.

Now it's unclear how many additional rate increases the Fed will forecast.

With the collapse of the two large banks fueling anxiety about other regional banks, the Fed may focus more on boosting confidence in the financial system than on its long-term drive to tame inflation.

The latest government report on inflation, released Tuesday, shows price increases remain far higher than the Fed prefers, putting Chair Jerome Powell in a tougher spot. Core prices, which exclude volatile food and energy costs and are seen as a better gauge of longer-run inflation, jumped 0.5% from January to February - the most since September.

On Monday, Powell announced the Fed would review its supervision of Silicon Valley to understand how it might have better managed its regulation of the bank. The review will be conducted by Michael Barr, the Fed vice chair who oversees bank oversight, and results will be released May 1.

A Federal Reserve spokesperson declined to comment further.

Elizabeth Smith, a spokeswoman for the California Department of Financial Protection and Innovation, said, "We are actively investigating the situation and conducting a thorough review to ensure the Department is doing everything we can to protect Californians."

Silicon Valley was an unusual bank. Its management took excessive risks by buying billions of dollars of mortgage-backed securities and Treasury bonds when interest rates were low. As the Fed raised interest rates to fight inflation, leading to higher rates on Treasurys, the value of Silicon Valley's bonds steadily lost value.

Most banks would have sought to make other investments to offset that risk. The Fed also could have forced the bank to raise additional capital.

The bank grew rapidly. Its assets quadrupled in five years to $209 billion, making it the 16th-largest bank in the country. And roughly 94% of its deposits were uninsured because they exceeded the Federal Deposit Insurance Corporation's $250,000 insurance cap.

That percentage was the second highest among banks with more than $50 billion in assets, according to ratings agency S&P. Signature had the fourth-highest percentage of uninsured deposits.

Such an unusually high proportion made Silicon Valley Bank highly susceptible to the risk that depositors would quickly withdraw their money at the first sign of trouble - a classic bank run - which is what happened.

The bank failures likely will color an upcoming Fed review of rules that set out how much money large banks must hold in reserve. Barr said last year he wanted to conduct a "holistic" review of those requirements, raising concerns that would lead to rules forcing banks to hold more reserves, which would limit their ability to lend.

Many critics also point to a 2018 law as softening bank regulations in ways that contributed to Silicon Valley's failure. Pushed by the Trump administration with bipartisan support in Congress, the law exempted banks with $100 billion to $250 billion in assets - Silicon Valley's size - from requirements that included regular examinations of how they would fare in tough economic times, known as "stress tests."

Silicon Valley's CEO, Greg Becker, lobbied Congress in support of the rollback in regulations, and he served on the board of the Federal Reserve Bank of San Francisco until the day of the collapse.