🎲 Rewards Fo’ Risk Brings Da Firs’ Republic Bank Down 💸
Risk stay da centah of all da kine financial kahakais since da 1980s. Wat we goin’ do fo’ make shua history no come back again an’ mess wit da bankin’ system, economy, an’ da jobs of da everyday peeps? 🤔
Firs’ Republic Bank wen’ bus’ up an’ be da second-biggest bank failya in U.S. history afta da bank wen’ get seized by da Federal Deposit Insurance Corp. an’ wen’ sell um to JPMorgan Chase on May 1, 2023. Firs’ Republic, she stay da latest victim of da panic dat wen’ go crazy fo’ da small an’ midsize banks since Silicon Valley Bank wen’ bus’ up in March 2023. 😱
Da fall apah of SVB an’ now Firs’ Republic show how da kine risky moves at one bank can go fasta fasta to da bigga financial system. Dis suppose to be da push fo’ da lawmakahs an’ da guys dat watch da banks fo’ take care one problem dat stay wit da bankin’ industree from da time of da savings an’ loan kahakai of da 1980s to da 2008 financial mess to da recent pilikia afta SVB wen’ bus’ up: da kine rewards dat make guys take mo’ chance den dey should. 🏦💥
Da top dog guy fo’ da Federal Reserve dat watch da banks tinks da same ting. On April 28, da centrah bank’s vice chair fo’ supervision wen’ give one mean report on top da bus’ up of Silicon Valley Bank, sayin’ da failyas wen’ happen cuz of da kine weak risk management an’ da guys watchin’ dem wen’ mess up too. 📉👀
Fo’ every financial kahakai since da 1980s, da main ting stay risk. Us, we stay professors of economics who study an’ teach da history of da kine financial pilikias. In every kine financial mess since da 1980s, da main ting stay risk. Banks wen’ give da kine rewards dat make da boss guys take big chances fo’ make mo’ money, an’ no worry if da kine bets wen’ go south. In oddah words, all da carrot an’ no mo’ da stick. 🥕🚫
Da question we stay scratchin’ our head wit’ now stay wat we goin’ do fo’ make shua history no come back again an’ bus’ up da bankin’ system, economy, an’ da jobs of da everyday peeps. 🏦💼🤷♂️
Da S&L kahakai set da stage fo’ da banking pilikias of da 21st century.
Da kine S&L kahakai, jus’ like SVB wen’ bus’ up, wen’ start in one fast changing intrest rate time. Savings an’ loan banks, or da kine thrifts, wen’ give home loans wit’ good intrest rates. Wen da Federal Reserve undah Chairman Paul Volcker wen’ go hahd an’ raise da rates in da late 1970s fo’ fight da kine inflation, da S&Ls wen’ make less on da fixed-rate mortgages an’ gotta pay mo’ intrest fo’ bring in da peeps dat put money in da bank. One time, dea losses wen’ be ova US$100 billion. 💸💸
Da S&L boss guys usually wen’ get paid based on how big dea institutions’ assets stay, an’ dey went hahd fo’ lend to da commercial real estate projects, takin’ on da kine risky loans fo’ make dea loan portfolios grow fasta fasta.
Fo’ help da shaky banks, da fed government wen’ take off da rules fo’ da thrift industree, letting da S&Ls go beyond home loans to commercial real estate. S&L boss guys usually wen’ get paid based on how big dea institutions’ assets stay, an’ dey went hahd fo’ lend to da commercial real estate projects, takin’ on da kine risky loans fo’ make dea loan portfolios grow fasta fasta. 🏢💰
In da late 1980s, da commercial real estate boom wen’ bus up. S&Ls, loaded up wit’ bad loans, wen’ fail all ova da place, needing da fed government fo’ take ova da banks an’ da kine properties dat no pay, an’ sell da assets fo’ get back da money paid to da peeps dat had insurance fo’ dea deposits. Da final cost to da taxpayers wen’ be mo’ den $100 billion. 💔💔
Da 2008 kahakai stay one odda clear example of da kine rewards dat make peeps take risky moves.
All ova da place fo’ mortgage financing—from Main Street lenders to Wall Street investment firms—da boss guys wen’ make out good by takin’ mo’ risk den dey should an’ pass ‘um to somebody else. Lenders wen’ give mortgages to peeps who no can afford ‘um to Wall Street firms, who wen’ package dose into securities fo’ sell to investors. All wen’ come crashing down wen’ da housing bubble wen’ bus’, followed by one big wave of peeps losing dea houses. 🏠💔
Da kine rewards wen’ give bonus fo’ short-term performance, an’ da boss guys wen’ go fo’ bigger risks fo’ quick gains. At da Wall Street investment banks Bear Stearns an’ Lehman Brothers, profits wen’ go up as da firms wen’ bundle more an’ more risky loans into mortgage-backed securities to sell, buy, an’ hold.
As mo’ an’ mo’ peeps wen’ lose dea houses, da value of dese securities wen’ go down fasta, an’ Bear Stearns wen’ bus’ up in early 2008, sparking da financial kahakai. Lehman wen’ fail in September of dat year, freezing up da global financial system an’ throwin’ da U.S. economy into da worst recession since da Great Depression.
Da boss guys at da banks, howeva, wen’ already cash in, an’ none of dem wen’ get in trouble. Researchers at Harvard University wen’ estimate dat top executive teams at Bear Stearns and Lehman pocketed a combined $2.4 billion in cash bonuses and stock sales from 2000 to 2008. 💰💰🚫
Dis bring us back to Silicon Valley Bank.
Da boss guys wen’ tie up da bank’s assets in long-term Treasury and mortgage-backed securities, not protecting against da kine rising interest rates dat would make da value of dese assets go down. Da interest rate risk stay really bad fo’ SVB, since plenty of dea peeps dat put money in da bank stay startups, who need investors’ access to cheap money.
Wen’ da Fed wen’ start raising interest rates last year, SV
B wen’ get hit double hard. As da startups’ fundraising wen’ slow down, dey wen’ pull out dea money, which made SVB fo’ sell long-term holdings at a loss fo’ cover da withdrawals. Wen’ da size of SVB’s losses wen’ come out, peeps wen’ lose trust, causing one run dat end wit’ SVB’s bus’ up. 💸🏦💥
But fo’ da boss guys, no had much downside fo’ no care or even no mind da risk of rising rates. Da cash bonus of SVB CEO Greg Becker wen’ go up mo’ den double to $3 million in 2021 from $1.4 million in 2017, making his total earnings go up to $10 million, up 60% from four years befo’. Becker also wen’ sell almost $30 million in stock ova da past two years, including some $3.6 million in da days right befo’ his bank wen’ bus’ up. 💰💼📉
Da impact of da bus’ up no stay jus’ wit’ SVB. Share prices of plenny midsize banks wen’ drop. Anodda American bank, Signature, wen’ bus’ up days afta SVB did. 🏦💥
First Republic wen’ make it tru da first panic in March afta it wen’ get saved by one group of major banks led by JPMorgan Chase, but da damage wen’ already done. First Republic recently wen’ say dat peeps wen’ pull out mo’ den $100 billion in da six weeks afta SVB’s bus’ up, and on May 1, da FDIC wen’ take ova da bank and made one sale to JPMorgan Chase. 💵🏦🔁
Da kahakai no pau yet. Banks had ova $620 billion in unrealized losses at da end of 2022, mostly cuz of da kine quick rising interest rates. ⏳📈💔
So, wat fo’ do?
We believe da bipartisan bill recently wen’ get put in Congress, da Failed Bank Executives Clawback, would be one good start. If one bank wen’ bus’ up, da law would give da power to da regulators fo’ get back compensation received by bank executives in da five-year period befo’ da bus’ up. 🏦🔙💵
But, dese clawbacks, dey only come in afta da fact. Fo’ prevent da kine risky behavior, regulators could make da boss guys’ pay fo’ focus on long-term performance ova quick gains. And new rules could limit da ability of bank executives fo’ take da money and run, including making da boss guys fo’ hold plenty of dea stock and options till dey retire. 💼💰🔒
Da Fed’s new report on wat caused SVB’s bus’ up points in dis direction. Da 102-page report recommends new limits on boss guys’ pay, saying leaders “no wen’ get paid fo’ manage da bank’s risk,” as well as stronger stress-testing and higher liquidity requirements. 📑💡🏦
We believe dese also good steps, but probably no enough.
It comes down to dis: Financial kahakais less likely fo’ happen if banks and bank executives think about da interest of da entire banking system, not jus’ demselves, dea institutions, and shareholders. 💡🤝💰
NOW IN ENGLISH
🎲 Rewards for Risk Brings the First Republic Bank Down 💸
Risk was at the heart of every financial crisis since the 1980s. What can be done to prevent history from repeating itself and threatening the banking system, economy, and jobs of everyday people?
First Republic Bank became the second-biggest bank failure in U.S. history after being seized by the Federal Deposit Insurance Corp. (FDIC) and sold to JPMorgan Chase on May 1, 2023. First Republic is the most recent casualty of the panic that has shaken small and midsize banks since the failure of Silicon Valley Bank (SVB) in March 2023. 🏦😨
The collapse of SVB and now First Republic highlights how the impact of risky decisions at one bank can quickly spread into the broader financial system. It should also provide the motivation for policymakers and regulators to address a systemic problem that has plagued the banking industry from the savings and loan crisis of the 1980s to the financial crisis of 2008 to the recent turmoil following SVB’s demise: incentive structures that encourage excessive risk-taking. 🌐📉
The Federal Reserve’s top regulator seems to agree. On April 28, the central bank’s vice chair for supervision delivered a harsh report on the collapse of Silicon Valley Bank, blaming its failures on weak risk management, as well as supervisory missteps. 🏦📋
In each of the financial crises since the 1980s, the common denominator was risk. Banks provided incentives that encouraged executives to take significant risks to increase profits, with few consequences if their bets went sour. In other words, all carrot and no stick. 🥕🚫🏒
One question we are grappling with now is what can be done to prevent history from repeating itself and threatening the banking system, economy, and jobs of everyday people. 🤔💭
The precursor to the banking crises of the 21st century was the savings and loan crisis of the 1980s. The so-called S&L crisis, like the collapse of SVB, began in a rapidly changing interest rate environment. Savings and loan banks, also known as thrifts, provided home loans at attractive interest rates. When the Federal Reserve under Chairman Paul Volcker aggressively raised rates in the late 1970s to fight raging inflation, S&Ls were suddenly earning less on fixed-rate mortgages while having to pay higher interest to attract depositors. At one point, their losses topped $100 billion. 🏠💰💸
S&L executives were often paid based on the size of their institutions’ assets, and they aggressively lent to commercial real estate projects, taking on riskier loans to grow their loan portfolios quickly. To help the struggling banks, the federal government deregulated the thrift industry, allowing S&Ls to expand beyond home loans to commercial real estate. 🏢📈
In the late 1980s, the commercial real estate boom turned bust. S&Ls, burdened by bad loans, failed in droves, requiring the federal government to take over banks and delinquent commercial properties and sell the assets to recover money paid to insured depositors. Ultimately, the bailout cost taxpayers more than $100 billion. 💣💔🏦
The 2008 crisis is another obvious example of incentive structures that encourage risky strategies. At all levels of mortgage financing – from Main Street lenders to Wall Street investment firms – executives prospered by taking excessive risks and passing them to someone else. Lenders passed mortgages made to people who could not afford them onto Wall Street firms, which in turn bundled those into securities to sell to investors. It all came crashing down when the housing bubble burst, followed by a wave of foreclosures. 🏠💥📉
Executives were rewarded for short-term performance, and they responded by taking bigger risks for immediate gains. At the Wall Street investment banks Bear Stearns and Lehman Brothers, profits grew as the firms bundled increasingly risky loans into mortgage-backed securities to sell, buy, and hold. 🏦💸📈
As foreclosures spread, the value of these securities plummeted, and Bear Stearns collapsed in early 2008, igniting the financial crisis. Lehman failed in September of that year, paralyzing the global financial system and plunging the U.S. economy into the worst recession since the Great Depression. 💔📉🌎
Executives at the banks, however, had already cashed in, and none were held accountable. Researchers at Harvard University estimated that top executive teams at Bear Stearns and Lehman pocketed a combined $2.4 billion in cash bonuses and stock sales from 2000 to 2008. 🎩💰🚫
This brings us back to Silicon Valley Bank. Executives tied up the bank’s assets in long-term Treasury and mortgage-backed securities, failing to protect against rising interest rates that would undermine the value of these assets. When the Fed began raising interest rates last year, SVB was doubly exposed. As startups’ fundraising slowed, they withdrew money, which required SVB to sell long-term holdings at a loss to cover the withdrawals. When the extent of SVB’s losses became known, depositors lost trust, leading to a run that ended with SVB’s collapse. 📉😨🏦
For executives, however, there was little downside in discounting or even ignoring the risk of rising rates. The cash bonus of SVB CEO Greg Becker more than doubled to $3 million in 2021 from $1.4 million in 2017, lifting his total earnings to $10 million, up 60% from four years earlier. Becker also sold nearly $30 million in stock over the past two years, including some $3.6 million in the days leading up to his bank’s failure. 💰📈🎩
The impact of the failure was not contained to SVB. Share prices of many midsize banks tumbled. Another American bank, Signature, collapsed days after SVB did. First Republic survived the initial panic in March after it was rescued by a consortium of major banks led by JPMorgan Chase, but the damage was already done. First Republic recently reported that depositors withdrew more than $100 billion in the six weeks following SVB’s collapse, and on May 1, the FDIC seized control of the bank and engineered a sale to JPMorgan Chase. 🏦💔💥
The crisis isn’t over yet. Banks had over $620 billion in unrealized losses at the end of 2022, largely due to rapidly rising interest rates. 📈💰💣
So, what’s to be done? We believe the bipartisan bill recently filed in Congress, the Failed Bank Executives Clawback, would be a good start. In the event of a bank failure, the legislation would empower regulators to claw back compensation received by bank executives in the five-year period preceding the failure. 🏛️💡📜
Clawbacks, however, kick in only after the fact. To prevent risky behavior, regulators could require executive compensation to prioritize long-term performance over short-term gains. And new rules could restrict the ability of bank executives to take the money and run, including requiring executives to hold substantial portions of their compensation in the form of equity for a longer period of time. This way, their financial futures would be more closely tied to the long-term health of the institutions they lead. 📈🏦💰
Moreover, regulators should require banks to maintain sufficient capital buffers to withstand potential losses. For instance, there could be stricter rules on how much a bank can lend compared to its assets, and these rules could be adjusted based on the bank’s risk level. This would mean that a bank taking on more risk would need to have more capital on hand. 🏦💵🛡️
More robust and active supervision is also critical. The Federal Reserve and other regulators need to closely monitor banks’ risk-taking, especially in an environment of rising interest rates. This would require more resources and a change in the regulators’ mindset – from reactive to proactive. They should act as gatekeepers, not just crisis managers. 🏛️🔍🚧
The fallout from the SVB and First Republic bank failures serves as a stark reminder of the systemic risk posed by unsound banking practices. Policymakers, regulators, and bank executives all have a role to play in ensuring that the lessons from these crises are learned and applied to prevent a similar situation from unfolding in the future. 🏦💔🔁
In the end, a banking system that values long-term stability over short-term profit can foster a healthier economy and safeguard the jobs and well-being of everyday people. It’s high time that the banking industry learns its lesson from past mistakes and takes the necessary steps to avert future crises. 🏛️🏦🌐👥🔮
