When inflation is high, the Federal Reserve has historically raised interest rates. But the recent failures of banks like Silicon Valley Bank have sparked worries about the stability of our banking system.
When inflation is high, the Federal Reserve has historically raised interest rates. But the recent failures of banks like Silicon Valley Bank have sparked worries about the stability of our banking system. Now the feds must weigh whether the banking system could withstand the turmoil that raising interest rates could bring. To get inside the mind of Fed chair Jerome Powell, we look to a previous era of high inflation, the late 1970s and early ‘80s, and the decisions of then Fed chairs Arthur Burns and Paul Volcker.
Today, we talk about what's next. Read the full transcript here.
Host: Gustavo Arellano
Guests: L.A. Times economics reporter Don Lee
More reading:
Did deregulation lead to Silicon Valley Bank’s collapse?
Federal Reserve officials sound warnings about higher rates
U.S. inflation eases but stays high, putting Fed in tough spot
Gustavo Arellano: Late last week, drama hit the world of banking and finance.
AP: Regulators have seized the assets of one of Silicon Valley's top banks.
Silicon Valley Bank's failure was the second-biggest in U.S. history, followed Sunday by the third-biggest, when Signature Bank failed.
Treasury Secretary Janet Yellen is trying to reassure Americans there won't be a domino effect like the meltdown in 2008.
Gustavo Arellano: Within days, the federal government stepped in with sweeping measures to shore up the U.S. banking system and assure people that their money was safe,
President Biden: Americans can rest assured that our banking system is safe. Your deposits are safe. Let me also assure you, we will not stop at this. We'll do whatever is needed.
Gustavo Arellano: But the failure of Silicon Valley Bank and two others couldn't have come at a worse time. For the past couple of months, the tech and startup industries have cut tens of thousands of jobs, and the Federal Reserve has tried to tame inflation by hiking interest rates.
Fed Chair Jerome H. Powell: if that's the one thing you know, you know that this committee is committed to getting to a meaningfully restrictive stance of policy and staying there until we feel confident that inflation is coming down.
Gustavo Arellano: Controlling the economy is a delicate balance, of course, and when inflation has been high, the Fed’s best course of action historically has been to raise interest rates. But in times of economic uncertainty and risky banking practices, raising rates could cause an overcorrection and spark a recession.
Clip: There were some unintended consequences of those interest rate hikes intended to rein in inflation.
Gustavo Arellano: The Federal Reserve is set to meet early next week to decide its next move. Will Fed Chair Jerome Powell decide to fight higher prices or stabilize the banking system?
I'm Gustavo Arellano. You're listening to “The Times: Essential News From the L.A. Times.” It's Friday, March 17th, 2023. Today, how the demise of Silicon Valley Bank affects us all.
Here to talk to me about all this is my L.A. Times colleague, economics reporter Don Lee. Don, welcome to “The Times.”
Don Lee: Good to be with you.
Gustavo Arellano: OK, so the big financial news this week was the collapse of a few pretty big banks, including Silicon Valley Bank in California. What caused SVB to fail?
Don Lee: Well, you might say it was a perfect storm of events, and it moved very fast.
If you can believe it, on March 8th the bank was in sound financial condition. On that day they reported a loss in selling some securities, and they said that they're going to raise some capital. That news hit the community. And in a tight-knit community of high-tech people, you had people who started then to make demands for withdrawals.
AP: Depositors made a run, hurrying to withdraw money as anxiety over the bank's health spread.
Don Lee: And on the very next day, March 9th, you had depositors initiating withdrawals of $42 billion.
Gustavo Arellano: Wow
AP: We can't operate our business without accessing some capital.
Don Lee: And the bank officials, you know, they scrambled to try to raise money to, of course, meet those demands.
AP: A bank is supposed to be one of the most secure places that you can work with.
Don Lee: And at the end of the day, it was about a billion dollars short. And so regulators locked the doors for good.
AP: The problem is this was a rush, this was a liquidity failure, it was a bank run. So they didn't have time to prepare to market the bank.
Don Lee: You know, there were a number of factors specific to Silicon Valley Bank. It grew very fast. It had an exceptional percentage of depositors who had lots more than, you know, the federal guaranteed $250,000, which is very unusual for a community bank.
It was concentrated in high-tech, which was struggling, the wine industry, some crypto markets. And there was mismanagement, you know, in terms of hedging risk.
But there were some broader factors too, which have also now taken Signature Bank and Silvergate, and they included very rapid Fed rate hikes.
AP: We have seen a rather sharp increase in interest rates, which have put some smaller banks at odds with their own balance sheet.
Don Lee: Deregulation that occurred in 2018, in which more stringent rules and requirements for smaller banks were basically eliminated.
President Biden: I'm going to ask Congress and the banking regulators to strengthen the rules for banks to make it less likely this kind of bank failure would happen again,
Don Lee: You also had regulators for Silicon Valley Bank, California-chartered bank. So you had state regulators, its primary regulator was the Federal Reserve, and you might say that they were asleep at the switch.
AP: The broader question will be, should the regulators have been on the ball to ensure that this bank could not have had this risk, and what else is out there?
Gustavo Arellano: All right, well that's sad, but I don't have my money at this SVB or Silvergate or Signature Bank, all these banks that you mentioned that have failed, I hadn't even heard of them. So how does their collapse affect me?
Don Lee: Well, I think, when you have the 16th-largest bank collapsing and then a couple of smaller banks and then people panicking, that there'll be a contagion. First there is the question about whether this could cause panic and a sell-off on Wall Street, and we all have our, you know, 401(k)s or other money, and so that could hit there. If things go really south, then, we're talking about risk and danger to the underlying economy. And that could cause problems for jobs and for other aspects of your living, and, of course, we still have high inflation and so this is definitely not good for people in general.
Gustavo Arellano: So that's why you have all these people from the government saying things like your money is safe, don't go pulling out your life savings from the bank right now, this isn't like the Great Recession and it's definitely not the Great Depression, everything is fine. That's what they say. But Don, everything is fine?
Don Lee: Well, the good news is that the banking system is a lot stronger than it was before the great financial crash in 2008. You know, the big lenders in particular, they've been more prudent in their lending. We don't seem to have huge credit problems. And the economy is still moving along pretty well. Job growth has been good. People's finances are generally in solid shape. And so the underlying economy is still pretty stable. I think, though, that we're still not out of the woods yet because, uh, we've started to see the problems and concerns about the banking industry spread globally and there’ve been reports of regulators in different parts of the world now taking measures to shore up confidence and we have investors and regulators giving a closer look and concerns about even big institutions like Credit Suisse. And so we're in early days yet. And so I think we'll have to see just where this all settles.
Gustavo Arellano: So all of this is happening at a time where I know this much about finance: interest rates have been going up. That definitely interests me and everyone. So why are they so high right now?
Don Lee: Well, interest rates are high because inflation is high and the Federal Reserve has been moving very aggressively to raise rates in order to bring inflation down.
We have high inflation, partly because of the unusual demand and stimulus from the pandemic, where we had lots of people staying home ordering many goods. And at the same time, we had supply chain bottlenecks. The war in Ukraine, caused further increases in oil prices. And so we had a number of factors that led to high inflation and the Federal Reserve, in an effort to cool the economy and to bring down inflation, has been super aggressive in raising interest rates.
And so since last March, they've raised interest rates by 4.5 percentage points. That's the fastest, in four decades. And so I think all of this is the broader context of what happened at Silicon Valley Bank and is causing concern for the banking industry as a whole.
Gustavo Arellano: So has the Fed, though, had any luck in tackling inflation by raising interest rates? I mean, just the other day, I bought four small burritos at my favorite spot, and they're as delicious as ever. But two years ago, they would've cost me $12. I had to pay 20 bucks this time.
Don Lee: Yeah, well, I'm not surprised. You know, food prices have been soaring and inflation for food is still very high. It's close to 10% by the latest statistics. And, bread prices have jumped and well, we all know about egg prices. They've gone through the roof, right, up more than 50%. That said, the Fed has had some success. Inflation peaked at about 9% in June of last year, and now it's down to 6%, which is still very high, it's triple what the Fed would prefer. Its preferred target is about 2%. But the so-called core inflation — that's inflation of goods and services excluding food and energy, which can be very volatile — that hasn't seen as strong progress. So it was as high as 6.5%, and now we're about 5.5%, and so that remains troublingly high.
Gustavo Arellano: I know the Federal Reserve meets pretty regularly to take a look at these numbers and so much more. In fact, Jerome Powell and the rest of the board is supposed to get together early next week. How do you think that meeting’s going to go down?
Don Lee: Well, this is going to be one of the toughest meetings because before Silicon Valley Bank blew up, the expectation was that Fed officials would continue to hike rates in order to continue its fight against inflation — maybe 25 basis points, some thought 50. But once you had this bank crisis, I think it changed the equation for this meeting, because the bank crisis has raised concerns about the stability of the financial system, which is a cornerstone of the economy. And you know, Fed officials, they don't want to spook the markets any further. And if you raise interest rates, you're essentially tightening conditions, financial conditions, and the bank crisis has already kind of done that. And so it will be a tough meeting for them because they don't want to give the impression that they're backing down from its battle against inflation. That is a long game.
But the immediate crisis, the short game here, is what to do about this banking crisis and to make sure that we get through this without something big like the Great Recession occurring.
Gustavo Arellano: Coming up after the break, the complicated decision that the Fed faces next week. Will it raise interest rates to tackle inflation, or back off rate hikes and stabilize the global banking system?
Gustavo Arellano: Don, the Fed has been trying to just clamp down on prices for the better part of a year now, as you mentioned, and you see some good things, some bad things. But again, I'm not the biggest economics person, but one thing I've heard is that if you raise interest rates, that drops demand and hence prices get lower. So if that's the case, why not raise rates a bunch and just be done with it?
Don Lee: You're right, that would be, uh, one way, and I think there are some people who would advocate ripping off the Band-Aid, right? But the problem there, of course, is that if you have sharp, even sharper and sudden rate increases, you could have a collapse in demand and spending and investment, and you would see businesses close, put a lot of people out of work. Stock markets will come tumbling down, and I think the Fed wants to have, you know, what's called a soft landing, which is to try to bring demand and spending down gently so that you don't have a crash in the economy, but that you have, you know, a slowdown that's manageable and orderly and that we don't have a big recession or cause something worse: chaos and something like akin to the Great Recession that we saw in 2008. And so I think the Fed is really trying to thread the needle here, to be careful not to, uh, hit too hard; at the same time to do it hard enough so that they can get the job done
Gustavo Arellano: So what's at stake if the Federal Reserve decides to not raise rates at next week's meeting?
Don Lee: I think one risk that you have is sending a conflicting message that maybe you're backing off in the battle against inflation. And I think even a pause, which is possible, that the Fed would pause in its rate-hike campaign could make things worse in the sense that the longer you delay, the longer you have high inflation, inflation could become entrenched.
And that is very dangerous because when people have expectations for high inflation, then they start to act like it. They want higher pay, and then the businesses correspond. They will start to raise prices, Uh, you kind of have a vicious cycle, and it is very hard to tame once you get into that pattern of expectations for high inflation and, uh, people thinking and then behaving in response to that.
Gustavo Arellano: So when was the last time inflation was this bad?
Don Lee: Well, for those of us who were around, back in the 1970s and early ’80s, inflation actually reached double digits and interest rates were also raised to that level.
President Carter: The most serious problem that our nation has is inflation, and it's getting worse.
Don Lee: We had, uh, the oil crisis at that time, the Iran Revolution.
AP: The Ayatollah has announced that the electorate here in Iran has unanimously approved the establishment of an Islamic republic .…
Don Lee: We were getting out of a very expensive war in Vietnam.
AP: The Saigon government surrendered unconditionally to the Viet Cong, ending 30 years of bloodshed.
Don Lee: And we had big spending, fiscal spending for things like Great Society programs.
President Lyndon Johnson: We have the opportunity to move not only toward the rich society and the powerful society, but upward to the Great Society.
Don Lee: The labor market too was very different. Baby boomers were coming into the labor market, and so we had all of these factors that were giving prices a big boost.
President Carter: I do not promise a quick way out of our nation's problems, when the truth is that the only way out is an all-out effort.
Gustavo Arellano: How did the Federal Reserve try to solve things back then?
Don Lee: Well, not very well. You know, Arthur Burns, uh, was the Fed chair from 1970 to ’78, But one of the problems that Burns had was that he came under a lot of pressure, especially, from Richard Nixon.
President Nixon: You see, Dr. Burns, that's a standing vote of appreciation in advance for lower interest rates and more money
Don Lee: You know, before Nixon campaigned for the presidency in ’72, he pushed Burns hard.
President Nixon: Ladies and gentlemen, as all of you know, the Federal Reserve is independent. I respect that independence. Uh, on the other hand, I do have the opportunity as president to convey my views to the chairman of the Federal Reserve
Don Lee: We know from history, from the Nixon tapes, that he pressured Burns directly and he would say things like, you know, trying to have him persuade fellow board members to go along with expanding monetary policy and expanding money into the economy, to strengthen it, even though it wasn't needed.
President Nixon: I have some very strong views on some of these economic matters, and I can assure you that I will convey them privately and strongly to Dr. Burns.
Don Lee: He would say things like, well, you can lead them; you always have, Just kick them in the rump a little. And so there was a lot of pressure on Burns to keep the economy running with a lot of money. And that sowed the seeds for high inflation later in the decade, and it would take a long time to get that under control.
President Nixon: I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed
Gustavo Arellano: What ended up happening to Burns?
Don Lee: Well, in 1978, Arthur Burns' term as Fed chair ended, and eventually Paul Volcker takes that seat in 1979.
Gustavo Arellano: After the break, the powderkeg economy that Paul Volcker inherited, and what we can learn from that history.
Gustavo Arellano: So Don, at the end of 1979, inflation was out of control, President Carter had nominated Paul Volcker as his newest chairman of the Federal Reserve to try and fix it once and for all. What did Volcker do?
Don Lee: Well, Volcker took the bull by the horns. He was very aggressive, and his belief was that he really needed to break the back of inflation and the way to do that, was to raise interest rates very high. And it was very unpopular.
Paul Volcker confirmation hearing: Business failures mushroomed and unemployment rose above 10%, meaning over 10 million unemployed. Was this severe depression necessary?
Don Lee: There was a double-dip recession, first in 1980, which was relatively shallow, but then a very deep recession in ’81 and ’82 because of the sharp interest rate hikes,
Paul Volcker confirmation hearing: Certainly most of the blame for this severity can be placed at the policies of the Federal Reserve Board
Don Lee: You know, farmers drove their tractors to the streets of D.C. and blocked the street to Fed headquarters. And people in the construction industry blamed him for ruining their business.
Paul Volcker: Well, as I said, I think it's a heavy price that we paid for dealing with the inflationary process that have built up over a period of years. And all I can say is that if we let that process go on further, I think we would've had still more difficulties.
Don Lee: It was tough, but he, uh, had resolve, and he will be remembered as somebody who reined in inflation and set the economy on a course where we had many years of low inflation and good expansion.
Sen. William Proxmire: I think we owe you. Chairman Volcker, a rousing vote of thanks for your great job in bringing inflation down. 1979 when you took office, yours was the only anti-inflation game in town. So good luck, Paul, you poor devil.
Gustavo Arellano: So if the Federal Reserve, then, were to lay low in raising interest rates for the foreseeable future, do we risk facing that situation that happened in the ’80s again?
Don Lee: I think there are some key differences from the ’80s. You know, one is that the demographics are quite different today. You know, we have a labor shortage and the population is probably growing at a half-percent instead of 1%. We don't have the double-digit inflation, nor is there strong evidence that we have, you know, what's called a wage-price spiral, right, where wages are rising very rapidly and then spilling into overall inflation, and the pressure from workers for high wage increases. Unions aren't as strong as in the past, and so we don't have the same kind of pressures there. But we do have some concerns of inflation becoming entrenched. Even at 3% inflation, that wipes out 30% of retirees' savings over a 10-year period.
Gustavo Arellano: Oh, wow.
Don Lee: And as I mentioned before, if expectations are built into people that we're going to have high inflation, then it is going to create increased demand for higher pay rates and businesses are going to lift prices, and that will make bringing down inflation very difficult. And so we could have a long period of inflation, and this is why the Fed is trying to, you know, be so aggressive in taming inflation.
Gustavo Arellano: So this history, how much does it weigh on the mind of Fed Chair Jerome Powell?
Don Lee: It weighs a tremendous amount. For one thing, Powell is a big fan of Volcker. He's like a hero to him. In fact, you know, shortly after Powell became Fed chair in 2018, the story is that he was carrying around a memoir by Volcker and then at a conference said that he thought about bringing 500 copies of the book and passing it out. And so he is taking a page from Volcker and wants to show the same kind of resolve, and I think he too wants to be remembered as Volcker is today as the Fed leader who reined in inflation. And so this is a high priority for him.
Gustavo Arellano: Yeah. It's always dangerous, though, when people are trying to emulate their heroes, because usually it doesn't work.
Don Lee: That's right. And I think some people would say that Powell is no Volcker, and the circumstances are quite different.
Gustavo Arellano: So what do you think then, is Powell likely to increase interest rates again, uh, next week?
Don Lee: Well, it's anybody's guess, really.
Gustavo Arellano: I know. I hate to put you on the spot, but you're the economics guy, not me.
Don Lee: You know, the markets are already in some turmoil and I think if things continue to be shaken as they are, then I think they're likely to pause. But it seems that people are divided, and I'm guessing that the Fed members who'll be voting on interest rates, that they too are divided.
Gustavo Arellano: Finally, Don, I mean, this Fed meeting was going to get a lot of attention either way, but now with the news of these bank collapses, what did the collapse of Silicon Valley Bank and the others potentially set off? As you mentioned, big banks failing is never a good thing. Inflation is not a good thing. All these financial problems swirling around: Are hard times ahead?
Don Lee: You know, even before the collapse of Silicon Valley Bank and the widening of the bank crisis, the economy was in a somewhat fragile state, right, because of the high interest rates and coming out of the pandemic. And so there was a lot of uncertainty, and some people were expecting that fall into recession sometime this year.
I think, you know, with what's happened, all of these different factors — the bank crisis, the Fed, and the markets now in seeming turmoil — I think we are in for a very bumpy ride at best. And I think that the economy is going to be severely tested, and even if we get past the bank crisis — and I think we'll know in a couple of weeks just how long-lasting this would be — even if we get over it fairly quickly, that still leaves the question of inflation and the war in Ukraine and other geopolitical risks and, um, just how the Fed is going to respond to it. And so it doesn't seem like, you know, we're going to be in a smooth path for some time to come.
Gustavo Arellano: Don, thank you so much for this conversation.
Don Lee: Thanks for having me.
Gustavo Arellano: And that’s it for this episode of “The Times: Essential News From the L.A. Times.”
Kasia Broussalian and David Toledo were the jefes on this episode. It was edited by Jazmín Aguilera and Mario Diaz mixed and mastered it.
Our show is produced by Denise Guerra, Kasia Broussalian, David Toledo and Ashlea Brown. Our editorial assistants are Roberto Reyes and Nicolas Perez. Our fellow is Helen Li. Our engineers are Mario Diaz, Mark Nieto and Mike Heflin. Our executive producers are Jazmín Aguilera, Shani Hilton and Heba Elorbany. And our theme music is by Andrew Eapen.
I'm Gustavo Arellano. We'll be back Monday with all the news and desmadre. Gracias.