Why More Banks Will Fail
A lot has been written about Silicon Valley Bank, Signature Bank, and the other financial institutions that failed or almost failed recently. People understandably want to know why that happened and who was responsible. And as I said on a recent podcast with Nikki (our CFO) and David (our creative director), there is a lot of culpability to go around.
My intent is not to rehash any of that here as better explainers have already been written. Instead it’s to build on an exchange that Emily and I had on Slack and that I tweeted about:
One of my favorite memos is the Lin Wells memo that Donald Rumsfeld shared with then President Bush in April 2001 ahead of the Quadrennial Defense Review. The point of the memo is that it’s hard to predict the future and that big changes can happen in short periods of time, so plans should be adaptable and not assume that anything will stay the same. The timing of the memo is evidence of that as well as five months later September 11th happened and the world changed again.
What does this have to do with banks failing?
A common thread across the banks that failed is that they assumed (1) that interest rates would stay low and (2) that depositors wouldn’t all ask for their money back at the same time. Assumption (1) was naive on its face, but to be fair rates until recently had hovered near zero for almost 15 years. And if you can’t assume (2), well, you can’t reasonably operate as a bank. So I understand why mistakes were made.
Regulators won’t want to read this but regulation is inherently narcissistic. It means that you think you reasonably know what might happen before it does and can write rules to prevent it. But as the Wells memo demonstrates, we often don’t know anything about even really big things before they happen. But to Emily’s point, rulemakers can’t also be constantly reactionary, deciding what’s allowed and what’s not ex post facto. That’s the Calvinball approach (shoutout Bill Watterson) and it wouldn’t work either!
How can these ideas hang together? The answer is they don’t. And that’s why, whether now or in the future, more banks will fail and other bad things will happen because we didn’t know what to prepare for.
Have a great weekend.
– By Tim Hanson