the money game

Jerome Powell Can Now Pivot to Saving the Economy From Imploding

Photo-Illustration: Intelligencer; Photo: Getty Images

For the past year or so, the Federal Reserve has been focused on one thing: keeping prices stable, preventing another head-spinning spike in groceries and cars and just about everything else U.S. consumers saw in early 2022. On Wednesday, the Federal Reserve raised interest rates for the tenth straight time in 15 months — the most aggressive hiking cycle in 40 years — then signaled, after reaching the highest level in 16 years, that it could be done. “We may not be far off, or possibly even at, that level” where it would stop, Fed chair Jerome Powell said in a news conference after announcing the move. But raising interest rates from basically zero (where they were early last year) to more than 5 percent is a big deal in a $25 trillion economy — the kind of thing that has consequences. We’ve seen a few banks collapse (and one or two more that seem headed for it), the housing market stall out, commercial real estate enter a crisis phase, and crypto get boring again. But inflation is coming down, and on Friday, the unemployment actually fell to 3.4 percent after employers added 253,000 jobs. In this context, Powell would probably say the consequences of the hikes have been worth it, yet it’s also clear that he and his colleagues have pushed rates about as high as they reasonably can and that yesterday’s meeting marked (unofficially, anyway) the beginning of a new phase for the Fed in managing this fragile but apparently still strong economy. Here’s a way to think of what comes next: We are entering a period when the world’s most important central bank will have to keep not only prices from spiking but the rest of the economy from imploding.

With rate hikes off the table, perhaps the most important tool at the Fed’s disposal — and the one that deserves the most attention right now — is overseeing the banks. Just hours after Powell stated that “the U.S. banking system is sound and resilient,” the California lender PacWest announced it was looking to sell itself, an admission that it could not survive on its own. On Thursday, another large regional bank, NorthWest Alliance, fell more than 60 percent after the markets opened. It has become something of a parlor game on Wall Street these past few weeks to pick which bank will be next to fail, and it feels, at this moment, as if it really could be any of them that aren’t already considered “systemically important” — the Fed’s preferred language for a bank that’s too big to fail.

So far, the extent of the Fed’s bank management after the crash of Silicon Valley Bank in March is in special lending programs, which have given out hundreds of billions of dollars in cash and emergency loans so far. As a matter of economic policy, it is almost tweaking at the margins. This was supposed to not only keep banks from crashing but return them to their normal business operations of lending. “A particular focus for us now over the past six, seven weeks now and going forward is what’s happening with credit tightening,” Powell said at a press conference on Wednesday. “Are small- and medium-sized banks tightening credit standards, and is that having an effect on loans, on lending? We can begin to assess how that fits with monetary policy.” The crash of Silicon Valley Bank in March instantly shocked the industry, and since then its peers have pulled back drastically on giving out loans. (Which is to say, they have tightened credit conditions for the country, just as Powell did with his yearlong rate-hiking campaign.)

Until last week, this was working fine. Three banks crashed in March, but they all seemed like weird outliers; they were badly managed or had something to do with crypto. The sense of uneasiness seemed to fade as the CEOs of the big banks all tried to one-up one other on declaring that there was no panic. In that kind of environment, the Fed would just use backdoor maneuvers to make it more expensive to give out loans — and voilà, banks are sitting on more of their deposits, and credit conditions have tightened incrementally.

But this week, it feels as though everything has changed. Things are moving so quickly right now that the consequences of the Fed’s actions, or inactions, could be profound. The central bank has expansive powers to lend during emergencies — think of the bailouts of 2008 or the Paycheck Protection Program in 2020. It also has the power to require banks to hold more money in reserves, essentially cushioning against shocks. And the Fed can make technical changes that could benefit banks by diverting more money back into bank accounts (after $1 trillion in cash was moved into money-market funds in the past year).

Probably the biggest thing the Fed could do would be to work with the Treasury and the FDIC to expand the definition of what is systematically important. In March, after SVB failed, it declared it too big to fail, or, in the parlance of the central bank, it made a “systemic risk exception.” This was to protect the depositors since most of the money SVB had wasn’t protected by FDIC insurance. (The FDIC isn’t a federal agency; it’s a private corporation run and funded by the banks.)

The reality is that, ever since systemically important entered the lexicon in 2008, large financial institutions have been trying to escape the label. Yes, it meant they were too big to fail, but it also meant they had to set aside more money, couldn’t make riskier (and more profitable) loans, and had to deal with pesky regulators bothering them more often. SVB was excellent at skirting that designation. First Republic, just acquired by JPMorgan on Monday, was even bigger, yet it was still not officially seen as systemically important. (The FDIC didn’t grant an exception for that bank after it collapsed since Jamie Dimon swooped in to save it.)

The right level of what should be systemically important has been debated since the Dodd-Frank Wall Street reform law was introduced. Representative Barney Frank had originally set the level to $50 billion, but he told my colleague Jen Wieczner he realized that was ” too low and was arbitrary.” In 2018, Frank successfully advocated for the cutoff to be $250 billion. (By that time, he was out of Congress and already on the board of Signature Bank, which crashed just days after SVB.)

One thing the Fed will have to consider now is whether it had it right the first time. This would take an act of Congress, but Powell is well liked in Washington, a Republican who’s trusted by Biden. I talked with Mike Mayo, a bank analyst at Wells Fargo, who predicted the landscape of banks will be more tightly controlled. The current crop of too-big-to-fail banks, your JPMorgans and Bank of Americas, are known as “globally systemic important” banks,” or G-SIBs. Mayo sees a new class emerging, those of “domestically systemic important” banks, or D-SIBs. They would have to have more deposits, less leverage, and more regulation, he said — but they would, in theory, be safer.

Banks losing 60 percent of their value in a day isn’t normal. Two of the top-20 banks by assets collapsing in a month is extreme. Every other person in the U.S. is worried about whether their bank can keep their money safe. It’s what happens during panics, and we’re in one. The thing is, this probably isn’t anywhere near the end. Many of these regional banks are still holding on to plummeting commercial-real-estate loans. Putting every moderately large bank under federal too-big-to-fail protection won’t solve every problem — how they will raise that much more cash is a key question, as are the limits to government backing from the debt ceiling — but it’s the kind of signal Wall Street looks for when it’s assessing risk. Powell has made it clear that he doesn’t yet see a reason to cut rates since he wants to beat back inflation. (If you want to be cynical about it, a massive recession would probably bring prices down, but that’s not a very desirable outcome.) If he sticks with this, he still has plenty of ways to keep the economy from imploding, but he’ll have to go into uncharted territory.

This story was updated on Friday to include the new unemployment numbers.

Jerome Powell Can Now Pivot to Saving the Economy