What does the Silicon Valley Bank collapse mean for a possible recession?

Could Silicon Valley Bank’s (SVB) closure have been avoided? And what does its end signal for the greater economy?

In mid-March, the business world watched California-based SVB collapse over the course of just a few days. The bank shut down on a Friday, leaving many company leaders unsure if they’d be able to access all of their funds over the weekend. Come Monday, the Federal Deposit Insurance Corporation (FDIC) announced that account holders would be able to recover all of their money.

Following this banking crisis, questions remained about the state of federal regulations for banks. The University of Pennsylvania’s Wharton School hosted a live virtual discussion last week with Wharton professors about what happened with SVB, and if this could be the beginning of a larger financial crisis.

Questioning the Federal Reserve’s actions

Peter Conti-Brown, an associate professor of financial regulation at Wharton, said he wasn’t surprised that a bank collapsed after an abnormally long period of time without bank failure. But parts of the SVB collapse were unique: The bank was poorly managed and susceptible to “rational run,” meaning rational reasons for people to pull their deposits.

What did surprise him was how quickly the government declared SVB’s failure a financial crisis, rather than calling it a “period of intermediate bank stress.”

“We have these sets of tools so that short of a banking crisis we can resolve concerns in a way that is both systemically appropriate but also fair to all of the bank’s stakeholders,” Conti-Brown said. “And the government skipped nearly every single one of those. That shocked me.”

In contrast, economist Joao Gomes, who is Wharton’s senior vice dean of research, centers and academic initiatives, said he was surprised by the collapse of SVB — especially because Federal Reserve chair Jerome Powell gave testimony to Congress a week before the collapse that didn’t mention any stress on the banking system in the financial sector.

Bank supervisors such as the Federal Reserve are meant to help banks manage asset risk management strategy and liability strategy. In this scenario, Conti-Brown said, the Fed knew there were problems and documented those problems — for instance, that SVB had a higher ratio of uninsured depositors than other banks. In moments of stress, uninsured depositors are more likely to leave their banks to seek shelter for their money elsewhere.

“It’s not a problem of a failure of information, it was a failure to empower the right people to act on that information,” Conti-Brown said. “That’s what we’re waiting for — the Fed and FDIC to tell us exactly where the break in passing that information up the chain occurred.”

The Wharton School’s “Understanding a Banking Crisis” panel. (Screenshot)

What does this mean for a recession?

At the beginning of 2023, it was unclear if inflation could be controlled without creating a recession, Gomes said. The Federal Reserve sets interest rates, and for the past year has been increasingly raising rates in the hopes of stemming inflation, from nearly zero to 5%. Meanwhile, the average national inflation rate is at 6%.

“I think coming into the year, the odds maybe were 50/50 that we would avoid a recession,” Gomes said.

He said he’s been working for the last 15 years to help policymakers to understand how their decisions impact the financial sector, and how the financial sector impacts the economy. In this case, he feels the Fed lost the ability to control inflation and understand how higher interest rates would affect both the financial sector and the economy.

“It’s just obvious 15 years later that the Fed still doesn’t have a handle on that. So that was shocking to me,” he said. “I think what’s started in the banking sector is almost surely not going to stay in the banking sector. How much contagion, how much spillover? That’s an open question.”

Gomes said what is currently happening with the economy does not feel like the 2008 recession — but it does feel like 2006 or 2007 because there are “vulnerabilities.”

“I think the Fed would tolerate a recession to fight inflation, but I just don’t think they’ll tolerate financial chaos and threat to financial stability,” he said. “I think they’re just too much of an unknown, as you all know, these kinds of financial crises just create very different macro dynamics and it could all become a much more severe downturn than anything we’ve seen.”