Treasury Secretary Janet L. Yellen recently tied the failure to raise the debt limit in time to the prospect of more bank failures. Secretary Yellen is absolutely right that if Congress wants to prevent more government bailouts of banks in the short term, it can ill afford to wait to enact a clean debt limit increase. But in order to help bring down the inflationary pressures that helped undermine Silicon Valley Bank, President Biden and Democrats must find common ground with Republicans to stabilize the national debt.
While liberal Democrats point to the Economic Growth, Regulatory Relief and Consumer Protection Act (a 2018 banking law that loosened Dodd-Frank Act Reforms) and MAGA Republicans to so-called “woke” investments as the culprit of SVB’s collapse, the reality is that neither factor was to blame. First, SVB’s commitment to investments in renewable energy, community development, and affordable housing was about $16.2 billion, only 8% of its total assets. And these assets were not the ones underwater.
Second, although SVB was no longer subject to the most stringent Dodd-Frank requirements as it had been previously, the bank was not investing in high-risk assets. It was holding a large portfolio of one of the safest investments in finance, 20- and 30- year Treasuries.
Unfortunately, SVB had too many of these safe assets on its balance sheet when the Federal Reserve began aggressively raising interest rates in 2022 to combat rapidly rising inflation. As a result, higher interest rates reduced the value of SVB’s outstanding bonds and left the bank with insufficient capital. When SVB’s depositors began pulling their money out in response to a decline in the tech sector, the bank sold $21 billion of Treasuries in a 24-hour period (at a loss of $2 billion) — leading to panic (hyper-charged by social media), a run on the bank, and soon after, insolvency.
But rather than focusing on false narratives of what caused SVB’s failure, Democrats and Republicans should focus on how to prevent additional bank collapses — in short- and long-term scenarios.
If the U.S. government cannot reliably pay its debts, lenders will demand higher interest rates for Treasuries, leading to more bank failures.
In addition, without a debt ceiling increase, the lending program that regulators use to keep banks liquid during financial crises (and was used to address the SVB collapse) would be put at risk, creating even more financial uncertainty and the potential for depositor panic.
Once a debt limit increase is enacted, Congress and the president need to come to an agreement to significantly reduce near-term deficits. Doing so would cut demand, help lower inflation, and thereby give the nation’s central bank more flexibility as to the size and timing of future rate hikes.
In the long-term, getting the growing cost of entitlements, tax expenditures, and interest payments on the debt under control will give Congress more fiscal freedom to act in times of crisis. The national debt has jumped 54% since 2017. To restore fiscal stability and reduce the burden on future generations, every option needs to be on the table.
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