This week in Bidenomics: Bank failures? WUT?

There’s more solid news from the labor market. But never mind that.

Anybody familiar with the 2008 financial crash gets palpitations with they hear about a bank going down. And a bank is going down. It doesn’t mean another crash is coming. But it does highlight the havoc inflation and rapidly rising interest rates can cause.

A California lender called Silicon Valley Bank shocked investors on March 8 when it announced plans to raise new capital, usually a sign of financial distress. The bank’s shares fell 60% the following day and the NASDAQ exchange halted trading in the stock on March 10. Then the Federal Deposit Insurance Corp (FDIC) seized the bank, shutting it down before a chaotic bank run vaporized all deposits. It’s the biggest bank failure since the 2008 crash.

FDIC insurance guarantees all deposits at the bank up to $250,000, which the FDIC says will be fully available beginning March 13. But SVB served many startup businesses and venture-capital firms, and many of them had more than $250,000 at the bank. Depositors with more than that, who didn’t manage to pull their money, will get “receivership certificates,” according to the FDIC. That sounds like a bankruptcy-style claim likely to amount to less than 100 cents on the dollar.

Most of the financial industry blowups of late have been crypto-related, including a California bank called Silvergate that served crypto firms and said it was winding down its business on March 8. But SVB is not a casualty of the crypto winter. It’s more like a regular bank that got squeezed as several forces crashed into each other in ways nobody foresaw, which is often how unexpected disasters occur.

SVB got into trouble as the startup industry slowed and depositors pulled money from the bank. To cover withdrawals, the bank had to liquidate assets, including billions of dollars in government bonds paying interest rates considerably lower than prevailing rates. Had SVB held those bonds to maturity, it wouldn’t have lost money. But being forced to sell caused losses that threatened the bank’s solvency. When it indicated the need to raise new capital, more depositors pulled their money, triggering a fatal run.

The question now is whether SVB is a harbinger of a broader banking crisis. It’s possible. While most retail banks aren’t overexposed to swings in the startup economy, virtually all of them are vulnerable to interest-rate risk. To combat inflation, the Fed has raised interest rates by 4.5 percentage points during the last 12 months, one of the fastest monetary-tightening cycles ever. Banks ultimately benefit from higher rates because they can charge more for loans. But they also have pay to higher rates to attract and keep depositors, whose money they need as the basis for loans.

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If the transition from lower rates to higher ones happens too fast, bank customers may pull their money to earn a higher rate of return somewhere else. If that happens en masse, it triggers the kind of asset selling that locked in insurmountable losses at SVB.

The nation’s biggest banks—JPMorgan Chase, Citibank, Bank of America, and so on—have dramatically improved their stability since the 2008 crash, in part because new requirements force them to. An interest-rate squeeze could dent profitability or cause losses, but probably not threaten their viability.

Some analysts, however, think regional, medium-tier banks could be in worse shape, with a few more meltdowns coming. The KBW bank-stock index fell 16% in 5 days from March 6 -10, reflecting those fears. That’s the biggest drop since the beginning of the COVID pandemic in 2020.

President Biden hasn’t said anything, so far, about the SVB failure or broader risks to the banking sector. On March 10, he cooed about the February jobs report, which showed employers created an impressive 311,000 new jobs for the month. The White House has also been boasting about the American Rescue Plan (ARP), the 2021 stimulus law Biden signed that pumped $1.9 trillion into the economy.

Biden hasn’t made the connection between the ARP and the emerging stress banks are under—but there is one. The ARP contributed to high inflation by fueling spending at a time many goods were already scarce because of COVID-related supply-chain snafus. There were other causes, but the ARP certainly helped push inflation to a peak of 9% last summer. That rapid rise in inflation forced the Fed to start hiking rates at one of the fastest paces ever. SVB and its money-losing depositors are now the first big casualties of that.

Inflation has come down, to 6.4% in the latest reading. But that’s nowhere near the Fed’s target of 2% or so, and Fed chair Jerome Powell has repeatedly said the Fed has more work to do, by pushing rates higher. The strong labor market, solid wage growth, durable spending and other factors all continue to show that many of the forces that caused inflation in the first place are still there. The Fed could raise interest rates by another point or more before it’s done.

If SBV turns out to be a one-and-done, the economy will shrug it off, and adapt to higher interest rates. But if more bank failures are coming, it will be a next-level concern for consumers, investors, and Biden himself. The worst type of business failures are bank failures, because they control the capital the economy needs to function. If that seizes up, every other problem becomes minor by comparison.

Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman

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