The Federal Reserve is sticking with its fight against inflation, confident that a massive government intervention to stabilize the banking system has averted a crisis.
“You can think of it as being the equivalent of a rate hike or perhaps more than that,” Fed Chair Jerome H. Powell said at the end of the central bank’s two-day policy meeting. “Of course, it’s not possible to make that assessment today with any precision whatsoever.”
The Fed joined the Treasury Department and the Federal Deposit Insurance Corp. earlier this month in an extraordinary intervention in the banking system, offering loans on favorable terms to banks that needed cash and guaranteeing deposits up to any amount at Silicon Valley Bank and Signature Bank when those institutions failed.
Those moves came as Fed officials were eyeing other economic data warily. Just before the banks collapsed, Powell told Congress that the Fed might need to raise interest rates more aggressively than planned because the economy was still running too hot.
But the economic picture quickly changed, and borrowing became more difficult as the banking system took a hit. Policymakers considered leaving interest rates unchanged on Wednesday, but they ultimately decided to move forward with a quarter-point hike as they prepare to stop sometime soon.
Now the question is whether the rate increases over the past year, combined with the banking meltdown, will slow the economy too much — or whether the Fed can bring inflation down to normal levels without causing a deep, painful recession.
Financial markets expected Wednesday’s move, which brought the Fed’s base policy rate to between 4.75 and 5 percent.
“The search for a soft landing seemed a lot more like a hope than a path,” said Diane Swonk, chief economist at KPMG. “We’re so early in this. … He talked about a pause, and they are obviously worried about signaling what’s next. They just don’t know.”
Stock markets were muted around midday, then rose slightly off the rate hike announcement. But the major indexes closed in the red, with the Dow Jones industrial average falling 531 points, or 1.63 percent. The S&P 500 fell 1.65 percent, and the Nasdaq 1.6 percent.
The central bank is also facing questions about its regulatory oversight of SVB, as Washington tries to figure out whether the government could have prevented the turmoil in the banking sector. Powell said that as the Fed tried to understand “how did this happen,” focus shifted to “what are the right policies to put in place, so it doesn’t happen again.” Management at SVB “failed badly,” Powell said, even while regulators were aware of problems and tried to intervene.
The Fed has undertaken an internal probe, and Powell said he would “welcome” an outside investigation. But it remains to be seen if — or how — the Fed will change its own regulations to prevent a similar shock. Pressure is mounting on Capitol Hill for the central bank to explain how its policies made it possible for SVB to fail, threaten the broader economy and necessitate emergency action.
“What went wrong here? How did this happen?” Powell said. “We will find that and then make an assessment of what are the right policies to put in place so that it doesn’t happen again.”
Treasury Secretary Janet L. Yellen also faced tough questions from lawmakers in both parties while testifying on Capitol Hill on Wednesday about the response to the banking crisis. Yellen and Powell have tried to assure Americans that their bank deposits are safe without putting the federal government on the hook to backstop every bank account — a position that has sometimes proved difficult to articulate.
Under questioning from Sen. Bill Hagerty (R-Tenn.), Yellen denied a news report that Treasury officials were considering lifting the FDIC’s insurance limit from $250,000 on their own. Raising that limit would probably require approval by Congress.
“This is not something we have looked at. This is not something we are considering,” Yellen said.
Still, Yellen maintained that Americans should consider their deposits safe. She told lawmakers that the administration will consider protecting more deposits but declined to endorse a specific limit.
“We need to focus on improving the confidence of the public, [so they know] that we do have a sound banking system; and we can debate in the days ahead whether or not $250,000 is the right level for deposit insurance, or if that system could be changed in some way,” Yellen said.
Bank stocks fell after Yellen’s remarks, though, because she left open the possibility that the federal government would not intervene to protect depositors over the current FDIC limit if other banks fail.
The Fed is now pressed to answer whether its interest rate increases are destabilizing parts of the economy, rather than just slowing it down. As the Fed raised rates repeatedly last year, the value of bonds issued at lower interest rates went down. SVB held an unusually high percentage of its assets in Treasury bonds and other long-term instruments that suddenly lost their value, meaning the bank couldn’t easily sell them for what it would have needed to get cash for depositors who wanted to make withdrawals.
In response, the Fed opened a lending program to help keep money flowing through the banking system. On Sunday, the Fed also announced it was coordinating with other major central banks to ease strains in dollar funding markets, a major move that was previously employed in 2020 — when the pandemic started — and 2008, during the financial crisis that led to the Great Recession.
The two-day policy meeting on the heels of the bank rescue was yet another twist for an economy that’s been hard to steer. In the past few months alone, policymakers and economists have shifted their tunes — at times expecting an inevitable recession, no recession, persistently high inflation or an all-out banking catastrophe.
In a fresh crop of economic projections, officials penciled in one more quarter-point rate increase this year, though future moves depend heavily on how the economy behaves. Officials otherwise made small tweaks to their previous estimates from December. They now expect the unemployment rate to end the year at 4.5 percent (down from 4.6 percent the last time the bank made projections) and that the economy will grow by 0.4 percent this year (down from the 0.5 percent they projected in December). Inflation will remain above normal levels through the end of 2023.
Powell said he still saw a path to what’s known as a “soft landing,” when policymakers manage to bring down inflation without causing a recession. But time and again, the Fed’s attempts to look ahead have been thwarted — once by the coronavirus pandemic and again when the war in Ukraine began. Now the rapid interest rate increases of the past year are also contributing to a worrisome degree of instability in the financial system.
SVB’s failure has also put the Fed — which works hard to maintain its independence — under a harsh political spotlight. Earlier on Wednesday, Sens. Rick Scott (R-Fla.) and Elizabeth Warren (D-Mass.) unveiled legislation that would replace the Fed’s watchdog with an inspector general appointed by the president and confirmed by the Senate.
For more than a year, Democrats and Republicans have been at odds over the Fed’s policies, with Scott and Warren typically holding opposite views. But scrutiny of the central bank has taken on a new dimension as lawmakers of both parties ask whether the Fed failed in its supervisory duties. That’s coming at the same time that more officials, including Democrats on the Senate Banking Committee, are calling for an end to rate hikes, fearing repercussions for the job market.
“The recent bank collapses and regulatory failures by the Fed have underscored the urgent need for a truly independent Inspector General to hold Fed officials accountable for any lapses or wrongdoing,” Warren said in a statement.
Jeff Stein contributed to this report.