When the Watchman Sleeps

The Federal Reserve's Vice Chair for Supervision, Michelle Bowman, has acknowledged what a new report now makes plain: the Fed's own staff possessed the information needed to identify Silicon Valley Bank's fragility and did not act on it in time (CNBC). The bank failed in 2023. Depositors were rescued at public cost. The question that demands answering is not merely how the examiners missed the signs, but why a supervisory apparatus, furnished with every legal power it required, allowed a concentrated and poorly hedged institution to accumulate risk until the run came.

I have never held that free markets require no regulation. On the contrary, I argued at considerable length that the framework of law and institutional discipline is precisely what makes free exchange possible and honest. A market without credible supervision of its banks is not a free market — it is an arena in which the imprudent can externalize their losses onto the public, which is a subsidy by another name. The East India Company of my day wielded monopoly privileges that let it socialize its disasters; a bank that operates in the certain knowledge that its collapse will be managed at public expense enjoys a similar, if quieter, advantage.

The moral philosophers of commerce have always known that information is the lifeblood of honest exchange. A buyer who cannot know the quality of what he purchases, a depositor who cannot know the solvency of his bank — these are not parties to a free and equal contract. They are parties to an asymmetric one, in which the better-informed side extracts advantage from the worse-informed. The regulator's function, properly understood, is to correct exactly this asymmetry: to stand as an informed proxy for the depositor who cannot himself examine the bank's balance sheet.

What the CNBC report suggests — and I mark this as inference, since I have not read the full document — is a failure not of legal authority but of institutional culture and attentiveness. This is, to my mind, the more troubling diagnosis. A lack of statutory power can be remedied by legislation; a failure of professional seriousness within an institution is harder to cure. The division of supervisory labor — examiners, economists, senior staff, board — can produce the very fragmentation of attention that the division of productive labor sometimes produces in the workshop: each hand attends to his own narrow task and no mind holds the whole picture.

I wrote in The Wealth of Nations that the proposal of any new regulation from those who trade in money ought to be received with great suspicion, since it commonly comes from men who have an interest in deceiving the public. But I also wrote that the sovereign has a duty to maintain the integrity of the banking system, precisely because the failure of that system falls on the many, not merely on the imprudent few. The resolution here is not deregulation, nor yet an ever-thicker rulebook. It is accountability: clear lines of responsibility, publicly answered for when they are breached, and a supervisory culture that understands its obligation to the depositing public as a moral one, not merely a procedural one.

The institutional question, then, is this: what framework ensures that the examiner's report reaches a mind capable of acting on it, and that the person in possession of that authority has the professional courage to do so? Answering it honestly, rather than reorganizing the same incentives under a new acronym, is the sovereign's obligation — and the public's right to demand.