The Fed’s Unpleasant Choice

The Federal Reserve faces a difficult decision at its meeting that ends this afternoon: Should Fed officials raise interest rates in response to worrisome recent inflation data — and accept the risk of causing further problems for banks? Or should officials pause their rate increases — and accept the risk that inflation will remain high?

This dilemma is another reminder of the broad economic damage that banking crises cause. In today’s newsletter, I’ll first explain the Fed’s tough call and then look at one of the lessons emerging from the current banking turmoil. Above all, that turmoil is a reminder of the high costs of ineffective bank regulation, which has been a recurring problem in the U.S.

The Fed’s dilemma

The trouble for the Fed is that there are excellent reasons for it to continue raising interest rates and excellent reasons for it to take a break.

On the one hand, the economic data in recent weeks has suggested that inflation is not falling as rapidly as analysts expected. Average consumer prices are about 6 percent higher than a year ago, and forecasters expect the figure to remain above 3 percent for most of this year. That’s higher than Fed officials and many families find comfortable. For much of the 21st century, inflation has been closer to 2 percent.

An inflation rate that remains near 4 percent for an extended period is problematic for several reasons. It cuts into buying power and gives people reason to expect that inflation may stay high for years. They will then ask their employers for higher wages, potentially causing a spiral in which companies increase their prices to pay for the raises and inflation drifts even higher. Today’s tight job market, with unemployment near its lowest level since the 1960s, adds to these risks. The economy still seems to be running hotter than is sustainable.

This situation explains why Fed officials had originally planned to continue raising their benchmark interest rate at today’s meeting — thereby slowing the economy by increasing the cost of homes, cars and other items that people buy with debt. Some Fed officials favored a quarter-point increase, which would be identical to the increase at the Fed’s meeting last month. Others preferred a half-point increase, in response to the worrisome recent inflation data.

The banking troubles of the past two weeks scrambled these plans. Why? In addition to slowing the economy, higher interest rates depress the value of many financial assets (as these charts explain). Some bank executives did a poor job planning for these asset declines, and their balance sheets suffered. When customers became worried that the banks would no longer have enough money to return their deposits, a classic bank run ensued. It led to the collapse of Silicon Valley Bank and Signature Bank, and others remain in jeopardy.

If Fed officials continue raising their benchmark rate, they risk damaging the balance sheets of more banks and causing new bank runs. That’s why a half-point increase now seems less likely. Some economists (including The Times’s Paul Krugman) have urged the Fed to avoid any additional increases for now. Many analysts expect the Fed will compromise and raise the rate by a quarter point; Jason Furman, a former Obama administration official, leans toward that approach.

The decision is unavoidably fraught. The Fed must choose between potentially exacerbating problems in the financial markets and seeming to go soft on inflation.

Why bailouts happen

All of which underscores the high cost of banking crises. In most industries, a company’s collapse doesn’t cause cascading economic problems. In the financial markets, the collapse of one firm can lead to a panic that feeds on itself. Investors and clients start withdrawing their money. A recession, or even a depression, can follow.

These consequences are the reason that government officials bail out banks more frequently than other businesses. Bailouts, of course, have huge downsides: They typically use taxpayer money (or other banks’ money) to subsidize affluent bank executives who failed at their jobs. “Nobody is as privileged in the entire economy,” Anat Admati, a finance professor at Stanford University’s business school, told me.

During a crisis, bailouts can be unavoidable because of the economic risks from bank collapses. The key question, then, is how to regulate banks rigorously enough to minimize the number of necessary bailouts.

Over the past few decades, the U.S. has failed to do so. After the financial crisis of 2007-9, policymakers tightened the rules through the Dodd-Frank Act. But Congress and the Trump administration loosened oversight for midsize banks in 2018 — and Silicon Valley Bank and Signature Bank were two of the firms that stood to benefit.

As complicated as finance can be, the basic principles behind bank regulation are straightforward. Banks require special scrutiny from the government because they may receive special benefits from taxpayers during a crisis. This scrutiny includes limits on the risks that banks can take and requirements that they keep enough money in reserve to survive most foreseeable crises. “You make sure they have enough to pay,” as Admati put it.

Bank executives and investors often bristle at such rules because they reduce returns. Money held in reserve, after all, cannot be invested elsewhere and earn big profits. It also can’t go poof when hard times arrive.

More on the economy

Silicon Valley Bank was taking obvious risks. The Times Jeanna Smialek asks: Why didn’t the Fed’s regulators intervene?

President Biden needs the Fed to help avert a full-blown financial crisis. Here’s what to expect from the meeting today.

Treasury Secretary Janet Yellen said the Biden administration was prepared to take additional action to protect smaller banks.

On today’s episode of “The Daily,” Barney Frank, an architect of the banking rules, reflects on whether he contributed to the bank failures.


Trump Investigation

The case to indict Donald Trump is full of salacious details, but it hinges on an untested legal strategy.

The Manhattan grand jury investigating Trump meets again this afternoon.

Donald Trump is focused on how an indictment would look, and has appeared disconnected from the potential severity of his legal woes.

Trump advisers hope to turn conservative outlets’ coverage of the investigation into a campaign advantage, The Washington Post reports.

Ron DeSantis is using Trump’s potential indictment to present himself as a low-drama alternative for 2024.

Michael Cohen, Trump’s former fixer, once said he’d take a bullet for him. Now he is trying to expose him.


At a summit in Moscow, Xi Jinping and Vladimir Putin declared an enduring economic partnership to insulate their countries from Western sanctions.

Gangs have taken over much of Haiti’s capital.

Venezuela’s socialist government has improved living standards for some, but not for all.


President Biden designated two national monuments in Nevada and Texas, protecting lands important to Native Americans.

“We were helpless”: Despair spread among C.D.C. workers during the pandemic under the Trump administration, a Times investigation uncovered.

Biden awarded medals to Walter Isaacson, Mindy Kaling, Gladys Knight, Julia Louis-Dreyfus, Ann Patchett, Bruce Springsteen, Bryan Stevenson, Amy Tan, Colson Whitehead and others. (During the ceremony, Biden made a re-election joke.)

Other Big Stories

Google released Bard, its A.I. chatbot, to compete with rivals threatening its search-engine dominance.

A man died at a Virginia psychiatric hospital after police officers and medical workers piled on top of him.

Another round of storms is hitting California.

Los Angeles school workers picketed in the rain during a three-day strike.


The U.S. is no longer the indispensable nation for negotiating peace agreements. Good, Trita Parsi writes.

Rents are spiraling in New York. The state’s Legislature should support more suburban housing, says Mara Gay.


Plane spotting: In Los Angeles, where life can feel cinematic, people gather to watch the skies.

Violent crash: Gwyneth Paltrow is on trial for her role in a ski accident.

Jam or cream: A decade-long quest of love, loss and scones.

Advice from Wirecutter: Get a mug warmer and slippers for people who are always cold.

Lives Lived: Willis Reed brought a resolute physicality to his 10-year career as a center for the Knicks, and his willingness to play hurt created an enduring basketball moment. Reed died at 80.


World Baseball Classic: Japan beat the United States, 3-2. Shohei Ohtani took the mound in the ninth inning and struck out Mike Trout, his Angels teammate. See the final moment.

“Not completely better”: Ja Morant, the Memphis Grizzlies star, said he’s still uncomfortable about his return to basketball after seeking mental health treatment. His coach says he should play tonight.

March Madness: The women’s Sweet 16 is down two No. 1 seeds. It’s a sign of parity among teams, Sabreena Merchant writes.


Return to ‘Camelot’

The musical “Camelot” debuted in 1960, during a golden age for Broadway shows, but it was never as big as “The Sound of Music” or “West Side Story.” A revival, starting next month, tapped Aaron Sorkin to overhaul what critics agreed was the show’s weakness: its script.

Sorkin’s penchant for witty, fast-paced dialogue has created anticipation among theater fans. One of his big changes: no supernatural elements. “This story, in particular, had a chance of landing more powerfully, more emotionally, if people felt real,” Sorkin said.


What to Cook

Ramadan begins tonight in the U.S. For many it wouldn’t be complete without qatayef asafiri, sweet stuffed pancakes drizzled with syrup.

What to Read

Jinwoo Chong’s debut novel, “Flux,” is a brain-bending pleasure.

Busted Bracket?

Our new N.C.A.A. prediction game requires no brackets.

Late Night

The hosts joked about Trump’s potential indictment.

Now Time to Play

The pangrams from yesterday’s Spelling Bee were conveyed and convoyed. Here is today’s puzzle.

Here’s today’s Mini Crossword, and a clue: Lover of Juliet (five letters).

And here’s today’s Wordle.

Thanks for spending part of your morning with The Times. See you tomorrow. — David

P.S. Sign up to receive twice-weekly pop playlists from Lindsay Zoladz, a Times critic.

Here’s today’s front page.

Matthew Cullen, Lauren Hard, Lauren Jackson, Claire Moses, Ian Prasad Philbrick, Tom Wright-Piersanti and Ashley Wu contributed to The Morning. You can reach the team at [email protected].

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