When Silicon Valley Bank went bust over the weekend, all hell broke loose. Panicked warnings about bank runs spreading throughout the banking system and outrage from depositors who lost money prompted the Biden administration to step in and take action.
Federal officials announced that they would be stepping in and insuring all depositors got their full money back despite the bank’s collapse. Without them taking these measures, many of SVB’s depositors would’ve lost their money because only up to $250,000 is ensured under pre-existing FDIC coverage.
“Let me be clear that during the financial crisis, there were investors and owners of systemic large banks that were bailed out, and the reforms that have been put in place means that we’re not going to do that again,” Treasury Secretary Janet Yellen said. “But we are concerned about depositors and are focused on trying to meet their needs.”
This is not a full-scale taxpayer bailout like the Obama-Biden administration enacted in 2008. But it still has some serious problems.
Everyday Americans WILL face costs
The Biden administration is insisting that this bailout will not directly be funded by taxpayers. Instead, they’re promising that the money will be raised by selling off SVB’s assets (fair enough) and through the “Deposit Insurance Fund — a reserve that is paid for by a quarterly fee on banks.”
That’s definitely better than a direct taxpayer bailout, but it does make other banks suffer the price for SVB’s recklessness, which hardly seems fair. We’ve also got to be honest about the fact that such sharp fees will inevitably get, at least partially, passed on to everyday consumers. There is no magical pool of money the Biden administration can pull from with no consequences for anyone.
Yes, because no bank has taxpayer customers who pay higher fees as a result.
As Gary Gygax called his section on how to deprive player characters of their excess loot in Advanced Dungeons and Dragons, "Duties, Excises, Fees, Tariffs, Taxes, Tithes and Tolls." https://t.co/MQnyCYViZb
— Iain Murray (@ismurray) March 14, 2023
Worsens ‘moral hazard’ in financial sector
The close entanglement between Big Government and the financial sector has already created tremendous “moral hazard,” an economic term for the recklessness that follows when people’s actions are divorced from their consequences. To understand moral hazard, just think about what would happen if the government promised to pay for all car repairs. Obviously, people would be less worried about driving safely and less careful to avoid dinging or scratching their car.
In the same way, bankers have been incentivized to take more risks by the fact that, in the past, the government has bailed them out from facing the consequences when things go awry. They did exactly that in 2008 even though the financial sector made grave mistakes. Ever since, they’ve operated under a higher willingness to take risky bets — as SVB did with its reckless investments — because they know that if things go bad, the government will step in and shield them from the consequences.
And it’s doing that again, albeit only partially. The moral hazard created by Biden’s move is definitely less than what you’d get from a full taxpayer bailout, but it absolutely does nonetheless encourage both bankers and depositors to continue making reckless decisions knowing the full consequences will be softened by the government if and when things blow up.
Stretches federal deposit insurance to dangerous new levels
The federal government is only supposed to insure deposits up to $250,000. But the Biden administration is very explicitly going beyond that to ensure all deposits at SVB, most of which far exceeded $250,000. (So, what exactly was the point of that limit if the feds were simply going to go beyond it anyway when push came to shove?)
The inevitable next step here is full deposit insurance from the federal government. After all, if they’re doing it for SVB customers, how will they be able to justify not doing it for the next bank’s customers? And while full federal deposit insurance might sound like a reasonable thing, it actually makes banking more reckless, not more stable.
“Virtually every academic study of deposit insurance shows that it promotes, rather than reduces, banking system fragility, with major costs borne by the insurers—which means ultimately by insured depositors and potentially taxpayers,” Charles W. Calomiris explains for the Wall Street Journal.
How? By undermining “market discipline,” which previously incentivized depositors to evaluate a bank’s riskiness before giving it their money—and avoid putting it in systems likely to lose it. When the money’s insured by the federal government regardless, there’s no pressure to do so.
So, with the expansion of federal deposit insurance that seems inevitable after Biden’s move, we can expect the banking system to actually get riskier, not more stable.
There was immense pressure on President Biden to “do something” after SVB collapsed. But, while his actions aren’t as bad as they could’ve been (or were in 2008), there are still going to be serious consequences from this federal intervention.