The editors of the Wall Street Journal are pretty upset about the direction of the Biden Administration’s strategy in dealing with the banks:
Financial regulators have ignored their post-2008 rule book to contain the latest banking panic. And on Tuesday Treasury Secretary Janet Yellen tore it up by announcing a de facto guarantee of all $17.6 trillion in U.S. bank deposits. Regional bank stocks rallied, but it’s important to understand what this moment means: the end of market discipline in U.S. banking.
“Our intervention was necessary to protect the broader U.S. banking system,†Ms. Yellen told the American Bankers Association convention. “And similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.â€
Translation: Depositors needn’t worry about the safety and soundness of banks. Uncle Sam will make sure you don’t lose money.
This isn’t an explicit guarantee, but it’s close enough for government work.
They characterize it as “the end of market discipline”:
The Administration is presenting its intervention as a one-off. But once regulators do something, they create the market expectation that they will do it again. And if they don’t, the ensuing market panic will invariably impel them. Biden officials are crossing a Rubicon here, and they’re doing it essentially by fiat without approval by Congress.
Regulators have become all too accustomed to doing anything they want during a market panic, reaching for extraordinary power even in non-emergencies. Ms. Yellen may have shored up confidence in midsize banks, but the cost of her guarantee will be a less sound and safe U.S. banking system.
IMO there are only a couple of viable ways to handle the situation.
- All commercial banks could be nationalized and all deposits covered.
- The FDIC’s insurance rates could be raised to cover all deposits. That alone would probably drive some depositors away and cause some banks to close.
- Only insured deposits should be covered; businesses that can’t meet payroll because they had too much in uninsured deposits in the wrong banks should be thrown a lifeline; the Congress should act to change the law consistent with all of this.
My preference is C. We don’t appear to be doing any of those but, as the WSJ editors point out, are encouraging banks (and companies!) to take greater risks.
The coming defeat of the US in its proxy war against Russia, the collapse of our (and Israel’s) diplomatic position in the Middle East, the alienation from the West of almost every country in Latin America, Africa, Asia, and even some allies in NATO and Asia, will fit right right inwith a Western banking crisis.
How did WW II start?
60 Minutes recent special on the difficulties of the US Navy was intended to get the American people ready for a realy big war.
I think someone here pointed out that it has been 40-50 years since a bank went down and depositors were not made whole.
How about D? When its a matter of illiquidity the Fed can step in. Any bank can face a run that it cant handle.
Steve
If that was the case it wasn’t because the FDIC covered uninsured deposits but because the deposits were assumed by another bank. So, for example, four banks failed in 2020. All deposits were covered because for each of those four the deposits were assumed by another bank.
If all banks are of systemic importance, then the term is meaningless.
So where does all the money go when a bank fails, it just doesn’t vanish into thin air, does it?
“If all banks are of systemic importance, then the term is meaningless.”
Precisely. And it encourages poor capital allocation decisions on the part of depositors, management and investors.
“I think someone here pointed out that it has been 40-50 years since a bank went down and depositors were not made whole.”
steve – And? Its one of the things you rail about, and I agree. We shouldn’t let managers reap the rewards of risky behavior, but socialize the losses. Pick a position.
“So where does all the money go when a bank fails, it just doesn’t vanish into thin air, does it?”
The deposits have gone out as loans or to the investment portfolio. Its not in the vault. Simply go to any Banking 101 article and read about fractional reserve banking.
I’ve asked before: When was the last time any depositor took a haircut? I’ve looked and can’t find anything for the past 40+ years. Maybe there is an instance here or there, but I haven’t been able to find anything.
During that time, the norm is for deposits to be de facto guaranteed. They are guaranteed with emergency action from the government, or the government facilitates selling/transferring the deposits to another institution with guarantees that they will be kept whole.
So it seems to me we are and have been, as a matter of practice if not law or discrete policy, already guaranteeing all deposits. Whatever option we try, I think the reality is that the government always will intervene at any scent of a banking crisis, so policy should be informed by that assumption and have the goal of preventing bank runs and failures in the first place.
I’ve seen many on the liberal side – notably Matt Yglesias and Kevin Drum – openly come out and state that the current system is untenable and that the US should move to consolidate banking into around eight giant banks heavily regulated and guaranteed by the government. As more of a philosophical classical liberal, I’m naturally inclined to be hostile to that sort of centralization, but at least it would be a more honest system than what we have now, where we pretend that deposits are at risk when they really aren’t. But the downsides of that should be pretty obvious and they aren’t trivial.
Being a non-expert, I guess the middle-ground for me would be to substantially increase the FDIC limit and/or, issue regulations that require large depositors to buy their own deposit insurance. But then I wonder what insurance company will insure a company like Roku for $400 million in cash and then we are back to government insurance.
So, I dunno what the best solution is.
Andy –
I suspect the reason we have had multiple rounds of bank failures over the years is that managers and depositors know they will get bailed out. That’s the argument AGAINST proposals to keep doing the same, not for it.
Regulatory capture is bad enough as it is. Do you really want the banks nationalized and then being made to make all sorts of organizational, investing or credit decisions at the behest of politicians and the political flavor of the day?
Look at my next post. If Joltin’ Joe decides EV’s are our future do you want banks commanded to invest? You do recall Obama had GM bailed out at the expense of bondholders, right. Its terrifying.
From a CNBC article.
EV losses
Farley argued last year that Ford’s stand-alone EV business will “produce as much excitement as any pure EV competitor, but with scale and resources that no start-up could ever match.”
Still, he described the legacy business as “a profit and cash engine” for the 120-year-old automaker. As with other automakers and EV startups, investors should expect deep losses when it comes to Ford’s electric vehicle business, according to Wall Street analysts.
Model e is expected to include the company’s EV platforms, electronics, batteries, motors, and embedded software and digital experience.
Morgan Stanley’s Adam Jonas expects Ford Model e to have negative gross margins of between 10% and 20% with adjusted EBIT margins of between negative 20% and negative 30%. Both would imply significant losses.
Ford has said it expects 8% margins on its EVs — along with 2 million units in annual production of the vehicles — by 2026, helping to boost its overall adjusted profit margins to 10%. The company’s adjusted profit margin last year was 6.6%.
Deutsche Bank analyst Emmanuel Rosner believes Ford could be incurring gross losses of about $9,000 per EV sold. The analyst expects Ford to reveal Thursday Model e operating losses of $6 billion for 2022. That’s after accounting for significant research and development investments — roughly 65% of the company’s total R&D — into the EV unit.
“The EV business could report much deeper losses than investors expect, which could make Ford’s target for 8% EV EBIT margin by 2026 particularly difficult to achieve,” Rosner said Monday in an investor note.
Aside from EV leader Tesla, no major automakers are expected to generate meaningful profits from electric vehicles for at least several years, as the industry works to increase EV output and manufacturing scale. That’s particularly true of EVs like Ford’s, as mass-market vehicles typically generate lower profits than luxury models.
$9000/vehicle. Remember Solyndra?
@Larry
So where does all the money go when a bank fails, it just doesn’t vanish into thin air, does it?
Actually, some of it does. With the possible exception of M0, all dollars are created from lending. When a loan is paid-off, paid-down, or written-off, money is destroyed. So, money “does vanish into thin air”. Welcome to the Modern Monetary System (MMS).
A bank is just a set of ledgers, and as long as the ledger balances, it is sound. Unfortunately, a ledger imbalance can occur rapidly, and it can be hard or impossible to stop.
Since all bank ledgers are interconnected through the Fed and financial agreements, one bank failure can cause a cascading collapse. This is why Treasury Secretary Paulson soiled his britches in 2008. The Money Market run threatened to collapse the entire financial system.
Nightly, bank ledger imbalances are cleared through lending excess funds or borrowing funds for deficits. When banks refuse to lend or purchase other banks assets, there is a liquidity crisis, and the system collapses.
When depositors lose faith in a bank, they withdraw money, and this causes imbalances in that bank’s ledgers. Unless the ledger is quickly balanced, other banks will/can not lend them the money, and if their assets are illiquid, the bank will fail.
The money that was withdraw before the collapse is now on another bank’s ledger.
The Modern Financial System (MFS) is highly unstable. It is made stable through trillions of daily or hourly adjustments, but this requires liquidity. It is like a multiple, simultaneous, interconnected, 3-dimensional game of musical chairs. It works. Until it doesn’t.
Allowing banks to collapse is like “cutting off your nose to spite your face”.
(M1 & M2 are the the Fed’s lending, and most people consider them base money. I disagree, but that is another discussion.)
TastyBits, thank you! Really!! finally, in my view, a clear understanding of why the bailout needed to happen.
Drew,
“That’s the argument AGAINST proposals to keep doing the same, not for it.â€
I agree with that in theory and in my fantasy world things would be different. But I don’t think we can ignore certain realities – the history of what policymakers actually do and the state of our political system.
As I said, I’m philosophically opposed to the idea of consolidating banking to a few big players. But another reality is that as long as small and medium sized banks keep failing then we are already on that glide slope. I dunno how to actually stop that.
I would prefer a world where there are no systemically critical banks and where any bank that might fail will go through a standardized process that everyone understands ahead of time what will happen. We don’t live in that world and I can see no path to get to that world. And I don’t really know or understand what is actually achievable.
“But I don’t think we can ignore certain realities – the history of what policymakers actually do and the state of our political system.”
Its a conundrum, isn’t it? We capitulate to bad policy because of the awful state of political discourse and incentives.
For what its worth, that’s why I am an advocate, at least always first biased towards, smaller government. I’m not an anarchist, as sometimes exaggerated here. But I’m always fascinated how government induced actions, or regulatory or other government failures or incentives gone wrong are met with calls for yet more government to fix the initial problem. It seems an odd choice.
“I suspect the reason we have had multiple rounds of bank failures over the years is that managers and depositors know they will get bailed out. ”
I think depositors and bankers are two entirely different entities. Lets do bankers and lets remember that bankers actually have incentives that are different from the banks/shareholders. They align at times but not always. Anyway, you claim to have some familiarity with people in the financial sector. Have you actually heard people say lets take big risks because we will get bailed out if we fail? I doubt it. No one has ever fessed up to that. It could be a conspiracy of silence, but I also think it is because they actually thought what they did would work ie arrogance.
So they are always going to be willing to take too much risk since they cant believe their ideas wont work. Plus, there is so much money to be made. Somehow money is an incentive when it comes to paying taxes but it is not when it comes to banking. So the incentives have always existed for banker to take too much risk. Look at the history of bank failures. They existed well before banks got bailed out.
What I think we want to have happen is that the bankers themselves should fail. They should lose jobs, bonuses should be clawed back. Students have to pay back debt if they make a bad decision why shouldn’t the smartest guys in the room, adults, have to pay back ill gotten gains? In some cases bank failures did lose to bankers losing jobs but not enough of them.
Depositors I would break down into two groups. If you are getting some special deal, say higher interest rates, to deposit money above the $250,000 limit then you should be at risk. If you are not then its ok to rescue. (I would also be happy if there were a safe, well known insurance product you can buy to insure risk for amounts over $250k. Some people keep saying these are readily available but I have never seen them and never had a banker offer one or had a financial advisor suggest one.)
Steve
Prohibit branch banking. That used to be the case.
“Prohibit branch banking. That used to be the case.”
Not sure how that would work today when the majority of banking is done online.
It would practically end online banking.
“I think depositors and bankers are two entirely different entities.”
Hello? steve? And then you go on to cite the thing that makes them behave the same: protection from risk.
You gnash your teeth at arrogant bankers, but there is no analysis there. Of course they are arrogant. With no consequences everyone can be arrogant. We see deals all the time that look like they could be home runs. But they have fatal risks that could result in loss of the entire investment. If the investment was guaranteed one could take every riverboat gamble that comes along. Enjoy the gains; socialize the risks.
Depositors are no less arrogant. Without consequences they concentrate their funds in these banks.
“Have you actually heard people say lets take big risks because we will get bailed out if we fail?”
And I’ve never heard a 13 year old say (or his older gang members) let me do the crime because I’m not an adult and will get leniency. But that’s how they behave.
Have you been paying any attention to crime incidence once liberal prosecutors decided they wouldn’t, well, prosecute?
Come on steve, you can do better than this.
“Have you been paying any attention to crime incidence once liberal prosecutors decided they wouldn’t, well, prosecute?”
Why yes. Homicide rates are down 10% ytd after being down 5% last year.
“And I’ve never heard a 13 year old say (or his older gang members) let me do the crime because I’m not an adult and will get leniency.”
You do know this has been covered in a number of books. 13 y/o kids do in fact commit crimes knowing they face fewer consequences. Gangs use teens for certain roles specifically because of that and they tell the kids.
“Depositors are no less arrogant. ”
Some are. I have already said that I would have no mercy for those, however there are many small businesses, like ours, that may have $2-$3 million in an account at any one time. We dont get a special deal from the bank for this. There is no readily available insurance of which I ma aware, and spreading money out to 10-15 different accounts with money going in an out quickly is an invitation to chaos and mistakes. We have tried to mitigate that by choosing very conservative banks, AFAICT, but we dont really access to all of their financial info so we are in the position of hoping they dont do anything crazy.
Steve
@Larry
If you are still following the comment thread, I apologize for the late reply. Now, my job is to write long screeds, and your job is to ignore them. @Drew and our host may read them, but everybody else ignores them.
Not all banks are FDIC members, but after the 2008 Financial Collapse, there are not many outside the system. “Bank” is a catch-all term for numerous types of financial institutions, and these types can operate very differently. Basically, the term “bank” is like the term “dog”.
All dogs have four legs, a tail, and similar genetic make-up, but not all dogs are suitable as a family pet. Banks are the same. Some are good house pets. Some are good guard dogs. Some are good work dogs. Some are smart, and some are dumb as “a bag of hammers”.
Prior to 1998, different types of banks were not allowed to intermingle, and after the 2008 crisis, many large banks were created through “shotgun weddings” arranged by the regulatory agencies.
The regulators determined which banks were too big to fail (TBTF), and mad them even bigger. Most of the proposals here and elsewhere will result in even bigger TBTF banks.
… bailout needed to happen.
Because the financial system has been become intermingled, yes, but it depends what you consider a bailout.
The FDIC insures and regulates commercial deposits and banks, and when a bank fails, the FDIC arranges for it to be sold. During this period, the FDIC does de-facto insure deposits above $250,000, but if a liquidation occurs, they are not covered.
A ‘troubled banks’ is a financial institute that has potential ledger issues due to its asset portfolio and the quality of those assets. Also, different types of banks have different levels of acceptable risk. So, the Bailey Brothers Building and Loan should not be lending money to tech start-ups.
The FDIC keeps and monitors a list of troubled banks, and if a member bank is about to collapse, it begins arranging for it to be purchased by another bank. Usually, this results in a smooth transition, but the process will naturally result in TBTF banks.
SVB was not a typical troubled bank. Usually, a troubled bank has bad assets which cause a liquidity problem, but SVB had a liquidity problem that caused a ledger imbalance. It needed to sell assets, but while its assets were good, those assets were not easily sold at face value.
For US Treasuries, holding them to term will result in full value. At times, they are like an underwater home mortgage, but as long as the homeowner makes the payments, the loan will eventually be repaid in full.
If a financial institution using these assets to balance its ledger, they can run into problems liquidating (selling) these assets for needed liquidity (cash). It would be like buying tons of toilet paper during the COVID shut-down. Now, it is still valuable, but it may take a while to sell your garage full of toilet paper.
(This is different from other assets. Stocks, real estate, currency, baseball cards, and Beanie Babies do not maintain an eventual fixed value.)
The 2008 Financial Collapse was due to bad assets causing a liquidity problem for banks balancing their ledgers. The FDIC was aware of the asset problems, and they had a plan to unwind their member banks.
But, the FDIC was excluded, and TARP was used to bailout some banks by funnelling it through others. This was a bailout, and basically, the government was money laundering.
From 1933 to 1998, the banking system was fairly stable, but there were problems. The S&L Crisis was one, but there were others. Most of the problems have a deregulation component, but there were government actions, also. (1968 – LBJ removed gold cover. 1971 – Nixon closed gold window.)
Prior to 1998, commercial banking was highly regulated, and investment banking was lightly regulated. Glass-Steagall provided stability by erecting a firewall between the two, but there were still bank failures. Also, ending the gold cover (1968) lead to closing the gold window (1971), and this lead to ending Bretton Woods (1973).
Many of today’s villains were confined to Wall Street, and like wolves and bears, they were not allowed to freely roam city streets. Today, we have wild animals living freely in cities, and there is a notion that with laws and animal control this will work without anybody getting mauled.
(NOTE: Villain is a subjective term, and I do not necessarily consider them or wolves to be villians.)
Investing is inherently risky, and there is no way to change that. @Drew notes that you used a Leveraged Buyout (LBO) to buy your home, and your loan is an investment by the bank. Both are true, but in a highly regulated commercial banking system, he is not an interested investor.
In the good old days, you and I were not allowed in @Drew’s territory. He and his peers know a hell of a lot more about the shit he is doing than we do, and if they have any sense, they do not want us there.
We may make quick tasty snacks, but at some point the government is going to start regulating them not us. The G-S firewall protected them as much as us.
The idea that the financial system can be highly profitable, highly liquid, and highly stable is nonsense. There can only be two, and the arguments are between highly profitable and highly stable. The highly stable people are mostly clueless about liquidity, and the highly profitable people assume liquidity is a given.
If you have gotten this far, I apologize for the length.
“For US Treasuries, holding them to term will result in full value………..
(This is different from other assets. Stocks, real estate, currency, baseball cards, and Beanie Babies do not maintain an eventual fixed value.)”
This is a concept that seems to escape so many, Tasty. And they act as if its not a real risk, just a timing issue. Just not true. If you get a redemption spike (just like a pension fund or endowment) you have a real mess on your hands.
“The 2008 Financial Collapse was due to bad assets causing a liquidity problem for banks balancing their ledgers.”
Institutions didn’t know their counterparty risk. What their counterparty had on their balance sheet: value, or air. Instant market lockup, and meltdown.
“So, the Bailey Brothers Building and Loan should not be lending money to tech start-ups.”
Amen. This is a concept that generally just doesn’t seem to resonate here (or elsewhere). There are only three ways to repay a loan: 1) cash flow from operations, 2) liquidation of hard collateral (receivables, inventory PPE), and 3) sale of the entire enterprise. Start-ups don’t have stable “1” or “3.” The only loan they should have is a collateralized A/R and inventory working capital line to get them through the purchase inventory-to-make-a-sale-to-book-a-receivable-to- collect that receivable “cash cycle.” They need to be capitalized with risk capital: non-amortizing subordinated debt or, preferably, equity.