Let Them Fail

Peter Jacobsen makes a prudent observation at the blog of the Foundation for Economic Education:

Allowing banks to fail may sound extreme, but it’s really the most reasonable solution. It’s true there will be some costs if the banks fail. Any time a business fails, other investors tied financially to the company lose.

But here’s the rub—people who invest in bad businesses should lose. SVB’s failure is a reflection of the fact that it was a wealth shredder. It took depositors’ perfectly good cash, and converted it into now severely devalued bonds.

Banks that destroy wealth shouldn’t be allowed to continue to do so indefinitely. And when depositors make a “run” on bad banks, they’re performing a public service.

At this point, a bank bailout not only would mean the taxpayers will be left holding the bag for bankers’ mistakes—it would mean screwing up incentives in the banking industry even more.

I suspect it will go unheeded. Here’s another consideration: it’s incoherent on the one hand to complain about income inequality and on the other to bail out financiers when they screw up. If there’s a more perfect example of privatizing profits and socializing losses than that I don’t know what it is.

Bailing out big banks when they screw up is a prima facie case that regulators don’t care about income inequality.

I’m not sure what the Biden Administration’s hypothetical retort to that would be. That they don’t want little people to get hurt? Little people don’t have deposits over $250,000 in banks. And harsh as it might be to say the tech companies that stored tens or hundreds of millions in Silicon Valley Bank don’t actually employ that many people and the median household income in Silicon Valley is $140,000/year. It’s a stretch to call those the “little people”.

7 comments… add one
  • bob sykes Link

    SVB’s investments in bonds only became stupid after the Fed raised interest rates. There must be dozens or hundreds of large banks in the same predicament. Should we forbid banks from investing in government bonds, or bonds with a maturity of moe than one (1) year?

  • CuriousOnlooker Link

    The chairman of the FDIC said last week (just before the collapse of SVB) that the banking system is sitting on $620 billion of unrealized losses on treasuries due to the rise in interest rates.

    To give an estimate of the size of the problem, that’s approximately 20% of the tier 1 capital that banks have altogether.

    On the other hand; this is quite a solvable problem. Those losses can be made whole by just changing one number —if the Federal Reserve rate went from 4.5% back to 2%, those losses disappear.

  • TastyBits Link

    Letting a bank fail sounds great, until you realize how interconnected the financial system is. Financial institutions are not single entities. One bank failure causes other bank failures. This is what started the Great Depression.

    Allowing investment banking and commercial banking to freely intermix is a bad idea. This is what Glass-Steagall was designed to prevent.

    Unless it has changed, the FDIC is self funding. FDIC banks pay for all loses. The FDIC may get loans from the government, but they are repaid through special levies on member banks.

  • PD Shaw Link

    What is the function in Jacobson’s world for depositors as important risk evaluators? Mainly he seems to see their suffering as what makes us all free from bad banking. I understand leaving shareholders with the losses, they sought to profit by the business, they have input into corporate governance, and their are institutional investors in position to evaluate the risks and influence pricing accordingly.

    Apparently most depositors had non-interest bearing which seems to indicate that their accounts for regular business expenses, like payroll, FICA, insurance, rent, etc. I’m trying to imagine wealthy individuals “investing” in banking deposits. I’m sure they exist, perhaps touched at least indirectly by the hand of the Great Depression, but seems farcical if so. I don’t think businesses have to be that large to exceed $250k deposits, and Jacobson says of them “business deals have risk.”

    How do responsible businesses deal with non-investment risks? Do they have access to a bank’s lending/investments statements? If so, how frequently do they need to inspect? What is the responsible business supposed to do if it simply wants to have an account to pay employees, buy paper products from the break room and pay the rent? Open multiple accounts in different banks? Does Crypto have a role here?

  • Unless it has changed, the FDIC is self funding. FDIC banks pay for all loses.

    The FDIC covers insured deposits. Most of the deposits in SVB were uninsured.

  • steve Link

    It looks like they are letting bank itself fail. That’s fine with me, but I am less sure about the depositors. OTOH if they had truly large amounts in that bank and they were getting interest on it I dont feel so bad. OTOH, PD is correct that you dont need to be that big and you can be very conservative and still have millions in deposits at any one time. We do. Could we have 20 different bank accounts to spread out that risk? Maybe but that also seems like a recipe for disaster as we have to tell the insurance companies where to send the checks and handing out 20 addresses is going to cause mistakes.


  • TastyBits Link

    When the FDIC takes over a bank, they do not just send checks to the insured depositors. They arrange for a buyer. The uninsured depositors are part of the purchase.

    The era of Bailey Brothers Building and Loan is long gone, and Uncle Billy does not physically make deposits at Potter’s bank. With the exception of desks, computers, and buildings, a bank is simply an amalgamation of ledgers.

    It is my understanding that this was an old fashioned bank run, but unfortunately, there was no George Bailey to calm the depositors.

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