The Moral Hazard Administration

The editors of the Washington Post have expressed their views on the tack the Biden Administration is taking on the incipient banking crisis and their views are closely aligned to those of the editors of the Wall Street Journal—the administration is erring and introducing serious moral hazard:

President Biden has long positioned himself as a champion of the middle class, but his administration’s bank bailouts have the potential to become a generous gift to the rich. The most controversial aspect of the emergency rescue of Silicon Valley Bank and Signature Bank was the decision to fully compensate all depositors of those banks, even sophisticated millionaires and billionaires who presumably were fully aware that the amounts they were holding in their accounts were well above the usual $250,000 limit that the government insures.

Now other bank executives are understandably asking: Are all their customers’ deposits fully insured as well? Treasury Secretary Janet L. Yellen pretty much said yes this week when she told the American Bankers Association that it is “our resolute commitment to take the necessary steps to ensure that deposits’ savings and the banking system remain safe” and that “similar actions could be warranted” if other institutions face runs like Silicon Valley Bank did.

A blanket government backing of all deposits in the United States would be a mistake. It would encourage risk-taking at banks because they know the government would step in if they faltered. Even worse, such sweeping action would protect wealthy Americans — and would be funded through fees that banks pay to the Federal Deposit Insurance Corporation, which means, indirectly, by anyone with a bank account.

They have their own proposal:

There is a better approach. The goal should be to protect the savings of the middle-class bank customers and of the small and midsize businesses that are key to economic dynamism and growth. These are the people and firms for whom the FDIC’s safety net was designed during the Great Depression, when thousands of banks failed, leaving their customers stranded. They do not have the financial sophistication, or the armies of financial analysts, to assess bank balance sheets and suss out the likelihood that a bank is going to fail.

To achieve this goal, the FDIC should continue to insure accounts up to $250,000 and add an emergency provision to fully back all “transaction accounts” that businesses use to make payroll and cover other basic needs. In so doing, it would protect the vast majority of U.S. deposits. It would also stabilize the banking system. This is exactly the approach that the FDIC took during the 2007-2009 financial crisis to help buttress the system during a more extreme crisis. Though such a move would require increasing the fees that banks pay to the FDIC, it would be manageable, especially if the coverage is temporary.

That will almost undoubtedly require an act of Congress.

As I see it there are several strategies that might be used:

  • Cover all deposits regardless of size by having the Treasury underwrite them. Not only is that at odds with controlling inflation, it is probably illegal and will disproportionately help rich depositors.
  • Cover all deposits regardless of size through the FDIC, increasing the FDIC levy to cover it, either via special levy or permanently. That appears to be the WaPo’s proposal using a special levy. That will bring a host of unforeseen secondary effects including driving some banks out of business (because depositors flee due to the increased cost), increase the number of the unbanked, and disproportionately help rich depositors.
  • Cover all deposits regardless of size through the FDIC, increasing the FDIC levy using a graduated scale to ensure progressivity. That alleviates some but not all of the problems listed above.
  • Let the FDIC cover deposits up to $250,000. Caveat emptor. Some companies may go out of business.
  • Let the FDIC cover deposits up to $250,000. Provide assistance to companies to allow them to meet payroll on a case-by-case basis. That seems to be the approach proposed by the editors of the WSJ.

If the last alternative is selected I think it absolutely, positively needs to be covered by either a) an increase in taxes or b) a reduction in other spending in the amount of the assistance. Anything else is inflationary.

Regardless of which strategy is adopted, there should be investigations, not just by the FDIC and the Federal Reserve but by the Congress as well.

1 comment… add one
  • Drew Link

    No great alternatives. No riskless society.

    Perhaps a variant on dot point two. Only partial coverage of depositors over some limit. (graduated?) Offsets some costs. Directs costs to the beneficiaries. Keeps incentives to be vigilant. But unwieldy.

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