You may have forgotten about the Silicon Valley Bank failure but the Wall Street Journal hasn’t. This quote is from Aaron Klein’s WSJ op-ed:
The deposit-insurance limit didn’t cause this crisis. Silicon Valley Bank’s management caused their bank to fail. The Fed failed as the bank’s supervisor. The bank’s auditors and credit-rating agencies didn’t catch the problem. SVB’s creditors, including the businesses that banked with them, ignored warning signs such as a Journal story five months ago flagging SVB’s problems.
There will always be some banks that fail. Government’s job is to protect the vulnerable, and existing deposit-insurance limits do that. When banks fail, losses should go to those who had their money at risk. Capitalism doesn’t work if the wealthy can never lose their money.
I honestly don’t see how extending FDIC protection to all deposits will work. If you raise the FDIC fees to the level that it will produce enough revenue to cover all deposits against all risks, I suspect that will be high enough to increase the number of the “unbanked” and most of those will be individual depositors and small companies. If you just cover defaults out of what is blithely called the “general fund”, it will effectively subsidize risk-taking to an intolerable level.
It seems to me that the failure was one of oversight. Nobody, not bank employees, board members, large depositors, the FDIC, the Federal Reserve, or anyone else who actually has a fiduciary responsibility was exercising it. Tighter regulations won’t help. Who guards the guards?
The early reports indicated that the SVB failed because the Fed’s raising interest rates had collapsed the value of the bank’s long term, low interest Treasury bonds and other low yield securities. Was that story false? If it was true, then the failure was not due to lack of regulatory oversight, but to the response of the Feds to the inflation caused by the huge covid giveaways.
I wouldn’t say “false” so much as exaggerated. Apparently, various sources had been warning about SVB for months, years even. The bank officials and board, depositors, and regulators ignored the warnings.
I wish the dream of allowing bank depositors to be treated as investors would come true as fast as possible. Then, we would all re-learn the lessons of 1929-1933.
The only reason to keep money in a bank is for liquidity. To invest in a bank, you purchase stock, and when a bank needs more capital, they issue new stock. Banks are not money warehouses.
There is not enough liquid money in the banking system for everybody to get their deposits, at once. When one bank fails, all of its obligations are somebody else’s assets, and as those asset values trend to zero, the asset holders must shore-up their balance sheets. If they cannot they fail.
As this process continues, seemingly “safe” banks suddenly fail, and because no bank can trust any other bank’s ledger will remain balanced, interbank lending slows, causing more bank failures.
There are no “safe” investment banks, and today, all banks are investment banks. Banks do not keep “extra” cash in the safe or on the books. It costs money to do so. The lend it to the most creditworthy borrower available, and once all the most creditworthy borrowers are taken, they lend to the next lower tier.
Allowing capitalism to work for Bear Stearns investors caused Lehman Brothers to collapse, and had capitalism been allowed to work for Lehman Brothers, the entire financial system would have collapsed.
Every bank relies upon every other bank, safe or unsafe. In the post-Glass-Steagall banking system, commercial banks relies upon investment banks somewhere in the interbank lending chain.
Firebreaks do not exist, and in the existing system, firebreaks cannot exist.
Could somebody explain why malpractice insurance does not create a “moral hazard”? Do lifeboats and lifejackets create a “moral hazard”? How about airbags? Are speed limits a “moral hazard”?
I would think that school zones are creating a “moral hazard”. Making sure it is safe to cross the street is a valuable life skill, and not learning this has most assuredly contributing to recklessly street crossers depositing their money in unsafe banks.
Actually, the banking problem is probably caused by the flood insurance program.
It is.
I will wait for my ER Doctor friend to weigh in on this. He can google faster than a speeding bullet and leap tall spreadsheets in a single bound.
It is my belief that most people, including er doctors and pe investors, try to do the right thing, or at least, they convince themselves it is right.
Just so you know Dave, that paper has had its methodology and stats reviewed and its not true. Poorly done. Literature looking directly at the effects of malpractice insurance show that it does influence defensive medicine ie too much testing and too many procedures, though not as much as most docs think. There is no study of which I am aware showing that its presence leads to more actual malpractice. (The costs of any malpractice suit are high. Besides the legal costs people miss days/weeks of work. The incentives all point towards wanting to avoid malpractice besides which people do want to do the right thing the huge majority of the time.)
On topic, my issue which I never see discussed is that for a lot of small businesses, and we are largely not talking about millionaires or international conglomerates, it is very likely that you could have a couple of million in a bank account at any one time. People just casually assert that businesses should maintain 10-15 bank accounts but that sounds to me like a recipe for chaos.
Steve
“If it was true, then the failure was not due to lack of regulatory oversight, but to the response of the Feds to the inflation caused by the huge covid giveaways.”
Bob. You can argue about the pace of the rate hikes. But management knew what rate hikes would do. And after all, rates were at the zero bound. Dave took the broadest view: no one exercized their fiduciary duty. But management was worst.
“On topic, my issue which I never see discussed is that for a lot of small businesses, and we are largely not talking about millionaires or international conglomerates, it is very likely that you could have a couple of million in a bank account at any one time. People just casually assert that businesses should maintain 10-15 bank accounts but that sounds to me like a recipe for chaos.”
Keep it in an investment account, not a deposit in a bank, steve. That’s the way most businesses do it.
Personally, I think it’s unreasonable to expect depositors to constantly and closely monitor a bank’s health. That is one of the defined jobs of banking regulators and they seem to have dropped the ball by not doing anything until the bank run had already begun.
And let’s assume that depositors were able to do that and could do it competently – once they got a hint something was wrong, they would start moving their money and you’d still have a bank run. Even healthy banks can have a run – a bank run is a mass psychological phenomenon, not something that can be modelled on a spreadsheet or account balance.
My view is that policy should be designed to stop bank runs. The easiest way to do that is to guarantee all deposits. We are already doing that, and have been doing that for decades, just not formally. The half-ass, ad hoc, de facto (wink wink) depositor guarantee is the worst of both worlds – costs are still socialized, but bank runs still happen.
I don’t think protecting depositors is a moral hazard. It’s protecting the owners and management of the bank that is a moral hazard. They should not be protected if they screw up their jobs.
I think there are depositors and then there are depositors. When you’ve got $100 million deposited in a bank, it seems to me your responsibility to assess the bank is higher than if you’ve got $100 deposited in a bank. Raising the $100 depositor’s fees to underwrite the $100 million depositor seems downright weird to me.
Allowing a strip club to build next to a school is a really bad idea. Allowing an investment bank to provide commercial bank services is a really bad idea. This is what Glass-Steagall prevented, but in 1998, it was repealed, and ten years later, history repeated itself.
G-S recognized the need for investment banks, but it also recognized the danger of allowing investment banks and commercial banks to intermingle.
We keep finding underage girls working the pole, and nobody thinks that having a strip club and a school in the same building might be the problem.
@Andy
Under G-S, there was no need for all deposits at commercial banks to be guaranteed. If an FDIC member bank was failing, it would be sold, and there was and is a hierarchy for settlement. Since commercial banks were prevented from risky investments, the sector was mostly stable.
Over the years @Drew has railed about the Community Reinvestment Act (CRA). It forced commercial banks to approve risky loans, but there was no way to counterbalance (hedge) that risk. So, a commercial bank was required to operate as an investment bank under commercial bank regulations.
@Dave Schuler
Today, there is no way to determine who is a simple depositor and who is an investing depositor. Prior to 1998, depositing $100 million in a commercial bank was not a really good investment strategy, but it was fairly safe. If your commercial bank failed, you might lose some but not all of your money.
You can invest in a weed store or a drug store, but when the drug store is selling weed, it’s kinda hard to figure out which is which.
“When you’ve got $100 million deposited in a bank, it seems to me your responsibility to assess the bank is higher than if you’ve got $100 deposited in a bank.”
I’m questioning the ability to do that regardless of whether one thinks depositors should have the responsibility. When have depositors ever historically been able to monitor a bank’s health continuously?
The other problem with making depositors responsible is that no bank can survive a bank run. So the depositors that act first might get their money out in time, but those that don’t will be screwed, giving a huge advantage to those who start the bank run. I don’t think that gives good incentives.
Also fundamental to my position is that, despite what is said ahead of time, the government always steps in for bailouts. Unless you can stop that from happening, the idea of holding depositors at risk is a mirage. My position is that – politically – we can’t stop that from happening, so we might as well make it official policy. The onus and responsibility for the stable operation of the bank would be the bank’s owners and employees along with regulators.