The Pulverizing Power Of Panic

Yesterday a bank failed. Silicon Valley Bank, one of the most prominent lenders to the tech industry and the 16th largest bank in the country, was shut down by the California Department of Financial Protection and Innovation, and the Federal Deposit Insurance Company took over operations as the bank’s receiver. The collapse of SVB is the second largest bank failure in U.S. history.

Bank failures are never pretty. They often recall Ernest Hemingway’s famous observation that there are two ways to go bankrupt: “gradually, and then suddenly.” Banks operate on a foundation of trust in their stability and integrity, and when that foundation is undercut, failure can occur with breathtaking speed. That appears to be what happened with SVB.

As an interesting CNBC article recounts, SVB’s downfall took less than two days. On Wednesday, the bank advised investors that it needed to raise $2.5 billion. At that point, the bank was apparently still reasonably well capitalized; at the end of December, it reported $209 billion in assets and $175 billion in deposits. But underlying issues with the American economy had caused some start-up depositors to withdraw their assets to stay afloat, the bank found itself short of funds and was forced to sell the bonds it had available for sale at a loss, and when it announced it needed to raise additional funds the blood was in the water. The bank’s stock price plummeted, the tech investment community spread the word that deposits should be removed from the bank, and customers withdrew an astonishing $42 billion in less than 48 hours, leaving the bank with a negative cash balance of $958 million. With the bank insolvent and unable to find a buyer, regulators stepped in.

The CNBC article quotes one fintech investor as saying that the failure of SVB was “a hysteria-induced bank run” caused by venture capital firms. That’s often what happens–and the sad thing is that the people who panic, withdraw their funds, and precipitate bank failures usually end up safe, whereas the people who leave their money in the bank and trust that all is well often end up sorry. In the case of SVB, the people who kept their deposits in the bank will now have to deal with the FDIC, which insures deposits up to $250,000 per depositor. If you’re someone who had more than $250,000 on deposit at SVB, you might well find yourself out of luck.

For all of our thin veneer of civilization and sophistication, people are still prone to panic–especially panic about money. Let’s all hope that the failure of SVB, coming on the heels of cryptocurrency collapses and other recent negative financial developments, doesn’t provoke a stampede.

Bank Failures And A Salutary Example Of Federal Regulation

Yesterday the FDIC announced the failure of three more banks, bringing the total number of bank failures this year to 123.  The 123 failures this year compare to 25 failures last year and three failures in 2007; there have been more bank failures this year than in any year since 1992.  The cost to the FDIC fund for the failures this year has exceeded $28 billion, and is one of the reasons the FDIC is looking to banks to prepay fees to help cover bank failure costs over the next few years.

The FDIC website has lots of information about the bank failures, including a list of all the institutions that failed this year and a guide for depositors who wake up to find that their bank has failed.  If you review the list of bank failures, you will note that they occur in week-long intervals.  That is because the FDIC typically announces bank failures on a Friday, after determining whether a healthy bank will assume some or all of the assets and liabilities of the failed institution.  The weekend then allows the FDIC to sort things out, so that commerce can proceed and accurate information can be made available to all affected parties the following Monday.  This weekend no doubt will see hectic activity at the offices of all three failed banks.

Conservatives often complain about government regulation, but I think the FDIC, its role, and the calming effect of federal insurance of bank deposits should be regarded as an inspired example of the salutary role federal regulations can play under the right circumstances.  Messy bank failures are, for the most part, handled quickly and discreetly.  As the story about funding linked above indicates, the regulated banks that benefit from the FDIC’s guarantees pay fees to defray the costs of the regulatory regime to the government.  And, the reality of federal support and insurance has had a calming influence on depositors that has avoided the panicky runs on banks that were seen during the Great Depression (and memorably depicted in It’s A Wonderful Life).  Without such insurance and depositor confidence, how would consumers react to alarming news stories about a dramatic spike in bank failures throughout the nation?

Of course, the fact that banks are failing says something negative about our economy, but it mostly says something negative about the bankers who ran the banks.  The traditional stereotype of the conservative, cautious, boring banker has long since been overtaken by extraordinarily aggressive practices by banks in their residential and commercial lending areas, in their issuance of credit cards and other forms of consumer credit, and in their general business operations, growth plans, and mergers.

Grampa Neal, who epitomized the traditional conservative model of a hard-headed banker who wanted collateral and protection before he made a loan, would no doubt cringe in horror at the lax practices of modern banks.  If the current crisis causes banks to return, even slightly, to more conservative lending practices that reject hyper-risky loans, that would be a good thing.