Bailouts/Non-Bailouts

As the fallout continues from the abrupt collapse of the Silicon Valley Bank and the closure of Signature Bank, the federal government’s response to those developments raises some serious questions.

Over the weekend, the Federal Reserve, the Treasury Department, and the Federal Deposit Insurance Corporation announced that all of the depositors in SVB and Signature Bank will be repaid in full, even if they kept more than the $250,000 federal deposit insurance limit in their bank accounts. In addition, the Fed announced that it would offer banks loans against the face value of their Treasury bills and notes and other holdings, even if inflation has eroded the actual worth of those investments.

The government contends that these actions don’t represent a “bailout,” technically, because the banks have been closed and those who owned stock in the banks will lose the value of those investments–but the actions sure smell like a bailout to many people. Some will praise the government for acting swiftly to avoid a potential panic and runs on other banks, but others will wonder about where we now draw the line on the full faith and credit of the U.S. government being employed in the wake of a bank collapse and whether the government’s action was motivated, even in part, by the fact that powerful people in California and elsewhere apparently had relationships with the banks.

President Biden, quoted in the Times article linked above, made an important point when he said that investors in the two banks “knowingly took a risk, and when the risk didn’t pay off, investors lose their money. That’s how capitalism works.” That is unquestionably true, but those who kept more than $250,000 in the banks also took a risk, because $250,000 is the limit for federal deposit insurance. Why should those people and entities be protected against what was a known, avoidable risk? And if the U.S. government is making every depositor whole, what is the point of having an announced limit for federal deposit insurance? Does this mean that, from now on, every depositor will be protected in full, irrespective of how much they have in their accounts? If not, what’s the distinction? And doesn’t this decision encourage risky practices by depositors and banks?

Left unsaid at this point is how the federal government is going to pay for acting as a backstop–again–for troubled banks. Banks have to be permitted to fail, and depositors have to understand that there is risk in going over announced deposit insurance limits. Otherwise, there is no point to having announced limits, and we are left in the untenable position of the federal government insuring every dollar deposited in a bank.

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.