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.

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.