This panic was a classic bank run, and it bears an echo to a different historical episode. In the 1980s, lenders known as savings and loans had invested their funds in long-term mortgages paying a fixed rate of interest. When the Federal Reserve, under pressure of rising inflation, began to jack up rates, S.&L.’s had to pay higher rates to attract deposits.
The mismatch between the cost of their money and the (lower) rate that their mortgages earned sank the industry. Many switched to riskier assets to juice their returns, but as these investments soured, their problems worsened. Roughly a third, or about 1,000, S.&.L.’s failed. The F.D.I.C. was not (luckily for it) involved, because the S.&L.’s were covered by a separate federal insurer. This agency, known as F.S.L.I.C., became insolvent, and the subsequent bailout was estimated to have cost taxpayers more than $100 billion.
Silicon Valley Bank’s failure looks a bit like an S.&.L. crisis in miniature. Like its 1980s counterparts, S.V.B. grew extremely rapidly, had many assets parked in fixed, long-term bonds, and was done in when inflation caused the Fed to raise interest rates, raising the cost of keeping deposits.
Like the S.&.L.’s, Silicon Valley Bank was heavily concentrated. It catered to start-ups for whom an S.V.B. account was a matter of status. One tech savant who had recently changed jobs (aren’t they always switching jobs?) told me that in his experience, roughly two thirds of start-ups banked with S.V.B. (the bank claimed that nearly half the country’s venture capital-backed technology and life science companies were customers).
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In the rescue of S.V.B. on Friday and of Signature Bank in New York two days later, the F.D.I.C. overtly ignored the cap and rescued all depositors, irrespective of size. This is a breathtaking leap.
Rescued seven-figure depositors were primarily venture companies steeped in the ideology of investing. The first plank of capitalism is that it entails risk. You cannot sensibly invest without assessing the chance for loss. If venture firms relied on groupthink rather than financial due diligence, that was their doing. In the case of Signature, which was exposed to the crypto industry, the rescue probably bailed out gamblers on speculative assets.
Federal officials have seized on a technicality to claim that it is not a bailout: Any required rescue payments will come from a special assessment on (private) banks, not the public. Prudent banks, which hedged their exposure to interest rates and suffered a competitive cost for doing so, will be hit with the added expense. Most likely, banks will pass along the rescue costs in the form of higher fees to consumers.
Strictly speaking, President Biden’s assurance that taxpayers are not on the line was accurate. However, in the sense that banking customers are a pretty big group, the “public” will be affected.
Moreover, the hazardous effect on behavior will be the same.
The regulators clearly failed to monitor S.V.B.’s unhealthy mismatch of assets and liabilities. Their job will be more difficult in the future, as risk-taking on deposits has effectively become socialized. What if a bank opts to attract more funds by raising its interest rate on deposits? Can the regulators permit it? Wait a second, this is what all banks do.
Once you take risk out of a part of a bank’s operations, it is hard to let market principles govern the rest. We should expect, at a minimum, tougher standards on bank capital (as now exists at the biggest banks), more regulation and higher costs. As this newspaper’s DealBook newsletter has predicted, more loans will move away from F.D.I.C.-member institutions to so-called shadow banks such as hedge funds, outside the purview of regulators.
In past bank failures, uninsured depositors did not lose all — 10 percent to 15 percent was typical. And in this episode, there wasn’t any systemically bad asset à la mortgages in 2008. Given that the risk was contained, and that the Federal Reserve provides liquidity to banks facing runs (and provided emergency liquidity this week), allowing uninsured depositors of banks that fail to suffer a haircut might have been healthier for the system in the long run.
And the bailout does nothing to address the condition that fostered financial instability: inflation. It may even exacerbate it. This is not what Henry Steagall had in mind.
