The Old Policy Issues Behind the New Banking Turmoil

As the shares of regional banks plummeted on Monday, while the over-all market held up reasonably well, the Biden Administration insisted that the steps it took over the weekend to prevent a full-on depositors’ panic didn’t amount to a taxpayer bailout. After the Federal Deposit Insurance Corporation shut down Silicon Valley Bank on Friday and Signature Bank, a crypto-friendly institution, on Sunday, it moved to protect all of their depositors, even the uninsured ones. “No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer,” the Treasury Department, the F.D.I.C., and the Federal Reserve said in a joint statement on Sunday. On Monday morning, President Biden repeated this message and added: “I am firmly committed to holding those responsible for this mess fully accountable.”

As far as the executives and shareholders of S.V.B. and Signature go, the Administration is on firm ground: taxpayers aren’t bailing them out. In closing down S.V.B., which was a big lender to tech companies, the F.D.I.C. promised to remove its top management, wiped out its shareholders, and created a new legal entity, the Deposit Insurance National Bank of Santa Clara (D.I.N.B.), to take over operations pending a possible sale. (Similar treatment was meted out to Signature.) Still, some individuals and businesses clearly benefitted from the government’s emergency intervention: S.V.B. and Signature customers with deposits that exceeded the quarter-million-dollar limit for insurance. “When you have people who were going to take losses and now they are not, they are being bailed out by somebody,” Morgan Ricks, a law professor at Vanderbilt University who previously worked at the Treasury Department, told me on Sunday night. “They have been making a lot of noise to be made whole, and now they are made whole.”

According to the joint statement, “any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.” This suggests that the ultimate cost, which at this stage is highly uncertain, will likely be borne by customers and shareholders at other banks. But, even if taxpayers aren’t directly on the hook for losses at S.V.B. and Signature, the actions taken raise larger questions about the financial sector and the favorable treatment it receives from the federal government, including implicit financial assurances that tend to become explicit guarantees during moments of crisis like this.

These questions were raised fifteen years ago, during the great financial crisis, when Congress bailed out the big banks and the Federal Reserve introduced a number of emergency-lending programs to stabilize the financial system. Essentially, taxpayers provided the banks with a much needed injection of capital, and the Fed agreed to allow these institutions to park some of their impaired assets in the central bank as collateral for cash loans. The reforms introduced under the Dodd-Frank Act of 2010 were meant to prevent such measures from being necessary. But, as part of Sunday’s rescue plan, the Fed launched a new lending vehicle, the Bank Term Funding Program, with Treasury backing, which will accept banks’ impaired assets as collateral at par value, thereby enabling them to avoid having to sell the assets at a loss, which was what happened to S.V.B. Evidently, the Fed believes that this move was necessary to defuse a potentially major problem: many banks are sitting on large holdings of Treasury bonds and other assets that have declined sharply in market value since it started raising interest rates. But the 2010 reforms were meant to prevent an intervention on this scale from happening.

What went wrong? In the case of S.V.B., it appears to have been a combination of incompetent management, lax regulation, and some powerful people in Silicon Valley crying fire in a crowded theatre. As interest rates fell to record lows during the pandemic, S.V.B. seems to have loaded up on long-term Treasury bonds, which had the highest yields, and failed to hedge against the possibility of interest rates rising. In retrospect, this was such a reckless move that it raises the question of why the bank’s primary regulator—the Federal Reserve—didn’t spot it and demand remedial action. One contributory factor may have been a loosening of the Dodd-Frank regulatory rules for medium-sized banks, which both parties in Congress approved in 2018 at the behest of the bank lobby. Among the changes: banks like S.V.B. were no longer subjected to annual stress tests, which could have enabled regulators to discover some of their vulnerabilities.

Finally, when S.V.B.’s financial problems emerged, and its top brass sought to address them by raising more capital, the entrepreneur Peter Thiel’s Founders Fund and other Silicon Valley figures reportedly advised companies to withdraw their deposits from the bank ASAP and a full-blown bank run ensued. Once the sixteenth-largest bank in the country collapsed, and the stocks of other banks plunged, it was pretty much inevitable that the authorities would step in to prevent further runs, a phenomenon known on Wall Street as contagion. According to the joint statement issued on Sunday, the F.D.I.C. and the Fed advised the Administration that these measures were necessary, and President Biden agreed to them.

Clearly, there is plenty of blame to go around. But the larger issues here are the same ones that the 2008 crisis raised. What is the function of banks? And to what extent are they truly independent businesses rather than wards of the state? “To my mind, the best way to think about banking history in America, and the structure of our banking laws, is that banks exercise delegated powers, to expand the money supply, as essentially franchises of the federal government,” Ricks told me, citing laws that go all the way back to the National Bank Act of 1864.

With S.V.B.’s collapse making this view more persuasive, it has become clearer that more needs to be done to prevent banks from following a business model of exploiting their privileged position during the good times and then turning to Washington when things go sour. One action that Ricks recommends is requiring all banks to insure a hundred per cent of their customer deposits, and charging them for this service in a way that yields a reliable revenue stream. “Taxpayers should be properly rewarded for writing insurance policies,” he said. Other reforms that may be necessary include forcing regional banks to maintain more equity capital so that they are less fragile, requiring them to hedge their interest-rate exposures, and restoring stress tests for medium-sized banks like S.V.B.

Going down this route would amount to recognizing that banks, even the smaller ones, are essential public utilities in the communities they serve and treating them appropriately. A more radical option, favored by some progressives, would be establishing public banks that, at least in theory, could provide essential banking services at lower cost than their private counterparts. The key point is that, even if the actions taken over the weekend were unavoidable, this can’t be the end of the story. As Ricks put it, the current turmoil is “another manifestation of a much deeper problem of thinking about the basic design features of money and banking.” ♦