About Those Banks…

News of the recent failure of two significant banks was enough to send chills down the spines of lots of Americans–especially those of us who are retired and dependent upon funds invested in the market. No matter how conservative our investment choices may have been, it’s like being on an ocean liner: if the entire vessel sinks, we’ll all go down, prudent stateroom choices or not.

As usual, Heather Cox Richardson could be counted on to produce the clearest explanation of the situation–not just the event itself, but the government’s (thankfully competent) response.

At 6:15 this evening, Secretary of the Treasury Janet L. Yellen, Federal Reserve Board Chair Jerome H. Powell, and Federal Deposit Insurance Corporation (FDIC) Chairman Martin J. Gruenberg announced that Secretary Yellen has signed off on measures to enable the FDIC to fully protect everyone who had money in Silicon Valley Bank, Santa Clara, California, and Signature Bank, New York. They will have access to all of their money starting Monday, March 13. None of the losses associated with this resolution, the statement said, “will be borne by the taxpayer.”

But, it continued, “Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.”

The statement ended by assuring Americans that “the U.S. banking system remains resilient and on a solid foundation, in large part due to reforms that were made after the financial crisis that ensured better safeguards for the banking industry. Those reforms combined with today’s actions demonstrate our commitment to take the necessary steps to ensure that depositors’ savings remain safe.”

My immediate reaction was to give thanks that the challenge posed by these bank failures was being handled by the knowledgable and competent people in the Biden Administration, rather than by the Keystone Kops assembled by Trump.

Of course, the obvious next question was: how did this happen?

Most of us think of bank failures as harbingers of Depression, so I was surprised to read that a few banks fail every year, although Richardson reports that these are the first two  during  Biden’s presidency. (There were sixteen during Trump’s four years in office, eight of which preceded the pandemic).

Silicon Valley was the go-to bank for tech start-ups, which typically begin with a lot of cash from investors and IPO’s, and don’t need much in the way of loans.

So, rather than balancing deposits with loans that fluctuate with interest rates and thus keep a bank on an even keel, SVB’s directors took a gamble that the Federal Reserve would not raise interest rates. They invested in long-term Treasury bonds that paid better interest rates than short-term securities. But when, in fact, interest rates went up, the value of those long-term bonds sank.

Then, because SVB concentrated on start-ups, they had another problem. As interest rates go up, investors want faster returns than most start-ups can deliver. That meant that SVB’s depositors began to withdraw their money.

So SVB sold securities at a loss to cover those deposits. Other investors panicked as they saw SVB selling at a loss and losing deposits, and they, too, started yanking their money out of the bank, collapsing it. Banks that have a more diverse client base are less likely to lose everyone all at once.

There is–as you have probably guessed–a larger lesson here. The “libertarians” (I’m looking at you, Peter Thiel!) who have been vocal opponents of government regulation of the banking industry and  government relief for student loans–or really, pretty much anything government does that doesn’t benefit them personally– immediately insisted that in this case, the banks should be bailed out.

Richardson points out that in 2018, under Trump, Congress “weakened government regulations for banks like SVB and that SVB’s president had been a leading advocate for weakening those regulations.” Had those regulations been in place,  SVB would probably have remained solvent.

The Biden administration had been considering tightening the banking regulations that were loosened under Trump, and it seems likely that the need for the federal government to step in to protect the depositors at SVB and Signature Bank will make it much harder for those opposed to regulation to keep that from happening.

Was this a “bail out”? There’s an argument that making depositors whole while letting the shareholders eat their losses isn’t a bailout. The intervention was clearly needed to contain the potential for an economic collapse that would hurt everyone. Whether this is considered a bailout or not, at least the banks, and not the  taxpayers, are on the hook.

Getting rid of the hypocrisy is probably an unattainable goal….