Here’s the Financial Times:
As bank runs spread, it has become clear that anyone who questions a government rescue for those caught underfoot will be tarred as a latter-day liquidationist, like those who advised Herbert Hoover to let businesses fail after the crash of 1929.
Liquidationist is now challenging fascist as the most inaccurately thrown insult in politics.
The new consensus in the “respectable” media seems to be roughly the following:
1. Billionaires should be free to move deposits from one bank to another by pushing a few buttons on an iPhone, merely in response to rumors of balance sheet problems.
2. Even though billionaires have been repeatedly told that deposits above $250,000 are not insured by FDIC, there should be special taxpayer funded bailouts of billion dollar deposits anytime a recklessly undiversified bank gets into trouble.
3. Anyone who claims that billionaires should be held accountable for their actions is an anti-social “liquidationist”.
Unfortunately, the term “liquidationist” conflates two completely unrelated claims:
1. The view that firms going bankrupt should not be bailed out by the government.
2. The view that central banks should not inject large quantities of liquidity if that is necessary to prevent a fall in NGDP.
I am a liquidationist in the first sense of the term, but not the second.
BTW, there are recent articles by Tyler Cowen and Clive Crook suggesting that occasional banking instability is almost inevitable, at least if we wish to have a financial system that finances investment. I don’t actually disagree with most of the specific points made in these two Bloomberg columns, but I worry about the framing. Yes, banking instability is almost inevitable, but the quantity of banking instability is very much related to the type of banking system, which is a product of regulation. Thus while Tyler is right that “regulation” cannot fix the problem created by moral hazard, he somewhat glosses over the role of regulation in creating moral hazard.
The US banking system has frequent banking crises, while the Canadian system does not. That’s not because Canada got lucky. Canada’s system is less susceptible to moral hazard for a very good reason. It lacks the thousands of small and mid-sized undiversified banks seen in the US. Those structural differences are due to different regulatory framework. Our regulations strongly encouraged the formation of small and mid-sized regional banks, making our system fragile. Canada is quite comfortable having a system dominated by large highly diversified banks.
Given enough time, even Canada may eventually face some sort of banking problems. But it is almost certain that the US will continue to experience much more frequent banking crises than Canada. If Congress wishes to find a culprit then they merely need to look in the mirror. This is the system Congress created, and the one they are trying to entrench with even more misguided regulations.
At one point Tyler says:
“To be clear, I am not arguing for zero regulation.”
I am arguing for zero regulation, if zero regulation also means no FDIC and no anti-trust actions against bank mergers.
Speaking of liquidationists, here’s the underrated Andrew Mellon (which the quote above implicitly refers to), standing between one of our best and one of our worst presidents:
Thank him next time you visit the National Gallery in DC.
READER COMMENTS
Spencer
Apr 2 2023 at 11:26am
The E-$ market doesn’t have FDIC insurance.
Andrew_FL
Apr 2 2023 at 12:49pm
Mellon was no liquidationist. Hoover slandered him in his memoirs to make himself look better.
Michael Sandifer
Apr 2 2023 at 5:09pm
I’d like to see an alternative US bank charter that allows for zero regulation, with fraud and theft being illegal of course, but also explictly zero bailouts or FDIC insurance. It’d be nice to see what innovations would come from a much freer banking system.
Unfortunately, this may not be a very realistic idea. For one thing, customers may largely ignore banks with non-FDIC insured deposits. It might not be possible to have free banking coexist with the regulated banking such as we have. Also, it doesn’t seem realistic to trust that the US government will refrain from bailing out troubled banks, whatever any laws or charters say.
Jose Pablo
Apr 2 2023 at 6:54pm
An alternative could be independent private institutions insuring deposits (for instance insurance companies).
The cost of insuring deposits would be, very likely, different for each bank. A helpful way of signaling the different riskiness of each institution. This price signal would also, very likely, be helpful in keeping in check the risk appetite of banks. The additional cost of insuring deposits in small and medium banks would also provided interesting information.
The problem is not insuring deposits. The problem is doing so thru a government sponsored system with artificial prices and tons of crosssubsidies, that don’t provide any meaningful information.
Thomas Hutcheson
Apr 2 2023 at 11:16pm
Can we derive NGDP targeting from first principles: an objective function (something like reap growth) and constraints (heterogeneous price flexibility, size and nature of positive, negative, real. and monetary shocks that growth maximizing relative price changes respond to)
seer of things
Apr 3 2023 at 1:15am
I asked an AI… What is the typical contract term for a 30 year fixed rate mortgage in the U.S. ?
The answer was… The typical contract term for a 30-year fixed-rate mortgage in the U.S. is 30 years.
At a Canadian bank website I see fixed rate mortgage contracts of 6 months to 10 years. These terms are not the amortization periods. You can have a 25 year amortization by getting a new 5 year contract every 5 years.
Wouldn’t banks in the U.S. be less likely to become insolvent if the contract term were less than the amortization period? If you lower the duration of the contracts, you will lower the duration of the mortgage backed securities.
Scott Sumner
Apr 3 2023 at 12:56pm
In the past, borrowing short-term and lending long-term has creating problems. The risk can be reduced with various hedging strategies. SVB did not hedge its maturity risk.
Dylan
Apr 3 2023 at 6:16am
In previous pieces on this topic you have talked about banks taking on too much risk. How do you quantify what the right amount of risk looks like for the banking sector as a whole? If I say that periodic banking crises + depositor bailouts are the price we pay for faster aggregate RGDP growth, is there evidence against this? We seem to have done better than Canada on this measure.
I admit I’m biased, my family started a company with a loan from one of those small undiversified banks, who also happened to be their first customer. They built that into a nice size small business by selling to other small and medium sized banks. I remember one of the first pitches, where there was concern about the size of the market, since bank consolidation was a known issue even back in those days, and they were able to show that the number of banks stayed relatively steady, since for every merger there were bank managers that went out and started a new bank.
That process pretty much stopped by the late 90s though, and we’ve had increasing bank consolidation that is not matched by new banks forming. What makes you think we won’t get to something on par with Canada naturally? I’m not sure that’s a good thing from a customer point of view, big banks tend to have horrible customer service and they lack domain specific knowledge that the small specialized banks have, but it seems to be happening anyway.
Scott Sumner
Apr 3 2023 at 12:58pm
I don’t think we can directly measure the optimal quantity of risk. All I can say is that our system encourages banks to take a socially excessive amount of risk. That makes it seem likely that they would do so. I’d prefer to leave it up to the market.
Dylan
Apr 3 2023 at 3:24pm
I sympathize with the problems of direct measurement of optimal risk, but I then question how we know that “our system encourages banks to take a socially excessive amount of risk.” If we agree that some amount of risk taking by financial institutions creates positive externalities in the form of greater innovation, then how do we know that the current system encourages “excessive” risk?
I think a valid position is we can’t know, but that the government is likely to get it more wrong than the market, so it’s better to let the market underinvest in risky innovation, rather than subsidize it and have banks go whole hog on Beanie Baby NFTs.
Scott Sumner
Apr 3 2023 at 5:25pm
Yes, I believe the free market approach is the safest option when we don’t know what’s optimal.
bb
Apr 3 2023 at 12:57pm
Scott,
I’m sure that I’m missing something, but it seems to me that the cleanest solution to situations like SVB is to take the bank in to receivership, inject capital, wipe out the shareholders and fire management, and then auction off new shares. I would think the government would rarely, if ever, need to spend taxpayer dollars. Wiping out shareholders and management solves the morel hazard concerns. And having a clear path for winding down these situation would reduce the risk of contagion. Punishing depositors isn’t a priority for me. Is there a reason that this isn’t a good option?
Thanks.
Scott Sumner
Apr 3 2023 at 1:01pm
“Wiping out shareholders and management solves the moral hazard concerns.”
This is incorrect, as I’ve explained in numerous recent posts. SVB’s losses are quite large, and will eventually be (partially) borne by the taxpayer.