Throughout our history, the US has always had a dysfunctional banking system. There was never a golden age of American banking. That doesn’t mean the system was always in crisis, but the potential for crises was always there. (Even in the 1970s.) This isn’t Canada.
There are many problems with the US banking system, but they all tend to revolve around the combination of too many undiversified banks and the socialization of financial losses. That combination creates moral hazard, which encourages excessive risk taking.
This tweet caught my eye:
There is no “if”. We are in trouble, and we’ve been in trouble for our entire history. And if depositors have confidence in deposits that exceed $250,000, then we will be in even greater trouble. The moral hazard problem will become even greater. Unfortunately, I suspect that SVB depositors have little to fear.
Dodd-Frank was supposed to fix the “problem” after the 2008 banking crisis. In fact, it did almost nothing to fix the underlying problem because key segments of the business and political world did not want the problem fixed. It’s easier to have a system where the profits are privatized and the losses are socialized, with taxpayers picking up the tab. Neither political party favors any sort of effective reform of banking.
So here we are again. In a follow-up tweet the congressman suggested “Bank management must be investigated”:
I’m reminded of that scene in Casablanca where the officer was shocked to discover that gambling was occurring in Rick’s establishment. It’s politicians that passed Dodd-Frank. It’s politicians that passed FDIC. It’s politicians that object to bank mergers that would make banks more diversified, less brittle. It’s politicians that demand bailouts even to depositors above the $250,000 threshold.
An investigation? Look in the mirror.
PS. I see complaints that sophisticated Silicon Valley investors couldn’t be expected to devise a safe way of storing their funds. Matt Yglesias provides some useful perspective:
(Bucks fans know that the number 50 has special meaning for Giannis.)
READER COMMENTS
Andrew_FL
Mar 11 2023 at 3:49pm
Your younger readers might appreciate knowing the next thing that happens in the scene is the officer is handed his winnings by an employee
RealityEngineer
Mar 11 2023 at 5:55pm
It seems likely was moral hazard leading people to ignore the insurance limits since they figured the government would make them whole. A comment on Marginal Revolution pointed out there are existing ways to handle the issue that the CFOs in the tech world should have taken care of:
https://marginalrevolution.com/marginalrevolution/2023/03/silicon-valley-bank.html“Option #1) Sweep to custodial account where you buy short duration treasuries, repos, etc.Option #2) Setup an ICS Account. This is relatively easy to do and any banking customer with large amounts of cash should be doing it. ICS stands for insured cash sweep. In an ICS account, your cash holdings are distributed amongst 100s of underlying accounts each at a different bank with no account holding more than $250k. All accounts are therefore fully FDIC insured, making your entire balance FDIC insured. Last I checked this could be done up to $125M in deposits for a given company.”
Wikipedia shows ICS is a real thing:
https://www.wikiwand.com/en/Insured_Cash_Sweep“The Insured Cash Sweep or ICS service is used by banks and savings associations that are insured by the Federal Deposit Insurance Corporation (FDIC). In 2021, the service was reconfigured with several others offered by IntraFi Network into IntraFi Network Deposits and IntraFi Funding.”
one bank describing its ICS service:
https://www.cbhou.com/Resources/Customer-Corner/entryid/237/faqs-your-guide-to-insured-cash-sweep“The Insured Cash Sweep service has been tested with billions of dollars and designed to comply with FDIC regulations. “
RealityEngineer
Mar 11 2023 at 6:01pm
It appears there were *many* that were over the insurance limit:
https://www.netinterest.co/p/the-demise-of-silicon-valley-bank“As at the end of 2022, it had 37,466 deposit customers, each holding in excess of $250,000 per account. Great for referrals when business is booming, such concentration can magnify a feedback loop when conditions reverse.
The $250,000 threshold is in fact highly relevant. It represents the limit for deposit insurance. In aggregate those customers with balances greater than this account for $157 billion of Silicon Valley Bank’s deposit base, holding an average of $4.2 million on account each. The bank does have another 106,420 customers whose accounts are fully insured but they only control $4.8 billion of deposits. Compared with more consumer-oriented banks, Silicon Valley’s deposit base skews very heavily towards uninsured deposits. Out of its total $173 billion deposits at end 2022, $152 billion are uninsured. ”
and one unfortunate argument for government intervention being made is to do so to be sure the rest of the public doesn’t realize they should address their accounts over the limit since its common:
https://twitter.com/BobEUnlimited/status/1634539450557505537“Fed/FDIC decisions on SVB determine whether they risk a bank run trillions of dollars in size. 1/3 of US deposits are in small banks and ~50% are uninsured. Haircutting SVB depositors will raise sensible questions about holding deposits at any small bank, risking a broader run.”
Though I suspect its doubtful it’d be anything like this run among the well networked net savvy world, with WSJ reporting:
https://www.marketwatch.com/amp/story/silicon-valley-bites-the-hand-that-feeds-it-in-svb-bank-run-84d9be20
““Silicon Valley bites the hand that feeds it in SVB bank run …Indeed, a state court filing late Friday noted that the bank was in “sound financialcondition” prior to March 9, when “investors and depositors reacted by initiating withdrawals of $42 billion in deposits from the Bank on March 9, 2023, causing a run on the Bank.” ”
Grand Rapids Mike
Mar 11 2023 at 6:43pm
Somewhat surprising that the large depositors (not linked to the SV Bank loan program) were not invested in at least short term treasuries and not sitting in a bank. Second with the fast rise in interest rates, banks bond holdings must be taking a beating. My understanding there are different requirements for mark to market requirements if bonds are held to maturity. Still there must be banks sweating out Powell’s mission to cut inflation and waiting for a start of interest rate reductions. Three surprised Fed did not see this coming.
Also given the Fed’s (1) unwarranted increase in M2 of 38% from March 2020 to Dec 2021, (2) then its initial certainty that inflation would not be an issue, and (3) and now this, the competency of the whole Fed system got to brought into question. So besides a moral hazard issue there is a real competency issue.
It is also a comforting thought that Rep. Eric Swalwell is going to save the day.
Justin in Texas
Mar 13 2023 at 8:00pm
Whenever you get a large deviation in trend NGDP, stuff breaks. So irresponsible of the Fed let NGDP expectations climb so high in 2021. Now we have high interest rates, and all these assets that had been priced for 4% NGDP growth, get repriced.
Jim Ancona
Mar 11 2023 at 7:30pm
John Cochrane has a good overview of what happened and how the regulations failed: https://johnhcochrane.blogspot.com/2023/03/silicon-valley-bank-blinders.html
Grand Rapids Mike
Mar 11 2023 at 11:09pm
Also interesting comments on a substack site netinterest.co Mark Rubinstein.
Scott Sumner
Mar 12 2023 at 1:06am
Great post by Cochrane. Of course he is correct, and of course his advice will be ignored.
steve
Mar 12 2023 at 2:47pm
I am not sure why this is the fault fo the regulators. They didnt force the bank into making such obvious interest rate errors. If there were not regulations the same thing would have happened.
Steve
Jim Ancona
Mar 12 2023 at 4:09pm
If we’re going to have regulators, it seems to me they should do their job. If banking were unregulated, at least depositors would have realized they were on their own, rather than expecting regulators to protect them.
Joel Pollen
Mar 13 2023 at 8:24am
It’s the fault of regulators because of the moral hazard produced by bailouts and FDIC. There are four possible systems here:
1) No regulation, but no expectation of deposit insurance and bailouts. People will either be smart about where they bank or suffer the consequences.
2) Regulation and an expectation of deposit insurance and bailouts. The regulators attempt to provide the incentive to make good decisions that the risk of losses cannot.
3) Regulation and no expectation of deposit insurance and bailouts. Regulation is unhelpful and mostly unnecessary, since people don’t need to be forced to make reasonable decisions most of the time.
4) No regulation and an expectation of deposit insurance and bailouts. The worst possible system, and what we have here. People are encouraged to take big risks, knowing taxpayers will cover their losses.
If you’re going to have bailouts, you have to have regulation. Of course it would be best to have neither. Half a free market is often the worst possible system.
steve
Mar 13 2023 at 9:27am
I agree that halfway may be the worst solution, but the fact remains that it was the bank that mismanaged the interest risks. Its as if the bank had no agency when clearly they did. Bankers get paid pretty well to assess risk but in this case they didnt do that. To ignore their mistakes and immediately blame the regulators is bizarre. In context, the regional banks had also had regulation decreased.
Steve
vince
Mar 13 2023 at 11:07pm
Then why have regulations? What was the point of Dodd Frank?
Philo
Mar 12 2023 at 1:39am
Giannis has $12.5M in bank accounts? He’s a lot more aggressive than that on the basketball court! (Well, maybe his mundane living expenses are greater than what is familiar to me.)
David S
Mar 12 2023 at 5:47am
I’m guessing that some sort of bailout plan will be announced on Monday. Meanwhile, we can round up the usual suspects–government regulators, idiot bank managers, and bank customers who aren’t as smart or cautious as Mr. Antetokounmpo. In terms of assigning blame I’m putting 30% of this on regulators, 60% on management, and 10% on customers.
I’m also going to indulge in just a little snark here and suggest that some Silicon Valley tech bros could infuse the bank with some magically mined cryptocurrency. They keep promising how they’ll change the world, here’s their chance.
Ben
Mar 12 2023 at 10:03am
If the banks equity and bondholders get wiped out, and it’s just the depositors that are saved, is there really much moral hazard on part of the bank management? They lose everything in either case.
Spencer
Mar 12 2023 at 1:37pm
The first thing I asked was where were the bank examiners. Cochrane’s post explains that.
The problem is that derivative holders have first claims. And interest is the price of savings. The duration mismatch is due to monetary policy blunders and the monetary transmission mechanism. FED credit should be restricted, but not by interest rate hikes.
The whole economic system is backwards. All monetary savings originate within the payment’s system, the commercial banking system. Banks should follow the old-fashioned practice of storing their liquidity, and not be permitted to buy their liquidity through open market instruments. The banks are collectively paying for the deposits that they already own.
The question is not whether net earnings on assets are greater than the cost of the funding [sic] to the bank; the question is the effect on the total profitability of the payment’s system. This is not a zero-sum game. One bank’s gains is less than the losses sustained by other banks. The whole (the forest), is not the sum of its parts (the trees), in the money creating process.
Scott Sumner
Mar 12 2023 at 9:24pm
“If the banks equity and bondholders get wiped out, and it’s just the depositors that are saved, is there really much moral hazard on part of the bank management?”
Yes. Of course it’s true that bankruptcy hurts them. But deposit insurance (including TBTF) makes it easier for risky banks to raise funds.
rick shapiro
Mar 13 2023 at 11:50am
The key takeaway is that expectation of bailouts by potential depositors enabled bank managers to make stupendous bonuses by increasing bank profits with partially concealed risk. Nothing regulators can do will make them disgorge those bonuses. What regulators can do (but won’t) is demand large equity stakes in the businesses of large depositors, in exchange for their bailouts. A mitigation of moral hazard for the future.
vince
Mar 13 2023 at 11:14pm
” is there really much moral hazard on part of the bank management? ”
If taxpayers pay for a bailout, the payees are being subsidized. Those someones, whoever they are, made profit when the risk taking was good but won’t take their share of losses when it’s not good.
Ken P
Mar 12 2023 at 1:19pm
I agree that the 250k limit should be held, but doing that is problematic since many of these small companies were bound by contract with SVB to keep all their company funds in SVB. I don’t think banks should be able to lock companies in like that.
The toxic assets this cycle are long dated T bills and the root cause is quantitative easing. Banks should be required to mark to market their Treasury Bills. That might encourage more careful purchasing of them.
There are many banks with significant long dated T bill exposure. Hopefully this doesn’t spread.
Scott Sumner
Mar 12 2023 at 9:26pm
Then they should have picked a different bank.
Dylan
Mar 13 2023 at 6:58am
Isn’t the whole point of SVB that they provided banking services to the kinds of companies that couldn’t get traditional banking?
Scott Sumner
Mar 13 2023 at 12:25pm
Yes, and isn’t that the problem? It’s like saying the whole point of a certain tavern is to supply drinks to underage kids that are not served by other bars.
Dylan
Mar 13 2023 at 3:52pm
Good business idea! Thanks!
Spencer
Mar 12 2023 at 2:20pm
QE by design breeds speculation. Cypto currencies were a byproduct (like the unregulated E-$ market with no reserve requirements). Savings should be matched with real investment. The money supply is not synonymous with savings.
…
Powell has no idea what he’s doing. With his background, there’s no possibility of a soft landing. The money stock can never be properly managed by any attempt to control the cost of credit.
…
The effect of current open market operations on interest rates is indirect, varies widely over time, and in magnitude. What the net expansion of money will be, as a consequence of a given change in policy rates, nobody knows until long after the fact. The consequence is a delayed, remote, and approximate control over the lending and money-creating capacity of the banking system.
…
Banks don’t lend deposits. Deposits are the result of lending. The increased lending capacity of the financial intermediaries is comparable to the increased credit creating capacity of the commercial banks in only one instance; namely, the situation involving a single bank which has received a primary deposit and all newly created deposits flow to other banks in the system.…But this comparison is superficial since any expansion of credit by a commercial bank enlarges the money supply, whereas any extension of credit by an intermediary simply transfers the ownership of existing money.
steve
Mar 12 2023 at 2:43pm
“The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.”–Lord Acton
Some people will concentrate on regulations but a lot fo this sounds like simple interest rate exposure and too much concentration into one sector, tech. This was awful management. Should we be worried that the CEO was on the SF Fed Board?
OT- Bucks are looking good if they can stay healthy. I still have them taking the East.
Steve
RealityEngineer
Mar 12 2023 at 4:02pm
re: “And if depositors have confidence in deposits that exceed $250,000, then we will be in even greater trouble. ”
The real problem is the existence of that government insurance. Without it there would be private insurance options that would be risk weighted and for whatever amount customers want, with the incentive for the insurere of course to spot problems. It might be covered by the bank (covered by however they make their money) or by the account holder to express their preference for how much risk to take at what price and which bank to go with based partly on premiums.
Todd Moodey
Mar 12 2023 at 5:33pm
Politicians are living, breathing negative externalities…
Michael Sandifer
Mar 12 2023 at 6:59pm
News just broke that all depositors will be made whole. Some, like Scott Galloway, are arguing that there isn’t much of a moral hazard problem here, because bank owners and management are wiped out. He does discuss having investments in companies with money in SVB.
Jon Murphy
Mar 12 2023 at 7:01pm
And the moral hazard perpetuates
Scott Sumner
Mar 12 2023 at 9:34pm
That’s just a disgrace. The inability of our policymakers to reform banking after 2008 is pathetic. Have we learned nothing at all?
Maybe we need to think about going back to the 19th century practice of making bankers personally liable when they default on deposits.
nobody.really
Mar 12 2023 at 10:02pm
A fair point. But why just bankers, and why have liability merely for defaulting on deposits?
I’ve always thought that corporate law–establishing limits on liability–represented a conspiracy between investors and government to deprive injured parties of the kinds of redress to which they would otherwise be entitled. It’s a font of moral hazard.
Presumably states authorize limits on investor liability because those limits generate more social good than harm. But this argument requires recognizing the existence of social good, and the trade-offs between the interests of society and the interests of the individual.
Jose Pablo
Mar 12 2023 at 10:23pm
The inability of our policymakers
And the inability of our investors which is even more worrying. The information Cochrane points out was available to SVB shareholders (actually it was mostly produced for them), and still they failed to see this coming.
And these are the investors charged with the not minor task of “optimizing capital allocation for society” and rendering EMH true.
We need “better” investors even more than we need better regulators. Apparently the incentive system is not working good enough to root out the worst money managers. That is, very likely, resulting in a significant misallocation of resources (compare with an scenario in which “investing monkeys” are not any longer on charge of properly pricing assets).
Very little is read on our need for better investors/asset managers.
nobody.really
Mar 12 2023 at 9:38pm
The feds are extending similar treatment to Signature Bank, which had seen its stock price grow 400% in a year as deposits from crypto reached 30% of is holdings. Again, the feds say that depositors will be reimbursed 100%, but shareholders/bondholders will be wiped out.
Jose Pablo
Mar 13 2023 at 3:16pm
shareholders/bondholders will be wiped out.
They were already wiped out, so this should not be on the column of FED achievements. And take a look at the value of the shares or other regional banks or the value of bitcoin this morning. Looks like somebody is being bailed-out (actually “we are bailing out other banks shareholders” and saying “we are doing this to prevent contagion” are EXACTLY the same thing)
And the line between bondholders and depositors is pretty blurred. Depositors are debt holders (non-interest bearing debt holders for the most part) whether they know it or not (as a matter of fact, deposits are on the liability side of banks accounting and this is extremely clear to every bank manager).
So, the headline should be more like:
“The FED is bailing out some of the debt holders of the failing banks and all the shareholders and debtholders of other banks that could have failed in the absence of this intervention”
Why keep bailing out investment morons? what’s the long term benefit to the system?
We need way more “natural selection” when it comes to investors and money managers. They play a too relevant role in this economic system to continuously bailing out incompetence.
David Seltzer
Mar 12 2023 at 7:13pm
Scott: Undergrad, MBA and PHD candidates are grounded in bond convexity and duration risk. All of the investment banks have rigorous training programs that emphasize financial engineering and risk management. Forget the regulators. What were the risk managers doing? A basic excel spread sheet using duration and convexity formulas demonstrate the effect of a 100bps change in yield on long dated bonds. As a former hedge fund managing partner and senior risk manager, I wonder why they didn’t hedge with CME 10 y bond futures? The CME’s most actively traded contract.
Grand Rapids Mike
Mar 12 2023 at 8:47pm
Read that the Risk Manager left in April 2022, was not replaced until January 2023.
Scott Sumner
Mar 12 2023 at 9:37pm
With FDIC insurance, excessive risk taking becomes a feature, not a bug. I seem to recall that Neil Wallace once said that any banker not taking a socially excessive amount of risk is not acting in the interest of their shareholders.
Jim Glass
Mar 13 2023 at 5:36pm
With FDIC insurance, excessive risk taking becomes a feature, not a bug
Roku had $487 million in one SVB account with $250k insurance. That’s really excessive risk. And it seems to be the investment model of the whole high-tech start up industry out there. Sequoia pushed all its firms to put their money in SVB. Well, I guess with Sequoia’s good buddy SBF not taking deposits any more….
Knut P. Heen
Mar 13 2023 at 12:27pm
There is a trade-off between diversification and moral hazard. There are many layers of moral hazard here. One between “society” and the banks due to deposit insurance, bail-outs, etc. A second one between the banks and the borrower. To reduce the latter type of moral hazard (perhaps also adverse-selection), banks may benefit from specializing in loans to certain sectors or certain geographical regions (learn who you are dealing with). This practice will reduce diversification and thus increase unsystematic risk. Given that bank failures tend to cluster in time, I suspect the reason most often is relatively low exposure to systematic risk (which per definition cannot be reduced by diversification) combined with high financial leverage. A 50/50-bet which pays-out $101 or $99 and trade at $100 is not very risky unless you borrow $100 to pay for it.
Jim Glass
Mar 13 2023 at 5:26pm
Silicon Valley Bailout — Patrick Boyle
Lots of interesting details and info. SVB had no risk manager on staff from April 2022 through January 2023, and hedged no interest rate risk while rates were rising. Hmmm…. “There are more scandals in this story than there is time to discuss”, e.g., employees receiving bonuses hours before regulators seized the bank.
As to regulations, the US community bank lobby obtained exemption for the likes of Silicon Valley (the 16th largest bank in the US by balance sheet) from Basel regulations that apply to near all UK and European banks of all sizes. Details given.
Also, the Fed’s new Bank Term Funding Program for cases like this “is a huge subsidy to benefit bank shareholders” … “allowing banks to pledge collateral that will be valued at par … goes against every risk management commandment of the last 30 years.”
And let’s not forget the acumen of SVB’s sophisticated VC and high-tech customers who poured so many millions into uninsured accounts. “90% of deposits were uninsured. This is unique to SV. Maybe there’s a reason but I don’t understand it.” Roku had $487 million in an SVB account. “You have to wonder what Roku’s corporate treasurer did all day long to look after that single bank account holding all the company’s cash.” 🙂
Ken P
Mar 13 2023 at 8:27pm
Looks like the solution was the same as last time: Fed buys the toxic assets at non-discounted prices. Last time around it was mortgage securities, this time it’s T bills.
T Boyle
Mar 13 2023 at 9:46pm
Virtually everywhere has deposit insurance; it’s not unique to the United States. And that, in turn, is because random bank runs – which are what you get when there isn’t deposit insurance – are hugely economically destructive. And no, that doesn’t create moral hazard: depositors cannot do diligence to make sure the bank is proof against runs because deposit-based banking cannot be proof against runs: it involves borrowing short (from depositors) and lending long, which means that any random meme that causes the depositors to withdraw money will bring down the bank. And if there’s no deposit insurance, experience shows you get a lot more runs, with the associated (devastating) social costs.
There is a social need for people to be able to store cash so they can readily access it. There would be an enormous cost to your proposed solution, that everyone should constantly monitor the health of their bank – even if that could work, which it can’t. People who lose their ready cash to a bank failure don’t deserve this weird moralizing “I told you so – moral hazard!” response; they deserve a better solution.
The key is not to condemn the whole population to an involuntary hobby of monitoring their bank; it is to a) provide a secure place to store ready cash and b) require investments to be investments: you bought it, you own it – you don’t get to ask for your money back (although you can sell the investment). The social need, for a place to store cash securely, is actually easily addressed, and I’m surprised it hasn’t been done (perhaps it’s because the banks have lobbyists). Let (not require, just let) depositors deposit their cash with the Fed, a business that – uniquely – cannot run out of cash. The banks can still act as storefronts for the Fed, taking in deposits and returning the cash, and charging for the service (in a competitive market). Sure, you get low interest rates on Fed deposits, but if all you want is to hold cash securely for ready access, so what?Investors, of course, can buy securities (like money market funds) through banks. Investors – not depositors – can also provide capital that can be loaned out – but now they’re consciously taking risk, and accepting that when they provide capital for a 10-year note, they don’t get to call it in – although they can sell the note at market (and no doubt the bank can be a market maker for that).Banks, because they are not offering to return investors’ money dollar-for-dollar after those investments go wrong, cannot become insolvent. No need for massive monitoring by every single depositor; and no bank runs, with their enormous social cost.
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