Fifteen Years After 2008, Why Do Banks Keep Failing?

The weekend rescue of uninsured depositors in Silicon Valley Bank and Signature Bank was absolutely essential and absolutely frustrating. We have to stop getting ourselves into these messes, people.

If the federal government hadn’t given a blanket of protection to all deposits, companies that had deposits in either of the banks above $250,000, the maximum that’s insured by the Federal Deposit Insurance Corp., would not have been able to pay their workers. Start-ups that bank with Silicon Valley Bank would have been imperiled. “It could have destroyed early-stage biomedical research in this country for a decade,” said Karen Petrou, the managing partner of the consulting firm Federal Financial Analytics, who sits on the board of a biomedical research foundation.

The damage could have been far greater. Depositors at other banks were beginning to panic, worrying that their banks would be next to fail and looking for safer places to stash their cash. We were looking at the early stages of a generalized bank run that would have done serious damage to the U.S. economy. Even a healthy bank can be destroyed overnight if all its depositors demand all their money at once. The only way to arrest the panic was for the government to assure all depositors that there was no need to yank from the bank.

Even after the emergency intervention, markets remained unsettled on Monday. Bank stocks were down. Economists at Capital Economics reported “worrying signs of incipient strains in core money markets.” Interest rates fell as investors speculated that the Federal Reserve might curb its rate-raising campaign to relieve pressure on banks (a concern I wrote about on Friday). A scare such as this one has lasting consequences.

True, the government didn’t bail out everyone involved. Shareholders in the banks are wiped out and members of senior management were fired. That’s fair — and contrasts with what happened during the 2008 global financial crisis, when the government propped up shaky banks while leaving management and shareholders in place.

Whether taxpayers helped pay for the rescue is a matter of semantics. On Monday, President Biden told reporters, “No losses, and this is an important point, no losses will be borne by the taxpayers.” Still, the government — and by extension, taxpayers — is providing a valuable guarantee to the banking system. The fact that any government expenditures will eventually be recouped through higher insurance premiums doesn’t take away from that. Also, the Federal Reserve is promising to support troubled banks by buying bonds from them at face value rather than their current depressed market price. Not a bailout, exactly, but certainly a good deal.

The real question is why this keeps happening. After the global financial crisis, Congress passed and President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Federal Reserve raised safety standards for banks, especially ones that are deemed “systemically important.” There’s a Financial Stability Oversight Council that’s supposed to take a broad view of risks in the system.

It clearly wasn’t enough. It didn’t help matters that bank lobbyists got Congress and regulators to roll back some measures that they regarded as onerous. For example, a 2018 law signed by President Trump — which was passed by Congress with bipartisan support — spared banks with $100 billion to $250 billion in assets from the highest level of scrutiny. Hard to say, but Silicon Valley Bank — which lobbied for the law — might still be with us if it weren’t for that law.

There are lots of things that could be done to improve banking supervision, require thicker capital cushions and so on, but for now I’d like to focus on the question of the day, which is what to do about uninsured deposits.

The theory in banking is that big depositors have the financial sophistication and the incentive to make sure that the banks where they keep their money are safe. Keeping deposits uninsured above a certain threshold is thus supposed to be a kind of market discipline, supplementing the supervision by state and federal regulators. But that was never a realistic expectation for most depositors, who have other things on their minds. Plus, because big depositors know that they’ll be protected when push comes to shove, they have no incentive to seek out safe banks.

This is hardly a new problem. In 1991, Jerome Powell, now the chair of the Federal Reserve, was a senior official in the Treasury Department who was assigned to deal with the collapse of the Bank of New England Corp. As he recounted in a 2013 speech: “We came to understand that either the F.D.I.C. would protect all of the bank’s depositors, without regard to deposit insurance limits, or there would likely be a run on all the money center banks the next morning — the first such run since 1933. We chose the first option, without dissent.”

Under the Federal Deposit Insurance Corporation Improvement Act of 1991, the F.D.I.C. is required to resolve bank failures in the way that incurs the least cost to the deposit insurance fund, even if that means wiping out uninsured depositors. But in practice, uninsured depositors almost never get wiped out because the F.D.I.C. arranges for a stronger bank to acquire the failed one, assuming all of its deposits. The Dodd-Frank Act of 2010 made an explicit exception to the least-cost test for cases of “systemic risk” — that is, if complying with the least-cost test “would have serious adverse effects on economic conditions or financial stability.” That’s the exception that the government invoked for Silicon Valley Bank and Signature Bank.

If market discipline works in theory but not in practice, one alternative is to bow to reality and explicitly insure all bank deposits. It would certainly lessen the number of panics such as the one that killed Silicon Valley Bank and Signature Bank, without giving banks carte blanche to behave irresponsibly. One person who favors that solution is Robert Hockett, a professor at Cornell Law School, who has written two pieces about the idea for Forbes recently. The F.D.I.C. premiums are higher for riskier banks, which makes sense. Given that the F.D.I.C. already takes risk into account, Hockett told me, the $250,000 limit is “vestigial, like the human tailbone.”

Insuring all bank deposits would make banks look more like public utilities, Petrou told me. She said she’d prefer relying more on market discipline, as originally intended. But that ship may already have sailed.

Outlook: Thomas Simons and Aneta Markowska

“It is hard to say that cracks are forming in the labor market when payrolls increase 311,000, but it seems like we are at least at the ‘beginning of the beginning’ of the process of seeing the labor market soften,” Thomas Simons, a money market economist at the investment bank Jefferies, and Aneta Markowska, the chief economist at Jefferies, wrote on Friday, after the Bureau of Labor Statistics reported that employers added 311,000 jobs in February. On pay, they wrote, “Although the path forward for wage growth is going to be uneven, today’s data suggests that further moderation is coming in the months ahead.”

Quote of the Day

“Call a thing immoral or ugly, soul-destroying or a degradation of man, a peril to the peace of the world or to the well-being of future generations: As long as you have not shown it to be ‘uneconomic’ you have not really questioned its right to exist, grow and prosper.”

— E.F. Schumacher, “Small Is Beautiful” (1973)

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