The Treasury and Federal Reserve stepped in late Sunday to contain the financial damage from Friday’s closure of Silicon Valley Bank, guaranteeing even uninsured deposits and offering loans to other banks so they don’t have to take losses on their fixed-income assets.
This is a de facto bailout of the banking system, even as regulators and Biden officials have been telling us that the economy is great and there was nothing to worry about. The unpleasant truth — which Washington will never admit — is that SVB’s failure is the bill coming due for years of monetary and regulatory mistakes.
Wall Street and Silicon Valley were in full panic over the weekend demanding that the Treasury and Fed intervene to save the day. It’s revealing to see who can keep a cool head in a crisis — and it wasn’t billionaire hedge-fund operator Bill Ackman or venture investor David Sacks, both frantic panic spreaders.
The Federal Deposit Insurance Corp. closed SVB, and the cleanest solution would be for the agency to find a private buyer for the bank. This has been the first resort in most previous financial panics, and the FDIC was holding an auction that closed Sunday afternoon.
But Rohit Chopra, the Elizabeth Warren acolyte on the FDIC board, is hostile to bank mergers on ideological grounds, and the purchase terms could be too onerous for some potential buyers. The biggest banks are now the safest, and deposits are flooding into them. J.P. Morgan can park that money at the Federal Reserve and earn interest on its reserves. Why take on a new political headache?
SVB executives made mistakes, and they will pay for them, but they were encouraged by easy money and misguided regulation. As the Fed flooded the world with dollar liquidity, money flowed into venture startups that were SVB’s customer base. The bank’s deposits soared — far beyond what it could safely lend.
In a world of near-zero interest rates, SVB put the money in long duration fixed-income assets in search of a higher return. Regulators after the 2008 crisis had deemed these Treasury bonds and mortgage-backed securities nearly risk-free for the purpose of measuring bank capital. If regulators say they’re risk-free, banks and depositors may be less careful.
But those securities declined in value as the Fed took interest rates up quickly to break the inflation it helped to cause. SVB had enormous capital losses if it were forced to liquidate those assets before maturity. That’s exactly what happened as SVB customers withdrew their deposits. The San Francisco Fed regulates SVB and somehow missed this rising vulnerability. The Fed and Treasury will try to blame the bankers, but they are as much if not more culpable. The idea of elevating San Francisco Fed president Mary Daly to the Board of Governors seems preposterous after SVB.
All the more so because the duration risk at banks may not be limited to SVB, as last week’s selloff in regional bank stocks shows. The FDIC created an entity to protect SVB’s insured depositors up to the legal limit of $250,000. But something like 85% to 90% of SVB’s deposits are uninsured. The worry is that depositors in other banks will now flee.
Thus the cries for federal intervention. Treasury Secretary Janet Yellen said Sunday there will be no “bailout” for SVB, but she is indulging in semantics. The feds said they will guarantee even uninsured deposits at SVB as well as at Signature Bank in New York. Typically in a bank failure those depositors would get their money back with a 15% to 20% haircut. This would no doubt be a hardship for many customers, but the $250,000 limit was known.
Will a universal uninsured deposit guarantee be next? This would be a monumental policy surrender, essentially admitting that the regulatory machinery established in 2010 by Dodd-Frank failed. We may be the only people in the world who still worry about “moral hazard.” But a nationwide guarantee for uninsured deposits, even for a limited time, means this will become the default policy any time there is a financial panic.
There’s also a question of the legality of such a guarantee. The FDIC created a “transaction account guarantee” program amid the 2008 panic, but Congress explicitly let it expire in Dodd-Frank. Congress set the $250,000 insured limit to protect average Americans, not venture investors in Silicon Valley.
The FDIC may have resorted to its “systemic risk exception” for SVB and Signature, but this is a stretch considering their size. The joint statement by regulators said it received the required two-thirds vote of both the FDIC and Fed boards, and we’d like to see the creative legal work by the Office of Legal Counsel at the Justice Department.
The Fed is acting as it should as a provider of liquidity to all comers. But it’s going further and offering one-year loans to banks against collateral of Treasurys and other fixed-income assets. The Fed will value these assets at par, which means banks don’t have to sell their assets at a loss. The Fed is essentially guaranteeing bank assets that are taking losses because banks took duration risk that Fed policies encouraged. This too is a bailout.
Perhaps this will contain any Monday market mayhem, but if it doesn’t our guess is that the Treasury, FDIC and Fed will look to guarantee uninsured deposits across the banking system. The Fed will want to avoid institutional blame for financial damage, and President Biden will do anything to avoid letting a financial panic affect the overall economy as he prepares to run for a second term next year.
