Fifteen Years After 2008, Why Do Banks Keep Failing?

The weekend rescue of uninsured depositors in Silicon Valley Bank and Signature Bank was both essential and 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.Without the federal government's protection of all deposits, companies with deposits in either of the banks above $250,000 (the maximum amount 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 and a board member of a biomedical research foundation.

A bank run could have done serious damage to the U.S. economy if all depositors had demanded their money at once. The government assured depositors that there was no need to yank from the bank in order to arrest the panic.

Even after the emergency intervention, markets remained unsettled on Monday. Bank stocks were down as 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.

The government didn't bail out everyone involved, which is fair. Shareholders in the banks are wiped out and members of senior management were fired. This 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 for the banks.

Why does this keep happening? After the global financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Obama signed. The Federal Reserve raised safety standards for banks, especially those deemed 'systemically important.' There's a Financial Stability Oversight Council that's supposed to take a broad view of risks in the system.

It wasn't enough and it made things worse that bank lobbyists convinced Congress and regulators to roll back some of the measures that they found to be burdensome. For example, a law from 2018 that was signed by President Trump and had bipartisan support spared banks with assets ranging from $100 billion to $250 billion from the most intense level of scrutiny. It's hard to say, but Silicon Valley Bank—which lobbied for the law—might still be around if it weren't for that law.

I'd like to focus on the question of the day, which is what to do about uninsured deposits, rather than discussing other possible improvements to banking supervision.

The theory of banking suggests that large depositors are financially savvy and have the motivation to ensure that the banks where they keep their money are secure. It is believed that by keeping deposits uninsured above a certain limit, this will act as a form of market discipline in addition to state and federal regulators. However, this was never a realistic expectation for most depositors who have other things to focus on. Furthermore, because big depositors know they will be protected in the event of a crisis, they have no incentive to seek out safe banks.

This is not a new problem. In 1991, Jerome Powell, who is now the chair of the Federal Reserve, was a senior official in the Treasury Department who dealt 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.'

The Federal Deposit Insurance Corporation Improvement Act of 1991 requires the F.D.I.C. 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. In practice, however, 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 does not work in theory or in practice, one alternative is to have the government insure all bank deposits. This 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. Robert Hockett, a professor at Cornell Law School, who has written two pieces about the idea for Forbes recently, favors this solution. The F.D.I.C. premiums are already 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 are two of the world's most respected economists.

"Although the labor market is still strong, cracks may be beginning to form," Thomas Simons and Aneta Markowska of the investment bank Jefferies wrote on Friday. They pointed to the moderate wage growth in the latest jobs report as evidence that "further moderation is coming in the months ahead."

"There is no greater agony than bearing an untold story inside you."
-Maya Angelou

"Bearing an untold story is one of the most agonizing things a person can go through." - Maya Angelou

You cannot truly question the morality or ugliness of something, or its effects on the soul or degradation of man, unless you can show that it is uneconomic.

E.F. Schumacher's "Small Is Beautiful" was published in 1973.