While US bank failures do not happen every week (as they once did) they are not as rare as people may assume. With the collapse of Silicon Valley Bank (SVB), markets suffered some minor turmoil, and some depositors were understandably concerned that the doors of their local branch were locked. But nearly all the individual depositors were covered by FDIC insurance, up to $250k per individual ($250K for each holder of a joint account).
This insurance is, well, insurance. Participating banks pay a small percentage of their deposits in order to be insured. It is accurate to say that under normal circumstances, taxpayer dollars are not used. Regulators appear desperate to avoiding the B-word, but Bailouts are not uncommon. In the recent past, there have been a long list of government bailouts, approved by both major political parties. These bailouts do involve taxpayer dollars, which are occasionally repaid by the entities being floated the funds.
When it comes to SVB, however, regulators at the Fed have stated that deposit accounts will be covered in excess of the FDIC maximum. This amounts to $175B, most in excess of the regularly insured amounts. Does this not sound a little like … a bailout?
There are two differences from a standard bailout, it’s true. First, SVB reportedly has $200B in assets. (These assets are not the same as having cash, so a bank run would have ruined them anyway, and the total value is being disputed). In theory, these assets can be sold to fund the deposits in question. National banking giant PNC sniffed at the asset pile and walked away, as did another bank. The second difference is that the funds used for the (OK, it’s really a Bailout) are from the FDIC insurance fund, and not from the US Treasury. (Check the details on the Bridge Bank site.) So apparently the B-word only applies if direct government funds are involved.
If most individuals are fully insured, why guarantee corporate customers like Roku? Presumably, to avoid a string of bank collapses, even though most well-run banks are in no such danger. The truth is that SVB was poorly managed. While having business concentrated mostly in the Tech Sector is not a great idea, the heart of the problem was inattention to interest rates. SVB did not have the assets it needed to protect itself from increasing interest rates. It had purchased low-interest bearing Treasuries, ignoring the rise in interest rates from the Fed (affecting both borrowing and paying depositors). Perhaps the bank managers were not aware that the same Fed that insured their accounts had been raising their interest rates for the past year.
In other words, the managers were bad managers, running a bad business, and we all know what happens to a poorly run business.
In 2015 SVB lobbied to loosen regulations and oversight of regional banks. In 2018 Congress passed, with bi-partisan support, and then President Trump signed the regulatory rollback into law. Certainly, this argues that the bank desired a higher degree of freedom, and therefor risk, in their operations. The FDIC is an insurance system. Most insurance companies are quite profitable because they charge their customers according to their estimate of risk. Bakeries do not pay the same liability rates as crane operators because insurers assess the risk involved. SVB and similar banks should have been paying far more than other banks for the increased risk.
Asset vs Liability risk is not difficult to calculate. One industry norm is called the Texas Ratio. This simple formula shows how safe a bank’s assets are (including your deposits). Lower numbers mean lower risks. SVB’s numbers were almost comically out of whack. Apparently, by the time this was pointed out in a newsletter, the end was nigh.
Where does this leave depositors, regulators, and taxpayers? Well, it can be argued that the B-word helped avoid further bank runs. After a brief dip, the stock markets appear to be rising again. Eventually, SVB’s assets will be sold to other institutions, and the Fed will likely be made whole (or nearly) on the insured accounts.
But a bad precedent has been set. If you get home insurance for a $200k property, you do not expect to be covered for a million dollars. (Otherwise, why even get $200k when you can collect whatever you want?). If the FDIC is insurance, then the issuer should act like an insurer and demand an acceptable level of risk, or else refuse to insure, or charge much higher rates.
Arguably, the existence of the FDIC makes the banking system less safe, like when government fire insurance encourages homeowners to build houses in fire zones. The FDIC is actually a gamed system, with mechanisms to protect large depositors. For example, wealthy depositors often use Certificate of Deposit Account Registry Services (Cdars). This system takes your millions and deposits it with as many banks as possible, in $250k bites, so that one individual is covered by dozens of insured banks.
Here’s an idea – what if a high-value depositor paid for their own insurance? (This exists is some situations but is not common). Most money managers advise the wealthy to simply use multiple banks to cover higher value deposits.
If SVB paid the appropriate rates, and the FDIC published easily understood risk rations, Roku would likely not have deposited half a billion dollars at an institution managed so poorly. But because of the bail-out, companies like Roku can go to “Crazy Edith’s Bank and Loan” down on the corner and expect that the Fed will back their deposits when Edith up and disappears to Belize.
At one time, banks were required to publish details about their fiscal health, making it possible for the public to decide who to trust. Setting aside the limits on FDIC insurance shift the responsibility from the banks to the FED. Bailing out large depositors only encourages irresponsible money management for all concerned. The result is rising banking costs and almost no consequences for poor financial decisions.
The government is arguing the B-word doesn’t apply here because they are not covering losses by the bank investors or managers. But they are covering deposits that were clearly never insured. While the Fed is supposed to operate independent of the executive branch and representatives, make no mistake – the president and his advisors made the final decision to enact the bail-out.
Financial institutions, depositors and insurers need to act responsibly, and depositors should believe what they read when the words on the bank door says “Each Depositor Insured to at Least $250,000.” The sticker does not add “unless we decide to bail you out”.
The good news is that this bail-out, so far, is not using taxpayer dollars. But it is early days. Just like any insurance system, higher payouts can result in higher consumer costs. The way to avoid the B-word is with greater use of the T-word: Transparency.
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