Ever since the 2008 financial crisis, and especially since the
To me, the solution is both obvious and simple; we should explicitly extend
Objections to full deposit insurance center on the problem of
At first, this might sound logical. It appeals to our sense of fair play; those who make bad financial decisions should suffer the consequences and taxpayers should never pay for private mistakes. But to me, this view is mistaken on at least two fronts.
First, to my knowledge, taxpayers have never paid for the bailout of a U.S. commercial bank. It is the banks themselves who have always (eventually) paid for bank bailouts, mainly through FDIC assessments. To be sure, the Federal Reserve does often lend to banks needing liquidity. But this is not a bailout. This is just the Fed doing its job.
As MIT economist Deborah Lucas observes, "prospective costs to taxpayers are small, even during a severe financial crisis. The direct costs fall largely on strong banks, which through the system subsidize weaker ones."
In its recent
In fact, the whole "heads I win, tails you lose" argument is a big canard, at least when applied to U.S. banks. In a typical bailout, equity holders are wiped out — mainly through dilution — so the risk-takers don't really "win."
A second, and far more important flaw in the "moral hazard" argument is the false premise that private depositors — even sophisticated ones — are capable of effectively differentiating between those banks that will fail and those that won't. After all, Silicon Valley's depositors were the definition of "sophisticated."
Think about it for a minute. How could any depositor have been expected to foresee the run at Silicon Valley when an army of so-called experts whiffed? Wall Street equity analysts missed it. Moody's and S&P, always reliable lagging indicators of credit problems, missed it too.
The planned Altos Bank in Los Altos cleared a big hurdle this week when state regulators approved its application to open a startup bank. Organizers are hoping for a soft opening before year-end.
And, of course, regulators missed it. As is recounted in the Fed's admirably candid
It is very much to the point that many of these experts had identified fundamental weaknesses at Silicon Valley prior to the run. The bank's imprudently long bond portfolio was staring everyone in the face. But it is easy to identify deficiencies in a bank. It is another thing entirely to predict that a particular bank is doomed to imminent failure. After all, many banks had imprudently long bond portfolios.
The point is that despite Silicon Valley's many deficiencies, it was virtually impossible for anyone to predict a fatal run. In other words, while we can explain in retrospect why Silicon Valley suffered its run, it could not have been foreseen. Runs are irrational, and unforeseeable by definition.
For the unfortunate First Republic, there is no rational explanation for its run, not even in retrospect. Its run was pure panic and contagion.
It seems to me that moral hazard implies intent. That is, the moral hazard standard requires that one knows when one invests in or lends to an institution that there is a strong probability of failure that justifies the excess expected return. Either that, or management is aware of such severe fundamental issues that they execute a "Hail Mary" play to save themselves.
Neither of these was true of SVB's shareholders (who lost everything) or of its depositors. Nor was it true of bank investors in the 2007-2008 financial crisis. It was sickeningly true of investors and depositors in the 1980's thrift crisis.
A compelling case in favor of full deposit insurance is that it would help balance the immense regulatory advantage held by our biggest banks over our smaller ones. As things stand now, every corporate treasurer knows that our government would never let depositors incur a loss at a systemically important financial institution. It is an easy decision to bank with these giants rather than take a risk with smaller banks whose large deposits do not have the same de facto guarantee.
I will admit to a strong bias in favor of our diverse banking system. Though difficult to prove, I believe that America's endowment of small- and medium-size banks has been an immense benefit to us compared to other nations in financing small entrepreneurial businesses and serving local communities. Even though technology may be driving banks inexorably toward consolidation, I believe that we should do what we can to encourage smaller banks by providing them with at least a level regulatory playing field. Full FDIC insurance would help them survive and, hopefully, prosper.
It is ironic, to say the least, that our policymakers delight in disparaging our "too big to fail" banks and the concentration of the banking industry while at the same time driving business away from small banks and into the giants.
