For the most part, bailouts of mobi banksIn addition to widespread concerns about moral hazard, the idea that if someone is saved from the consequences of his actions, he will take even greater risks in the future. This time, a popular opinion shared by many commentators is that depositors in banks, even if they are sophisticated companies with large deposits and not insureds who are in danger, cannot be expected to monitor how their banks behave.
● JP Morgan analyst warns: the likelihood of market madness is increasing
● On deposits or loans: which bank has the highest interest rate?
● After the precedent of Credit Suisse’s bond write-off, Europe and the UK promise to behave differently
This opinion is both right and terribly wrong. And this is important for how we, as a society, decide what the banking system should look like following the collapses of Silicon Valley Bank (SVB) and the smaller Signature Bank.
It’s true that even before that, the big depositors in SVB simply didn’t have it Cares about the risks the bank took, however obvious they may be in hindsight. Streaming company Roku had $487 million in deposits there, a quarter of its cash. This, despite the fact that SVB offered an interest rate on large deposits that was much lower than half of what the customers could get from a financial fund that would invest all the money in Treasury bonds and other safe assets. The customers simply did not bother to do due diligence on their bank.
Probably not the place to leave the money
After ignoring the risks, last week depositors suddenly became aware of the danger, and realized that a bank with unrealized losses, which will use up virtually all the capital it has, is probably not where they want to keep their money. This resulted in a chaotic run on the bank, and on Friday SVB was seized by the Federal Deposit Insurance Corporation. Over the weekend, the government decided to collect the deposits in the bank – and in the crypto-focused Signature Bank – at a level beyond the insurance corporation’s $250,000 limit, after complaints from many startups among SVB’s customers, who remained stuck.
The deposit back-up could in theory be a one-off, but it’s hard to see how the government could avoid providing it the next time a medium-sized bank fails (and there are many banks that are losing deposits quickly in the current uncertainty). The definition “too big to fail” is being stretched these days to a whole array of additional banks.
This view is horribly wrong because moral hazard is part of the design. Unlimited deposit insurance should indeed reduce the risk of bank runs, because it means that depositors will not care even when they find out at a very late stage that their bank is unsafe. If uninsured depositors at SVB had been covered last week, they would have had no reason to fear the fact that SVB is technically not insolvent, just because accounting rules allowed it to ignore large paper losses on its assets. This is moral hazard in its most extreme form.
The management crossed their fingers and hoped for the best
We need a supervisory system for the taking of risks by banks, which does not include panicked runs on the bank and the chaos they cause. What should have happened is that when it became clear that SVB was losing a lot on bonds, it should have recognized the losses early on, raised new capital or put itself up for sale. But the management team chose to cross their fingers and hope that everything would work out. The shareholders chose to sell instead of move for action (as a result, the stock lost two-thirds of its value last year).
And the regulators, it seems, have ignored the danger that the Federal Reserve itself will raise interest rates aggressively and thus hurt banks that have long believed the Fed’s low interest rate predictions. The Fed’s most recent stress tests did not include the danger of a spike in interest rates, and instead fought the last war by focusing on a deep recession and counterparty risk.
“Maybe the problem was the Fed’s promise of low interest rates for a long time – not only did SVB’s chief financial officer believe it, but the people who designed the Fed’s stress tests believed it too,” said Professor Douglas Diamond, of the University of Chicago’s Booth School of Business. who won the Nobel Prize in Economics last year for his work on bank runs. “The supervisors didn’t do their job in this case.”
In the short term, none of these things should happen again. Depositors are suddenly acutely aware of the risks to banks, despite the extended deposit guarantee. Shareholders divest themselves of their stakes in banks at the slightest hint of possible trouble. Regulators are already working on stricter rules.
But in the long run, we can expect complacency to take over again, because that’s what always happens. There are only two ways to prevent this, and neither of them is realistic. First, to occasionally assume that a bank whose collapse does not constitute a systemic risk – like SVB – will crash against the wall, the uninsured depositors will lose, the management will resign in disgrace and the shareholders will lose everything. Do this once every few years and the lessons will be internalized. Unfortunately, the government has decided that it is not possible under any circumstances to expect that the important and respected members of Silicon Valley Bank will lose in the context of the collapse of the bank, and therefore this option is rejected outright.
Redesign of the entire financial system
The second way is to redesign the financial system so that it eliminates the risk of a run on the bank. Current accounts will be held in “narrow banks” that are largely similar to a government monetary fund, and do not hold anything more dangerous than short-term Ministry of Finance bonds, and make their money from commissions for carrying out operations, rather than from taking out short-term loans and providing long-term loans.
The rest of the banking system will be replaced by funds that only accept deposits for a fixed time, and coordinate between the repayment of the deposits and the end dates of the loans. The financial system will have much less flexibility, but it will need far fewer regulators and no deposit insurance. This may have been possible in 2009, when the whole system collapsed, but concerns about the banks are not sufficient for this kind of structural change today.
Instead, we will get compromise, hesitation and costs. More insurance on deposits – even if this is only implied and not written in an official form in the rules – means even more regulation, in an attempt to address the moral hazard. More regulation means higher costs, less competition and more difficulty in obtaining credit, along with more bureaucracy.
This will probably prevent further runs on the banks for a certain period. But mistakes are inevitable, on the part of bank managers and on the part of regulators. On the plus side, in the case of SVB, at least the shareholders lost their money and the managers lost their jobs. But the large depositors, and the apparently prudent ones, who chose to turn a blind eye, came out of this unscathed, and will probably avoid losses in the future falls as well, and instead will pass the costs on to other banks or to the taxpayers. This is a moral hazard.