Yes, it's a bailout—and yes, it's unwise. The U.S. government will guarantee all customer funds in Silicon Valley Bank (SVB) after a series of bad decisions and a run on deposits led to the bank's collapse. The decision creates bad incentives for financial institutions and their customers.
The Federal Deposit Insurance Corporation (FDIC) is supposed to guarantee money at insured banks up to $250,000 per depositor, per bank, in each account ownership category.* In this case, however, it will fully protect all depositors with no limit.
"Depositors will have access to all of their money starting Monday, March 13," Treasury Secretary Janet Yellen, Federal Reserve Board Chair Jerome Powell, and FDIC Chair Martin Gruenberg said in a joint statement yesterday. The FDIC will also guarantee funds for customers at New York's Signature Bank, which regulators closed on Sunday. "All depositors of this institution will be made whole," announced Yellen, Powell, and Gruenberg.
The FDIC will sell off SVB assets to cover some costs but, beyond that, depositors will be paid with money from the Deposit Insurance Fund. This fund has been built up by fees collected from banks. Any losses to the fund "to support uninsured depositors will be recovered by a special assessment on banks," write Yellen and company.
A lot of folks are insisting this isn't a bailout and that it comes at no cost to taxpayers. For instance: The joint statement says, "No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer."
But this is misleading. For one thing, banks are themselves taxpayers. And in situations like this, the many institutions who act responsibly must bear the burden of bank fees in order to inoculate less responsible actors. Besides, these fees assessed on banks don't exist in a vacuum that only burdens big businesses; banks pass on the costs of regulatory compliance to customers in a number of ways. So the idea that the government's bailout funds come from some sort of magical pool of consequence-free money is silly.
"The public is always on the hook for any Fed program, no matter how much government insists costs won't be borne by taxpayers," commented former Rep. Justin Amash (L–Mich.) on Twitter, pointing out that "a bailout creates a moral hazard, even if it's *just* a bailout of depositors at a bank; it doesn't fix—but instead exacerbates—the systemic problem."
Moral hazard is one of the major worries when it comes to bailouts like these. Both banks and consumers have less incentive to be cautious with their money if they can plausibly assume that the government will step in and save them from any mistakes. So, a bailout like this uses public money to compensate for risky or bad financial decisions and incentivizes more risky or bad decisions in the future.
What SVB did with their portfolio is either a signal of enormous incompetence or of outright moral hazard at play – gamble away billions as policymakers will rescue you
I can't believe incompetence reaches these levels, & there are some clear hints moral hazard was at play
2/
— Alf (@MacroAlf) March 11, 2023
It's also likely to spur more rules and regulations that could further burden all banks and their customers. People are already calling for the Biden administration to tighten regulations on regional banks in response, laying blame on a supposed lack of government oversight rather than on SVB's myriad bad judgement calls.
It appears this problem stems in part from the fact that SVB was flush with cash from a venture capital boom. "People kept flinging money at SVB's customers, and they kept depositing it at SVB," explains Matt Levine at Bloomberg Opinion. Typically, a bank flush with cash would loan out most of this money. "But [SVB's] customers didn't need loans, in part because equity investors kept giving them trucks full of cash and in part because young tech startups tend not to have the fixed assets or recurring cash flows that make for good corporate borrowers," writes Levine.
So rather than make a lot of loans, SVB put a lot of its money into long-term, fixed-rate interest investments, such as Treasury bonds and 10-year mortgage-backed securities. (At the end of 2022, SVB reportedly had around $120 billion in investment securities and only around $74 billion of loans.) "This was mistake No. 1," argues Andy Kessler at The Wall Street Journal. "SVB reached for yield, just as Bear Stearns and Lehman Brothers did in the 2000s. With few loans, these investments were the bank's profit center."
Then the feds raised interest rates and "SVB got caught with its pants down as interest rates went up," as Kessler puts it:
Everyone, except SVB management it seems, knew interest rates were heading up. Federal Reserve Chairman Jerome Powell has been shouting this from the mountain tops. Yet SVB froze and kept business as usual, borrowing short-term from depositors and lending long-term, without any interest-rate hedging.
The bear market started in January 2022, 14 months ago. Surely it shouldn't have taken more than a year for management at SVB to figure out that credit would tighten and the IPO market would dry up. Or that companies would need to spend money on salaries and cloud services. Nope, and that was mistake No. 2. SVB misread its customers' cash needs. Risk management seemed to be an afterthought. The bank didn't even have a chief risk officer for eight months last year. CEO Greg Becker sat on the risk committee.
Higher interest rates meant having to pay more interest on deposits. But SVB couldn't compensate fully by getting paid more interest on loans, since it didn't have enough loans. Meanwhile, higher interest rates also meant its long-duration, fixed-rate securities were losing value. So instead of profiting off higher interest rates overall, it was losing money.
Meanwhile, higher interest rates also meant that venture capital was drying up for a lot of SVB's startup depositors. That meant fewer customers depositing new money and more customers withdrawing a lot of funds. And because a lot of SVB's money was tied up in longer-term investments, it had to sell securities at a loss in order to pay back depositors, making its short-term financial situation even more precarious.
By January of this year, people were noticing SVB's problems. In February, the tech and finance newsletter writer Byrne Hobart pointed out that "Silicon Valley Bank was, based on the market value of their assets, technically insolvent last quarter." Accordingly, even more depositors started withdrawing more funds, further exacerbating its instability. This, of course, further frightened depositors, who yanked even more funds. "By the time the lender closed for business [last] Thursday, depositors had attempted to withdraw $42 billion," The Wall Street Journal reported.
The situation came to a head on Friday, when SVB collapsed and the California Department of Financial Protection and Innovation took possession of it, appointing the FDIC as receiver.
In the end, "the culprit" in SVB's collapse "wasn't the kind of exotic derivatives and risk-taking that doomed banks in the 2008 financial crisis. Rather, it was a mismatch between deposits and assets—the building blocks of the vanilla business of commercial banking," the Journal writers explain. "The episode has exposed a new set of vulnerabilities for the financial system. Bankers that grew up in the easy-money era following the 2008 crisis failed to ready themselves for rates to rise again. And when rates went up, they forgot the playbook."
Still, SVB should stand as a lesson about making this same kind of mistake in the future. And perhaps as a lesson to depositors about putting too much into one financial institution, especially one trendy with startup businesses and overly focused on serving them.
Instead, it's teaching that risk really doesn't matter, because if things go sour the government will step in and bail you out.
The moral hazard here is we've greatly reduced the incentive for depositors of any size now (250K my ***) to actually give a moments thought to the riskiness of where they're putting their money.
It's not as bad as if we also let SBF off the hook.
But it ain't ok. https://t.co/4ZQaJi31dq
— Clifford Asness (@CliffordAsness) March 13, 2023
FREE MINDS
Media columnist Jack Shafer takes a look at Tucker Carlson's troubles. Carlson's mask is slipping thanks to filings in a defamation lawsuit Dominion Voting Systems filed against Fox News. "In the filings—text messages and emails authored by Carlson (and other Foxies)—he reveals that the wildly pro-Trump stance that he and his network long cultivated has been a theatrical performance," writes Shafer:
Carlson, who has long defended and promoted Trump, as well as advised him on national security issues, has never been a genuine Trumpie, he has just played the role on TV. His support of Trump and many Trump-adjacent issues has been one of convenience, and when not a matter of convenience, a measure of his fear of Trump.
"We are very, very close to being able to ignore Trump most nights," Carlson texted an unnamed Fox co-worker on Jan. 4, 2021. "I truly can't wait." When Carlson's colleague responded, "I want nothing more," Carlson texted back, "I hate him passionately."
Carlson continued: "What he's good at is destroying things. He's the undisputed world champion of that. He could easily destroy us if we play it wrong." Elsewhere, Carlson said of the Trump presidency, "That's the last four years. We're all pretending we've got a lot to show for it, because admitting what a disaster it's been is too tough to digest. But come on. There isn't really an upside to Trump."
How did Carlson—once "one of the most talented Washington-based journalists of his generation"—get here? "Carlson's slide into the dark side" came after a number of serious journalistic ventures of his failed to really take root, Shafer suggests. More here.
In related news: "Fox News braces for more turbulence as second defamation lawsuit advances."
FREE MARKETS
Junk statistics. The Atlantic takes a look at the proliferation of junk statistics. "Through endless repetition, numbers of dubious origin take on the veneer of scientific fact, in many cases in the context of vital public-policy debates," lament the Boston University economist Raymond Fisman, the Columbia political scientist Andrew Gelman, and the Harvard law professor Matthew C. Stephenson.
One prevalent category of junk statistics is purported measures of the size of illicit economies:
For years, the three of us have been tracking the origins of numbers that claim to measure illicit activities, which are by their nature hard to measure. You may have heard that more than $1 trillion in bribes is paid each year, or that corruption costs the world economy $2.6 trillion annually. The $1 trillion figure comes from a set of extrapolations from a handful of surveys conducted by the World Bank and the World Economic Forum in the early 2000s in a variety of countries. These calculations produced a wide range of estimated annual-bribe payments—from about $600 billion to $1.7 trillion. The $1 trillion figure is roughly the midpoint of that range. The problem with taking just the average is that doing so strips the data of the enormous uncertainty in already-questionable estimates. And yet, the figure keeps resurfacing—the World Bank's website, for example, cited it as recently as 2020—as if the annual amount of bribery were constant.
The $2.6 trillion corruption estimate, meanwhile, traces back to a one-sentence bullet point in an advocacy brief from a group of respected organizations, including the World Economic Forum and Transparency International. The brief cited no source, and, as far as we can tell, the number was likely based on a careless misreading of an earlier study. But the figure was later cited by the heads of prominent international bodies, including the United Nations and the Organization for Economic Co-operation and Development.
These numbers are what we might call "decorative statistics." Their purpose is not to convey an actual amount of money but to sound big and impressive. That doesn't keep them from being added, subtracted, divided, or multiplied to yield other decorative statistics. Some organizations and news outlets combine the bribery and corruption estimates and declare that the planet experiences $3.6 trillion in graft year after year….
We recently came across a study by two respected researchers that put the scale of illegal bets placed each year at $1.7 trillion. Where did such a precise figure for hard-to-measure, clandestine activities come from? Their paper cited a document published by the UN Office on Drugs and Crime. That document, however, actually gives a range of $340 billion to $1.7 trillion, cites no source, and rightly warns about the inherent difficulty of measuring the underground economy. But the $1.7 trillion figure has taken on a life of its own.
See also: "The false claim that human trafficking is a '$9.5 billion business' in the United States."
QUICK HITS
• A new report details how plea bargaining hurts defendants and warps justice.
• Here's a complete list of the 2023 Oscar winners.
• Reason's science correspondent, Ron Bailey, looks at the new obesity-curbing drugs.
• Meta is considering creating a decentralized social network.
• Kentucky is the latest state to advance a bill that would limit drag performances.
• The criminal charges that Manhattan District Attorney Alvin Bragg wants to pursue against former President Donald Trump "are so iffy that they reinforce Trump's reflexive complaint that he is, as always, the victim of a long-running Democratic 'witch hunt,'" writes Reason's Jacob Sullum.
*UPDATE: This post has been updated to offer more details about FDIC insurance coverage.
The post Everyone Is Learning the Wrong Lessons From the Silicon Valley Bank Collapse appeared first on Reason.com.
