What's the dirtiest word in financial policy?
My vote goes to "bailout." The term evokes giveaways to the most undeserving of fat cats, people who accept "responsibility" for financial crises as long as that doesn't involve punishment.
Bailouts exemplify the long dishonorable principle of privatizing profits and socializing losses — that is, we're going to mulct the consumer for every cent of black ink but stick it to the taxpayer when our own mistakes put us in a hole.
The perennial issue has bubbled up again in connection with the government response in recent weeks to the collapses of Silicon Valley Bank and Signature Bank.
In those cases, the Federal Deposit Insurance Corp. acted to guarantee the full deposit accounts of the banks' customers even beyond its standard insurance limit of $250,000 per depositor. As it happened, the vast majority of deposits at both banks — 88% at SVB and 90% at Signature, according to the FDIC — were in accounts exceeding that limit.
That's the aspect of the bank rescues that has drawn the focus of their critics, who demand to know who will ultimately pay the bill. The FDIC says the cost of the excess coverage, which it pegs at about $22 billion, will be covered by a special assessment on its member banks, as the law requires. In other words, not a cent will be billed to taxpayers.
"That position just doesn't square with reality," charged Sen. Bill Hagerty, R-Tennessee, when he grilled FDIC Chair Martin Gruenberg at a March 28 Senate Banking Committee hearing.
Or does it?
One often overlooked aspect of government bailouts as they're often implemented is who's getting bailed out. The 2008 banking bailout protected many of the executives whose manifest imprudence created the housing crash that precipitated the financial crisis. Indeed, it protected the banks themselves — Citigroup, Bank of America, Wells Fargo and Goldman Sachs among them.
But it left home buyers whose mortgages were driven underwater in the crash at the mercy of some of these same banks, which often made ad-hoc decisions on whether to restructure the loans or foreclose.
As investment manager and financial commentator Barry Ritholtz observed in his 2009 book "Bailout Nation," the proper solution to the banking crisis was obvious: "Put the insolvent banks into FDIC receivership, fire management ... wipe out shareholders." But to the mandarins of financial policy, those choices were "simply unthinkable."
The bailout's chief architect, Treasury Secretary Henry Paulson, was a banker himself, the former chief executive of Goldman Sachs. So it should not have been a surprise that the bailout left the perpetrators of the 2008 crash almost entirely unscathed.
We shouldn't overlook the negative effects of traditional bailouts as they've been implemented in recent financial history. Ritholtz reduced them to several concise categories in his book, which came out just after the banking bailout.
"First," he wrote, "there is something inherently unjust about some people getting a free ride when everyone else has to pay his or her own way."
Then there are the opaquely secretive political machinations that allow some groups to get a government rescue "while others are left to flounder." Finally, the costs in dollars and cents — $14 trillion for the 2008 banking rescue, by Ritholtz's reckoning, in terms of the immediate expenditure and the long-term damage to the economy.
As Ritholtz pointed out, bailouts are often crafted in response to an immediate crisis, with the consequences left to work themselves out over time. Those consequences include "moral hazard" — confidence that an outside force (usually the government) will always ride to the rescue encourages increasingly reckless behavior.
The managers of the recent crisis — Gruenberg, Federal Reserve Chairman Jerome H. Powell and Treasury Secretary Janet L. Yellen — appear to have learned at least some of the lessons of that earlier event. Let's take a look at how their rescue plan has unfolded.
To begin with, is it a "bailout"? The answer is plainly yes. But the beneficiaries aren't the banks' executives and shareholders. According to the government, the former are all fired and the latter will be wiped out.
The chief beneficiaries are depositors with balances exceeding the deposit insurance limit. One can debate the level of their imprudence in parking millions of dollars in cash in unprotected accounts, but it does appear that many if not most were not investment plutocrats, but rather executives of tech startups and other companies dependent on that money to launch operations and pay their employees' wages.
That brings us to the question of whether the cost of the bailout will land on taxpayers. Hagerty's point was that the cost of the special assessment will ultimately be borne by consumers.
"As we all know," Hagerty said, "these banks will have to pass these costs along. Last time I checked, those costs get passed along to consumers. Those consumers are American taxpayers."
Hagerty wasn't alone in making that point. "We all know that what [the banks] will do is pass the costs on to someone like me," Rep. Roger Williams, R-Texas, told Gruenberg at a companion hearing by the House Financial Services Committee.
Even former Treasury Secretary Lawrence Summers seemed to buy into a variation of this theme. "These were stunningly expensive transactions," Summers told Bloomberg in a videotaped interview March 31. "Everybody's going to say, 'It's not coming back to taxpayers.' But banks are taxpayers on behalf of people — their depositors, their customers, the people they lend to — and the $23 billion the FDIC has spent is 100 bucks per adult American. And that's a fair amount."
The underlying idea is that commercial enterprises pass their expenses on to consumers on a dollar-for-dollar basis. It's a common notion, often reflected in arguments against raising taxes on corporations or raising the minimum wage — that doing so will simply mean that customers will have to cover the full increase at the fast-food counter.
But it's plainly untrue. It fails to acknowledge the contributions of other factors in product pricing, such as the quest for market share, which requires businesses to swallow some costs in order to compete with rivals on price.
Nor does banking resemble businesses that have the freedom to pass costs along to customers. That's especially so in the current financial environment.
Indeed, over the last year many banks have been forced to increase interest rates on demand accounts and certificates of deposit to attract customers — in effect, to reduce prices on those products.
That trend may well show up more among smaller banks in the wake of the SVB and Signature Bank failures, if depositors spooked by the impression of instability in the banking system move their money to bigger and theoretically safer brand-name institutions.
One other theme aired in the congressional hearings deserves scrutiny — that small community banks shouldn't be saddled with the costs of the special assessment imposed to cover the SVB and Signature failures.
This concern was aired by Williams, among others. He asked Gruenberg if "smaller community banks in Texas ... will be left responsible for bailing out the failed banks in California and New York, which we don't even know where they are?"
Williams called small community banks "some of the most trusted institutions in the financial community."
Williams' remark skated over the very nature of the FDIC insurance fund, which is designed to spread the costs of its coverage to the banking system as a whole.
Gruenberg did assure Williams that the FDIC is permitted by law to adjust its assessments based on the nature of a member bank and the reason for the assessment. But the notion that small community banks are somehow simon-pure, in contrast to the risk-happy banks of the East and West Coasts, is ludicrous on its face.
In 2008-15, as the housing crash and great recession was playing out, 515 banks failed in the U.S. A plurality were small community banks in the South, including 14 in Williams' home state, 87 in Georgia and 59 in Florida. In California, 32 banks failed in that period, and in New York, the number was four.
In other words, what goes around comes around, and any effort to immunize community banks from helping to shoulder the costs of the latest rescue may not look so smart if a future banking crisis hits those "trusted institutions" where they live.
None of that means the SVB and Signature rescues were perfect or that no financial services customers won't see their costs rise.
The rescues were an ad hoc response by regulators to sudden depositor runs on those institutions that seemed to threaten the stability of the banking system as a whole.
These were conditions that weren't specifically expected by the Dodd-Frank Reform Act of 2010, enacted in the aftermath of the 2008 crisis, but that only reminds us that regulators, like armies, are often limited to fighting the last war. Dodd-Frank did give the government agencies some flexibility, which they exploited by declaring the two banks "systemically important" institutions, a designation typically reserved for big money-center banks.
As for who may face higher costs in the wake of the bank failures, they're likely to be people who are already abused by the banking system — notably low-income customers and the less wealthy.
As banking expert Adam Levitin of Georgetown Law School observes in a blog post about what might happen if the cap on FDIC insurance is completely removed and banks are charged concomitantly higher premiums, "average Joes are going to be facing things like higher account fees or lower APYs [that is, annual percentage yields on investments such as certificates of deposit], without gaining any benefit."
"The benefit of removing the cap would flow entirely to wealthy individuals and businesses," Levitin writes. "This is one massive, regressive cross-subsidy."
That would only increase the inequality of the banking system. Lower-income and less-wealthy Americas are already grossly overcharged for financial services and saddled with costly nuisances such as overdraft fees and required minimum balances.
That has kept nearly 6 million American households from having any bank accounts at all, driving them to predatory services such as payday lenders and check-cashing firms.
Put it all together, and there are certainly costs associated with the rescues of Silicon Valley and Signature banks.
Critics who dispute that taxpayers will be held harmless have the wrong end of the stick, however. There's no evidence that the costs will be directly charged to taxpayers, but the idea that the government will always bail them out in a crisis won't foster healthy behavior in bankers or bank depositors.
Still, no one who says the regulators were wrong to do this rescue seems to have grappled with what may be the most important consideration: What would have happened to the banking system and the U.S. economy if they hadn't done so?
