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Preventing panic in the banking sector
A government-organized deposit guarantee should tame the animal spirits.
“So you run down to the safety of the town/ But there's panic on the streets of Carlisle” — The Smiths
Well, I guess I know what I’m going to be writing about for at least the next few days! In my post on Friday, I tried to explain the basics of why Silicon Valley Bank had a run. Today I’m going to talk about how to prevent a wider panic in the banking sector. (Note: This post was obsolete practically as soon as I wrote it, since the government stepped in to guarantee SVB’s deposits. But this post is still useful because it explains why this was done, and why this wasn’t a bailout.)
In that earlier post, I noted that the biggest danger from SVB’s collapse has nothing to do with startups failing to pay their employees. If a bunch of startups fail to pay their employees for a while and a few go out of business as a result, it’ll be bad for tech workers and founders and VCs, and it’ll probably be bad for the local economies of tech clusters like San Francisco, but ultimately it’ll just be one more piece of the tech bust that has been going on since early 2022. The far, far bigger danger is a banking panic — a bunch of people might see what happened in SVB and pull their money out of other banks, sparking a wave of bank failures and ultimately a recession.
As I noted, if this happens, it won’t be for the reasons it happened in 2008. The banking system as a whole does not depend on Silicon Valley Bank. Other banks are not dependent on loans from SVB, or on lending to SVB, and if SVB’s assets are dumped in a fire sale, it will not make other banks suddenly insolvent. Thus, we are not at risk of a true financial contagion. That’s good!
What we are at risk of is a panic. A bunch of people who never saw a major bank run in their careers, or who forgot about 2008, or who just assumed it could never happen to them, might wake up and go “Oh my God, banks aren’t safe! The sky is falling! Help help help!!!”, and rush to pull their money out of their bank and put it in Chase or Treasuries or cash stuffed in socks. And then other banks might start failing too. This sort of panic isn’t rational, but as I explained in my last post, it’s a self-fulfilling prophecy — you don’t need rationality to have a bank run. Indeed, people in the VC/startup world are saying a lot of very panicky things right now:
This seems like a bad comms strategy to me, since A) it could cause more bank runs, and B) if the government decides that the VC/startup world is systemically financially important, there will be a lot of new regulation in the pipes, like there was for housing after 2008. But panic isn’t a comms strategy; it’s an emotion.
Anyway, it’s unlikely that a panic would focus on big banks, which have an implicit government guarantee after 2008. And it’s unlikely it’ll focus on small banks, most of whose deposits are FDIC insured. But mid-size regional banks, especially in California, could definitely be vulnerable. The stocks of First Republic Bank, Signature Bank, Western Alliance Bank, and PacWest took a big dive this week, even as big bank stocks took only a small dip:
There are a lot of wild rumors and claims floating around about these banks right now. I don’t trust any of them. But nevertheless, it is possible that this coming week, or the next, we’ll see some runs in these banks.
It’s also possible that the rest of the U.S. economy and financial system will simply ignore the tech sector again. Maybe the corporate depositors of banks around the country will simply shrug and decide that the failure of SVB and a couple of other California banks that cater to tech nerds has nothing to do with them, and go about their business. So far, that has been the pattern — tech stocks crashed in 2022, VC funding dried up, and big tech companies had a ton of layoffs, but overall consumption and employment and growth in the nationwide economy are doing great. So maybe that will happen again.
But there is a reason why people outside the tech world might be worried: interest rates. SVB may have been famous for making risky loans to startups, but its balance sheet was heavy on long-dated government and corporate bonds. One reason it was at increased risk of a run was that those bonds had declined in value due to rising interest rates. (Remember, when rates go up, bond prices go down!)
Other banks, outside of the tech world and California, also have a lot of long-dated government and corporate bonds on their books. (If you see people talk about “hold-to-maturity” or “HTM” assets, that just means long-dated bonds.) That’s why recent rate hikes have reduced the value of a whole lot of banks’ assets. So if SVB’s collapse causes depositors outside tech to focus on that fact, and start to worry that rate hikes have made their own banks insolvent, it could fuel a panic that spreads well beyond the nerds in California. This is obviously a worst-case scenario, but of course we can’t rule it out.
The next question becomes: What can the government do to prevent or stop a wider banking panic? Well, it starts with the FDIC.
The FDIC is doing its job
The FDIC, established in 1933 after a major banking panic kicked off the Great Depression, has two jobs. First, it tries to prevent bank failures by offering deposit insurance. Second, it tries to minimize the damage from bank failures by taking failed banks into “receivership”, selling off their assets, and paying their depositors.
The latter is what the FDIC is doing now, with SVB. SVB has been put into receivership, meaning that its shareholders have been wiped out and its employees will, after 45 days of getting paid to help clean up their mess, be out of a job. The FDIC is even now looking for a buyer, or buyers plural, for SVB’s assets.
Whether it’s one buyer or several is actually pretty important. In most bank failures, the failed bank’s assets and deposits are both transferred to one other bank — in other words, if you’re a yesterday you had an account at SVB, today you have an account at some other bank, and you don’t lose a penny of your deposits. There have been hundreds of bank failures since 2008, and this is almost always what happens. The most famous example of this was Washington Mutual in 2008, which was an even bigger bank than SVB. When WaMu failed, its assets and deposits just got transferred to JP Morgan Chase, and depositors kept all their money.
That’s the good scenario, and hopefully the FDIC will find a bank who’s willing to do the same for SVB. In fact, it’s frantically searching for such a buyer right now. If this happens, it’ll go a long way toward quelling panic. But this really has to happen in the next day or so, so by the time you’re reading this, that optimal solution will likely either have happened or will have been ruled out.
Anyway, if that fails, the FDIC has to go to Plan B, which is to sell off SVB’s assets to various different buyers and send the proceeds to the depositors. This is not the optimal plan because there’s a basic tradeoff here. On the one hand, the FDIC can try to sell as much as possible quickly, to help SVB’s depositors make payroll this week. On the other hand, it can take its time to sell some of the assets, in order to get a good price for them, so that depositors don’t end up losing any of their money.
It’s actually not clear which of these approaches would be more effective in quelling panic. Maybe people will panic more if SVB’s depositors have to wait for a full payout, or maybe people will panic more if they end up having to take a haircut on their deposits. The FDIC has to make its best bet.
So far, it looks like it’s going with some sort of balance between the two. Unless the good scenario miraculously happens and some bank buys all of SVB today, the FDIC will begin selling off the assets piecemeal so that SVB depositors can start making payroll on Monday:
US regulators overseeing the emergency breakup of SVB Financial Group are racing to sell assets and make a portion of clients’ uninsured deposits available…The initial payout — the amount of which is still being determined — would aim to tide over the firm’s distressed customers, many of them Silicon Valley entrepreneurs and their companies, with more cash to follow as the bank’s assets are sold. The amount will depend in part on the Federal Deposit Insurance Corp.’s progress in turning assets to cash by Sunday night…Figures being floated behind the scenes for an initial payment range from 30% to 50% or more of uninsured deposits[.]
This will leave some of the deposits in limbo, which runs the risk of sustaining the atmosphere of panic. Depositors will worry that they’ll end up like the depositors of IndyMac, who got 50% of their deposits back immediately when that bank failed in 2008, but never got anything else.
So in this case, there are going to be calls for more dramatic government action to prevent panic. In fact, those calls are already going out. So what would that action look like?
A deposit guarantee
The easiest thing the government could do (Update: and which it has now done) would be to guarantee the uninsured deposits of SVB depositors. In other words, the government would declare that if you had money in SVB, you will definitely get 100% of it back. This is being considered now:
Federal authorities are seriously considering safeguarding all uninsured deposits at Silicon Valley Bank…Officials at the Treasury Department, Federal Reserve, and Federal Deposit Insurance Corporation discussed the idea this weekend…
Although the FDIC [only] insures bank deposits up to $250,000, a provision in federal banking law may give them the authority to protect the uninsured deposits as well if they conclude that failing to do so would pose a systemic risk to the broader financial system…In that event, uninsured deposits could be backstopped by an insurance fund, paid into regularly by U.S. banks.
Before that happens, the systemic risk verdict must be endorsed by a two-thirds vote of the Fed’s Board of Governors and the FDIC board along with Treasury Secretary Janet Yellen.
Crucially, it appears this doesn’t require an act of Congress, which is always a tricky proposition because legislators like to grandstand and obstruct things and delay.
In fact, it appears the deposit guarantee fund wouldn’t just be for SVB. It would be able to guarantee uninsured deposits at any other bank that fails or even just looks shaky as a result of this episode.
In other words, every bank customer would know that what they thought were uninsured bank deposits are now insured bank deposits. Ta-da!! And with zero danger of losing any deposits, customers won’t bother withdrawing their deposits from any bank, and the panic will, presumably, end.
A lot of people will complain about this, calling it a “bailout” and drawing parallels to 2008-9. But a deposit guarantee is not a bailout. The two situations are very different, for two reasons.
First, in 2008, the bankers who made the bad decisions that led to the financial crisis generally got to keep their (very lucrative) jobs after getting bailed out. And their banks continued to exist as well, and even got government to guarantee them some profits going forward. Even as normal people suffered mass unemployment and the loss of their careers and livelihoods, many of the people responsible for the disaster kept collecting million-dollar checks and being in respected positions of power, now with government guarantees. If that seemed unfair, it’s because it was unfair.
A deposit guarantee for SVB and other banks will not be similar at all. SVB will cease to exist, its owners will lose their money, and its employees, who made a lot of questionable business decisions, will be looking for new jobs. The people who get paid out will not be its owners or its employees, but its customers — people who stuck their money in a bank and didn’t think too carefully about whether that bank was a good bank. Maybe that was a little negligent, but it wasn’t greedy — they didn’t get rich by having a checking account at a badly run bank.
The second difference is that a deposit guarantee wouldn’t cost taxpayers any money. It would be paid for by a new deposit insurance fund that banks pay into. So regular folks won’t be on the hook for some Silicon Valley billionaire’s mistakes. Again, not a bailout.
(Broadly speaking, the only way bailouts ever become necessary for financial stability is when most or all of the big banks are about to fail at the same time, as in 2008. But since the big banks aren’t in danger of failing now, the government doesn’t need to step in with its own money.)
The only worry regarding a deposit guarantee is that it would create moral hazard. Some people will fret that this sort of move would effectively make all uninsured bank deposits FDIC insured, which will encourage people to put their money in crappy banks in the future. But this is unlikely. Bank failures are very normal occurrences, and people will understand that this kind of emergency measure only comes in the rare case when a bunch of banks are in danger of failure all at once. They’ll also know that almost all bank failures get resolved with full recovery of uninsured deposits, even without emergency measures like this one.
So I think there won’t be much downside to a deposit guarantee. And if people are really really worried about moral hazard, they could just lower the asset threshold necessary for a bank to be considered a Systemically Important Financial Institution. This threshold was $50B in the years after the 2008 crisis, but under Trump it was raised to $250B — in fact, SVB itself lobbied for the change, and made sure to keep its assets just below the threshold. So if people want to make the banking world pay some sort of price for irresponsibility, lowering this $250B cutoff would be one way to do that.
But the larger message here is that the government has plenty of tools to quell a banking panic and guarantee uninsured bank deposits, without the need for any bailouts. If a buyer isn’t found to take over SVB’s deposit accounts very soon, the government will almost certainly step in and guarantee deposits. Some banks might still fail, because people are panicky herd animals, and people in the VC/startup sector seem to be more panicky and exhibit more herd behavior than most. But if other banks fail, those depositors, too, will almost certainly get all their money out.
It will be a nail-biting couple of days for a lot of people, especially in the VC/startup industry. And it may take a little while for everyone to get all the deposits back. But unless our economic officials are extraordinarily stupid, I don’t see anyone’s deposits going up in smoke.
Update: As expected, the Treasury, Fed, and FDIC have released a joint statement guaranteeing all the uninsured deposits at SVB, as well as Signature Bank, using a new special insurance fund. Key excerpts:
After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank…in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.
We are also announcing a similar systemic risk exception for Signature Bank…
Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.
Finally, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.
As I wrote, this is not a bailout; no regular folks will owe any money, SVB no longer exists, and SVB management will lose their jobs.
It’s clear that this fund will be expanded to other banks, e.g. First Republic and PacWest and Western Alliance, if they experience runs tomorrow. The knowledge that all depositors will get all of their money out in a prompt manner should prevent the panic from spreading beyond those banks, and will hopefully save all of those banks from runs as well.
Here is a useful thread from Brad Setser on the details of the government’s solution:
And as always, read Matt Levine. He argues that although the deposit backstop isn’t a bailout for SVB itself, it is a bailout for other banks that would otherwise have suffered from runs. He is right in that those banks’ management gets to keep their jobs and their stockholders will keep some of their money. But that benefit isn’t taxpayer-funded either. And if we start defining “bailout” to mean any government action that makes unsafe banks more safe, then interest rate cuts become bailouts too…so I’m not so sure about this…But anyway, do read what Matt has to say!
Also, I have a new post thinking about what SVB means for monetary policy, and why we don’t just shore up the banking system by cutting interest rates.