March 10, 2023 should have been another Friday, but it ended up being when Silicon Valley Bank (SVB) collapsed, thereby triggering the second-largest bank failure in U.S. history. If that were not enough, the Federal Deposit Insurance Company (FDIC) stepped in on March 12 to say that they will protect all of SVB's depositors. In addition, the Federal Reserve created a new emergency lending program called the Bank Term Funding Program. Banks in need of liquidity can have a loan between 90 days and a year. What is noticeable about BTFP is that the assets are valued at par instead of market value.
The federal government went to great lengths to stress that this was not a bailout. In some respects, the government's latest intervention is different from the 2008 bailout. SVB is not going to be revived by taxpayer dollars. The lenders and shareholders are not getting government money approved by Congress. Even so, it is still a bailout. Why? The government is stepping in to shore up the banking system with the FDIC's Deposit Insurance Fund (DIF). The DIF is technically funded by other banks. Right now, the DIF has less than $130 billion, whereas deposits in U.S. banks amount to $22 trillion. The Right-leaning American Enterprise Institute estimates that the bailout will cost at least $100 billion.
What happens when the Fund runs out of money? It is possible to recapitalize FDIC to help fund the DIF and spread the cost done to other banks, but that will be done through garnered returns on your bank account. But that is not how the Fund has traditionally been covered when it runs low on funds. If there is not an appeal to Congress, FDIC can ask the Treasury for more money, which is another way of saying this will in all likelihood be funded by taxpayer dollars. And if the Fed decides to buy up some of that government debt to create the funds, we will pay in the form of inflation. One way or another, taxpayers will pay for SVB's mismanagement.
How concerned should we be about financial contagion?
This is the big question I would like to ask today. This bailout might seem like nothing more than a subsidy for rich, politically connected venture capitalists in the Silicon Valley. Proponents would argue that is not the case. The main justification for such bailouts is the worry over financial contagion. Financial contagion is when an economic crisis spreads from one market or region to another.
Financial contagion is not mere conjecture or economic theory. While this phenomenon occurred with the bank runs in the Great Depression, the phrase "financial contagion" first emerged during the 1997 Asian financial markets crisis. The Great Recession and the COVID-19 pandemic are other examples of financial contagion. The argument for the bailout is presented succinctly by the American Enterprise Institute:
Without a clear purchaser of SVB, it was entirely plausible that that there could be additional runs on regional banks by Monday. The costs for stabilizing these banks is likely much less than cleaning up the cost of cleaning up a broader financial collapse.
While SVB's customer base is primarily in tech, there is at least some marginal risk to the broader economy. SVB was the bank for 44 percent of ventured-backed technology and health initial public offerings (IPO). The bank's loans helped start-ups in life sciences, healthcare, and AI technology companies, not to mention funding 15 percent of Massachusetts' charter schools. These are some concerns that point to the potential of contagion.
While the concerns about contagion are plausible, I have to wonder how likely they are. Forget the poetic notion that SVB had lobbied to remove the systemic risk label off their bank. As covered in my previous analysis of the SVB failure, the conditions leading to the collapse of SVB are much more idiosyncratic in nature. The bank's customer base was predominantly well-off, risk-taking venture capitalists and players in the tech industry. More traditional banking institutions keep a more diversified customer base, which helps spread out risk and better shield themselves from a single shock. Being a niche specialty bank with a narrow customer base in sectors made SVB more prone to high investment risk.
As we see below from The Economist's analysis, SVB was unique in terms of size, as well as the combination of uninsured deposits and held-to-maturity securities. The bank had a relatively non-diversified portfolio filled with long-term government bonds and mortgage-backed securities. Such a concentration in SVB's portfolio was more prone to interest-rate risk than the average bank portfolio. There was also the "ill-timed and failed securities sale and planned recapitalization [that] were unique to SVB." Furthermore, the interest rate increases did not happen overnight. They were announced by the Fed and anticipated. SVB's lack of hedging against deflationary policy was pure negligence on SVB's end.
The uniqueness of the SVB case do not signal a broader weakness in the banking sector, especially since "the banking system's overall leverage is much less than 15 years ago and bank assets are higher quality than back then." There is the final counterargument that there are enough healthy banks out there that could have purchased and absorbed SVB's assets with little to no shock to the economy. We will never know if that would have been the case because the federal government intervened. The question that remains, which I will have to answer at another time, is whether the potential of contagion outweighs the potential for moral hazard.
Part II will cover the costs of deposit insurance and concerns over moral hazard.
No comments:
Post a Comment