Is there moral hazard if no one was paying attention? |
So the Feds stepped in to
protect all deposits at Silicon Valley Bank, even though the law says
that deposits only up to $250,000 are insured and even though there was a
pretty good case that allowing big depositors to take a haircut
wouldn’t have created a systemic crisis. S.V.B. was pretty sui generis,
far more exposed both to interest risk and to potential runs than any
other significant bank, so even some losses for larger depositors may
not have caused much contagion. |
Still,
I understand the logic: If I were a policymaker, I’d be reluctant to
let S.V.B. fail, merely because while it probably wouldn’t have caused a
wider crisis, one can’t be completely certain and the risks of erring
in doing too much were far smaller than the risks of doing too little. |
That
said, there are good reasons to feel uncomfortable about this bailout.
And yes, it was a bailout. The fact that the funds will come from the
Federal Deposit Insurance Corporation — which will make up any losses
with increased fees on banks — rather than directly from the Treasury
doesn’t change the reality that the government came in to rescue
depositors who had no legal right to demand such a rescue. |
Furthermore,
having to rescue this particular bank and this particular group of
depositors is infuriating: Just a few years ago, S.V.B. was one of the
midsize banks that lobbied successfully for the removal of regulations
that might have prevented this disaster, and the tech sector is famously
full of libertarians who like to denounce big government right up to
the minute they themselves needed government aid. |
But
both the money and the unfairness are really secondary concerns. The
bigger question is whether, by saving big depositors from their own
fecklessness, policymakers have encouraged future bad behavior. In
particular, businesses that placed large sums with S.V.B. without asking
whether the bank was sound are paying no price (aside from a few days
of anxiety). Will this lead to more irresponsible behavior? That is, has
the S.V.B. bailout created moral hazard? |
Moral
hazard is a familiar concept in the economics of insurance: When people
are guaranteed compensation for losses, they have no incentive to act
prudently and in some cases may engage in deliberate acts of
destruction. During the 1970s, when New York, in general, was at a low
point and property values were depressed, the Bronx was wracked by fires,
at least some of which may have been deliberately set by landlords who
expected to receive more from insurers than their buildings were worth. |
In
banking, insuring deposits means that depositors have no reason to
concern themselves with how the banks are using their money. This in
turn creates an incentive for banks to engage in bad behavior, such as
making highly risky but high-yielding loans. If the loans pay off, the
bank makes a lot of money; if they don’t, the owners just walk away.
Heads, they win; tails, the taxpayers lose. |
This isn’t a hypothetical case; it’s pretty much what happened during the S.&L. crisis of
the 1980s, when savings and loan associations, especially but not only
in Texas, effectively gambled on a huge scale with other people’s money.
When the bets went bad, taxpayers had to compensate depositors, with
the total cost amounting to as much as $124 billion — which, as an
equivalent share of gross domestic product, would be something like $500 billion today. |
The
thing is, it’s not news that guaranteeing depositors creates moral
hazard. That moral hazard is one of the reasons banks are regulated —
required to keep a fair bit of cash on hand, limited in the kind of
risks they can take, required to have assets that exceed their deposits
by a significant amount (a.k.a. capital requirements). This last
requirement is intended not just to provide a cushion against possible
losses but also to give bank owners skin in the game, an incentive to
avoid risking depositors’ funds, since they will have to bear many of
the losses, via their capital, if they lose money. |
The
savings and loan crisis had a lot to do with the very bad decision by
Congress to relax regulations on those associations, which were in
financial trouble as a result of high interest rates. There are obvious
parallels to the crisis at Silicon Valley Bank, which also hit a wall
because of rising interest rates and was able to take such big risks in
part because the Trump administration and Congress had relaxed
regulations on midsize banks. |
But
here’s the thing: The vast bulk of deposits at S.V.B. weren’t insured,
because deposit insurance is capped at $250,000. Depositors who had
given the bank more than that didn’t fail to do due diligence on the
bank’s risky strategy because they thought that the government would
bail them out; everyone knows about the F.D.I.C. insurance limit, after
all. |
They
failed to do due diligence because, well, it never occurred to them
that bankers who seemed so solid, so sympatico with the whole venture
capital ethos, actually had no idea what to do with the money placed in
their care. |
Now,
you could argue that S.V.B.’s depositors felt safe because they
somewhat cynically believed that they would be bailed out if things went
bad even if they weren’t entitled to any help — which is exactly what
just happened. And if you believe that argument, the feds, by making all
depositors whole, have confirmed that belief, creating more moral
hazard. |
The logic of this view is impeccable. And I don’t believe it for a minute, because it gives depositors too much credit. |
I
don’t believe that S.V.B.’s depositors were making careful, rational
calculations about risks and likely policy responses, because I don’t
believe that they understood how banking works in the first place. For
heaven’s sake, some of S.V.B.’s biggest clients were in crypto. Need we
say more? |
And
just in general, asking investors — not just small investors, who are
formally insured, but even businesses with millions or hundreds of
millions in the bank — to evaluate the soundness of the banks where they
park their funds is expecting too much from people who are, after all,
trying to run their own businesses. |
The
lesson I would take from S.V.B. is that banks need to be strongly
regulated whether or not their deposits are insured. The bailout won’t
change that fact, and following that wisdom should prevent more
bailouts. |
And you know who would have agreed? Adam Smith, who in “The Wealth of Nations”
called for bank regulation, which he compared to the requirement that
urban buildings have walls that limit the spread of fire. Wouldn’t we
all, even the ultrarich and large companies, be happier if we didn’t
have to worry about our banks going down in flames? |
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