SVB mess demands a rethink on government bailout plans
The demise of Silicon Valley Bank has put the U.S. government into an uncomfortable position, backstopping depositors like never before to prevent a broader and potentially devastating bank run.
Given the risks, officials did the right thing. The hard part will be figuring out how to handle the consequences.
Customers, goaded by industry influencers, proved surprisingly quick to pull out their deposits ($42 billion in one day). Other banks’ customers started getting jittery, increasing the risk that imposing losses on some depositors might trigger a widespread exodus. So regulators expanded the backstop, pledging to make whole all depositors at SVB and at Signature Bank, a failed institution that had catered to crypto clients. The Federal Reserve agreed to make emergency loans up to the full face value of certain high-quality bonds, to help other banks survive any surge in withdrawals.
This response appears to be working, but it also creates new problems. Although officials insist it wasn’t a bailout, in some respects it was indeed. It’s hard to see how regulators can now impose losses on depositors at any failed bank, meaning that taxpayers have effectively become the guarantors of all uninsured deposits (which amounted to more than $7 trillion last year).its, secure in the knowledge that the government will back them.
What to do?
As a start, officials will most likely strengthen existing regulations. If the Fed, for example, extends big-bank liquidity rules to certain midsized banks, it might better prepare them for sudden deposit outflows. Also, increasing requirements for loss-absorbing equity capital would make the whole system more resilient.
Yet such reforms won’t address the underlying problem. If enough depositors try to withdraw their money at once, no reasonable amount of capital or liquidity will prevent failure: Banks simply can’t sell their assets fast enough without incurring catastrophic losses. And if there’s any chance that such a run will spread to the entire system, officials will feel obligated to intervene, putting taxpayer money at risk — something they’ve demonstrated time and again.
Solutions exist, but they may require a more radical rethink. One approach: Reduce the potential for bailouts by getting some control over the sheer volume of money-like instruments that might require backstopping. The Fed, for example, could limit deposits and other short-term obligations to the assets that financial institutions pledge in advance as collateral for emergency loans, minus “haircuts” to ensure the central bank wouldn’t incur losses. This would enable the Fed to safely guarantee all short-term debt without relaxing lending standards as it did this week. By removing run risk, it would allow banks to fail with minimal drama or collateral damage. Even better, it would obviate the need for deposit insurance, liquidity requirements and reams of other regulations.
Regulators can’t be expected to eliminate the risk of failures entirely. But they need to consider reforms — including ambitious ones — that would credibly limit the scope of future interventions. Doing more of the same and expecting a different result isn’t a sane response.