Jon Hartley is a PhD student in economics at Stanford University and a research fellow at the Foundation for Research on Equal Opportunity.
With the Silicon Valley Bank collapse, troubles at several other regional banks, and the crisis at Credit Suisse CSGKF, what comes next will be interesting to watch: A new regime is dawning.
The banking world changed dramatically this month with an implicit guarantee of almost all U.S. bank deposits and the lightning-fast bailout plan pushed by the Swiss government. That world changed further on Sunday when six major central banks, including the U.S. Federal Reserve and the Bank of Canada, came together to further buttress the international financial system by enhancing U.S.-dollar swap line provisions. At the same time, the European Central Bank explicitly said it would lend money to any continental institution that needs it.
Fifteen years ago, the 2008 bailouts sparked concerns that banks would never learn their lesson about risk management. Today, the banks in trouble are different entities, with different issues, but that earlier concern is not just returning but is being reinforced. Governments have now hammered home the idea that they would rescue their banks no matter what, and that raises a fundamental question of identity: What, really, is a bank now?
While the move to provide for all previously uninsured deposits in the United States arguably was the right one, to prevent contagion across the regional banking system, this implicit deposit insurance is not without cost. It will likely come in the form of banks being required to contribute greater insurance premiums. Such costs could further be passed on to depositors in the form of more bank fees and higher required minimum balances. A decade before the financial regulatory era of the Dodd-Frank legislation enacted in 2010, things like free checking accounts still existed. They have since disappeared, making banking more costly for the poor and those whose income is below the median. Similarly, services we now take for granted could disappear.
More importantly, as with the Swiss plan to rescue the scandal-ridden Credit Suisse, there are potential hidden costs, such as the possibility of creating moral hazard: unintended consequences associated with removing incentives for better practices now that banks are implicitly backed by their governments.
Some venture capitalists are even arguing that fellow VC investors should put money back in their long-preferred Silicon Valley Bank, since it now has explicit guarantees of unlimited deposit insurance and is the same bank that gave VCs access to below-market loan rates and additional leverage.
This is all the more worrying when we consider that the errors on the part of Silicon Valley Bank are so extraordinarily egregious. The troubles stem from how the assets side of SVB had taken a massive hit as it held about US$120-billion in long-term Treasury bonds which were – unbelievably – unhedged, a colossal risk management failure that is the equivalent of buying a house on the Florida coast without also buying flood insurance. The firm had no chief risk officer from April, 2022, to January, 2023. Ironically, Joseph Gentile, the chief financial officer of Lehman Brothers at the time of the 2008 crisis, was chief administrative officer of SVB Securities at the time of its collapse.
Banking is now threatening to become more unfriendly to retail customers, more reckless in its risk-taking – and more subsumed into the orbit of governments.
The month’s events, which began with issues surrounding Silicon Valley Bank, have been quite a spectacle to witness for me – from Silicon Valley itself. While all this may seem like something that merely echoes the bailouts of the 2008 financial crisis, it’s in a way a more magnified version, at least in its long-term significance.
While there may now be calm in the markets on the horizon, according to the more optimistic of us, the amount of the Federal Reserve discount window usage – that is, the Fed’s short-term emergency lending facility directly to banks – is roughly equal to the amount from 2008 when adjusting for inflation.
Are bank deposits in the United States now some form of government-guaranteed money? A similar question emerges with Credit Suisse, which has been absorbed by the Swiss bank UBS in a move pushed by the Swiss government. Are banks now effectively becoming quasi-nationalized, with moral hazard, private gains and socialized losses abound?
While the continued government-sponsored rescues will undoubtedly restore stability, there’s no doubt that, in the long run, the face of banking will be significantly changed.