Here we go again. The federal government is bailing out the banking industry, and the American people, who have seen this show far too often, have every right to be furious.
The proper target for that anger, however, is not the bailout itself, but the need for it.
The government's decision to guarantee the full amount of insured and uninsured deposits at Silicon Valley Bank and New York's Signature Bank is the best choice available to preserve the health of the broader economy. A new Federal Reserve program that offers subsidized loans to banks is also a good idea under the circumstances. President Biden's pledge on Monday that "we'll do whatever is needed" was needed.
But the wide-ranging intervention is only necessary because the newly shuttered banks -- the second- and fourth-largest failed banks in American history -- were not exceptions to a pattern of general probity. Just as before the 2008 financial crisis, banks have once again managed to ring up billions in profits by making risky bets and then gone running for government aid as those bets have started to sour. At the end of 2022, the U.S. banking industry was sitting on a total of about $620 billion in unrealized losses as a result of investments undermined by the rise of interest rates.
When the American public last swallowed the bitter pill of a bank bailout, policymakers promised to regulate the industry more stringently to end the long-running cycle of privatized profits and losses absorbed by the public.
Those changes, including the safeguards imposed by the 2010 Dodd-Frank Act, were, largely, to the good. On average, an American bank failed every three days between 1980 and 1994. The pace of failures reached similar heights in the immediate aftermath of the 2008 financial crisis, but since then failures have been much less common. The failures in recent days ended the second-longest stretch without a bank failure since the Great Depression.
Yet the details of Silicon Valley Bank's rise and fall are depressingly familiar. The bank took big risks to grow quickly by gathering and investing money from a wide range of tech start-ups; its shareholders cheered, and its auditors and regulators did nothing to interfere. Indeed, regulators treated Silicon Valley Bank's core strategy of investing in government bonds as essentially risk free, blind to the dangers posed by a rapid rise in interest rates. Regulators also should have limited the bank's dangerous reliance on large, uninsured deposits.
Policymakers -- in Congress, the Treasury Department and the Federal Reserve -- have a duty to explain to the American public how things were allowed to spin so far out of control. Banks are different from most private-sector companies. They are insulated from market discipline by various forms of federal protection because, like the power companies that keep the lights on, they provide a public service that is essential to a modern economy. Regulators have a responsibility to ensure that banks do not abuse those privileges.
In the case of Silicon Valley Bank, regulators failed to do that job. The Federal Reserve's role as the lead agency in responding to this crisis has obscured its failures as the agency that was responsible for supervising the bank in the first place. "They should have stopped them months ago," said Anat Admati, a finance professor at Stanford University. "That's my problem with the Fed: If they were honest, they would admit their own mistakes."
Congress bears responsibility, too. In 2018, a bipartisan bill weakened regulatory oversight of midsize lenders like Silicon Valley Bank, reversing key portions of the Dodd-Frank Act. The new law increased the threshold for the strictest category of regulatory scrutiny to $250 billion from $50 billion. Greg Becker, the chief executive of Silicon Valley Bank, testified before Congress in 2015 that his institution, like others of its size, "does not present systemic risks." Signature Bank officials also lobbied for, and benefited from, the 2018 changes.
Lawmakers accepted the arguments of the two banks, and their allies, barely a decade after the failure of similar-size lenders like Washington Mutual and National City Bank played a starring role in the 2008 financial crisis. The recklessness of that decision, and companion measures to loosen other safeguards, was clear at the time. This board warned that policymakers were inviting another crisis.
Congress should now correct its mistake by restoring the $50 billion threshold.
Policymakers also need to recognize the limits of government oversight as a substitute for market discipline. Banks should be required to raise more money from shareholders, who have a strong incentive to keep an eye on the way that money is used, since they can lose all of it. Money raised from shareholders is called capital, and banks have far less of it than other kinds of companies. They are allowed to borrow most of the money they use from lenders and depositors. If, for example, banks were required to raise 20% of funding from shareholders, that would still be well below the norm for other kinds of companies but enough that it might have covered Silicon Valley Bank's losses and saved the bank.
Congress should also require clawbacks of executive compensation and dividends at failed banks. If bankers are required in the future to return some of what they have gained from their poor decisions, it might have a sobering effect.
The government does not want to describe its actions as a bailout because voters don't like bailouts. The customers of Silicon Valley Bank, in particular, have been loudly unhappy to be described as the beneficiaries of a bailout because that's an embarrassing thing to be; it contravenes the mythology of Silicon Valley as a scrappy frontier where people build the future without help, or oversight, from the government.
But the success of both the financial industry and Silicon Valley has always depended on government aid and prudent regulation. This bailout is necessary because the government was not paying enough attention. Policymakers ought to be honest about those mistakes and be clear about the steps they will take to avoid a repeat.
-- The New York Times, March 14