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Three and a Half Myths About the Bank Bailouts

March 16, 2023
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Three and a Half Myths About the Bank Bailouts
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Last weekend, U.S. policymakers went all in on bailing out two medium-size banks: Silicon Valley Bank and Signature Bank.

And yes, they were bailouts. I wish the Biden administration weren’t trying to claim otherwise. Yes, stockholders were cleaned out. But legally, deposits are insured only up to $250,000; by choosing to make all depositors whole, the feds have done holders of big accounts a major favor.

It’s true that losses, if any — it’s not clear whether either bank was insolvent, as opposed to simply lacking the ready cash to handle a bank run — won’t be made up with higher conventional taxes; the money is coming from the Federal Deposit Insurance Corporation, which will recover funds, if necessary, by imposing higher fees on banks. But these fees will be passed on to the public, so taxpayers are de facto on the hook.

But was it a bad decision? I’ve heard four basic kinds of criticism. One is ridiculous. Two are dubious. But the last one has me a bit worried, although I think it’s probably wrong.

Let’s start with the silly stuff. On the right side of the political spectrum, many have quickly rallied around the claim that S.V.B. failed because it was excessively woke — which is only marginally less ludicrous than claiming that wokeness somehow causes train derailments.

For what it’s worth, no, S.V.B. didn’t stand out from other banks in its concern for diversity, the environment and so on. And banks have been going bust for centuries, since long before H.R. departments began including boilerplate language about social responsibility in their mission statements. So the talk about wokeness tells us nothing about bank failures — but a lot about the intellectual and moral bankruptcy of the modern American right.

On to more serious criticism. There is a reasonable argument, one that I largely agree with, to the effect that the failure of S.V.B. didn’t pose a systemic threat in the way that the failures of financial institutions beginning with Lehman Brothers did in 2008. So why rescue the depositors?

Well, one answer is that, like it or not, Silicon Valley Bank had come to play a key role in what you might call the financial ecosystem of the technology sector. Notably, if depositors had lost access to their money, even temporarily, this would apparently have left many technology companies unable to meet their payrolls and pay their bills — which might have done lasting damage. True, killing the crypto industry would be a public service, but there’s also a lot of good stuff that might get hurt.

In this sense the bailout of S.V.B. was something like the bailout of General Motors and Chrysler in 2009, which was also justified on the grounds that it would preserve a crucial piece of the economic ecosystem. And although the auto bailout was harshly criticized at the time, in retrospect it looks like the right call, even though it ended up costing taxpayers billions.

A third criticism is the claim that the feds have now established the principle that all deposits are effectively insured without imposing correspondingly tighter regulation on what banks do with those deposits — creating an incentive for irresponsible risk taking. But policymakers explicitly didn’t guarantee all deposits everywhere, and at least so far, we’re seeing an outflow of funds from smaller banks to more tightly regulated large banks. You may not like this — whatever else you may say about big financial institutions, they aren’t lovable. But on balance we seem to be seeing the financial system move toward reduced, not increased, risk taking.

Which brings me to the criticism I take seriously, although I think it’s probably wrong: claims that the bank failures will undermine efforts to control inflation.

It’s true that the bank blowups have caused investors to rethink the future course of Federal Reserve policy: a rate hike at the next Fed meeting, which seemed to be a done deal, now looks uncertain, with markets now pricing in the possibility of a rate cut and two-year interest rates (a good indicator of expected Fed policy over the near future) plunging. And some sensible people I talk to are now warning about financial dominance, in which the Fed puts a higher priority on protecting Wall Street than on stabilizing inflation.

But given the way the banking system is reacting to the S.V.B. affair, there are actually good reasons for the Fed to limit rate hikes, at least for a while. The Fed has been trying to cool off the economy; well, banks’ increased sensitivity to risk and the shift of deposits to more tightly regulated banks will probably cool the economy even if the Fed doesn’t raise rates. Some financial newsletters are even predicting a recession. And market expectations of inflation have, if anything, ?g=11hqe” rel=”noopener noreferrer” target=”_blank”>declined.

The fallout from banking problems has made a murky economic situation even murkier, and it will be a while — maybe forever — before we know whether policymakers made the right call. But I’m hearing a lot of apocalyptic rhetoric right now, none of which seems justified by the available facts.

The post Three and a Half Myths About the Bank Bailouts appeared first on New York Times.

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