Maybe this goes without saying, but on the off chance it’s not obvious, it bears mentioning: It’s going to be very difficult for US officials to explain any decision not to protect uninsured deposits in the event of additional bank failures.
The definition of a “systemically important bank” is at least somewhat objective, even if we can quibble over the details. If an institution is large enough and interconnected enough that a disorderly (note the emphasis) collapse would entail a global paroxysm, that’s a systemically important bank. So, Credit Suisse, for example. But not SVB.
What’s less clear-cut is what could count as a “systemic risk” if confidence erodes under certain circumstances. We know what would happen if Citi failed overnight (bad things). If we’re being honest, though, we don’t really know what would’ve happened last week if uninsured SVB depositors weren’t made whole. Would everyone have called in sick to stand in lines at regional banks, as Bill Ackman essentially suggested? Probably not, frankly. In fact — and I’m just playing Devil’s advocate here — there’s a decent case to be made that protecting SVB’s uninsured depositors was itself an example of screaming “Fire!” in a crowded theater.
If the question with SVB was, ultimately, “What are we supposed to do about all of these startups who need to make payroll next week?” there were surely better answers than guaranteeing the deposits which, in some cases, was just tantamount to guaranteeing VC money.
Anyway, time was short, people panicked and decisions were made. The problem with this particular panicked decision isn’t first and foremost about moral hazard. That comes later. The immediate problem is that Janet Yellen (consistent with her authority, by the way) has claimed for herself (and also for the Fed board) the ability to objectively determine what could pose a “systemic risk.” But that’s not something that can be determined objectively outside of a scenario that involves the SIFIs.
Yellen was, of course, questioned about precisely this last week, and her answer was less than convincing. Uninsured depositors will only be protected if failing to protect them “would create systemic risk and significant economic and financial consequences,” she told the Senate Finance Committee. But, again, there’s no way to determine that objectively. In the era of social media, videos of a run on some tiny bank in the middle of nowhere could easily go viral and spark a crisis of confidence that could turn systemic.
Moreover, consider that Treasury’s position by definition means that the larger and more interconnected your bank is, the safer your deposits are. There’s no other way to interpret the situation. If you bank at a renovated Pizza Hut in a town with 20,000 people in it, deposits beyond $250,000 are in extreme peril relative to the same dollars deposited in a larger bank. And not just because larger banks are ostensibly safer (try not to laugh). Rather, because size is correlated with importance, and the more important the bank, the more likely it is to be backstopped.
There isn’t any way around this, and particularly not now. Treasury crossed the Rubicon with SVB, which means either Congress agrees to insure all deposits or this situation is guaranteed to come up again at some point (maybe not in 2023, but at some point) and when it does, anyone out money is going to refer to this episode and ask why their 251st thousandth dollar is less important than the flying taxi startup’s 251st thousandth dollar.
Earlier this week, Bloomberg said the administration was pondering contingency plans for backstopping all deposits, but none of them sounded very good. You can’t, for example, guarantee every dollar in a savings account above $250,000 with the ESF. That’s not tenable for too many reasons to plausibly enumerate, not least of which is that the ESF isn’t for that. Yes, it’s been used to capitalize the Fed’s alphabet soup of leveraged liquidity facilities during recent crises, but you don’t want the nation’s deposits to be “guaranteed” by a legally questionable end-around. To call that “suboptimal” would be an understatement.
Predictably, the House Freedom Caucus is set to oppose any attempt to raise the FDIC insurance cap, but at the end of the day, the situation as it currently stands is highly unstable. Selectively saving people is only viable as long as nobody else needs saving. Other banks will fail, the same way another recession will happen. Maybe not this week. Maybe not next week. Maybe not even as part of the current mini-crisis. But at some point, somewhere, another bank will collapse. When that happens, the first thing any uninsured depositors are going to do is cite SVB as precedent, ask what the criteria were for the “systemic risk” determination and then promptly sue somebody. I don’t know who, exactly, would be sued, but this is a litigious nation, and people with more than $250,000 in spare cash to put in a bank account either i) aren’t people (i.e., they’re businesses) or ii) they’re rich people. In either case, they have lawyers.
Without weighing in on whether it’s a good or a bad idea to backstop all deposits, we know where this is headed. If you backstop all deposits, banks will surely take more risk, but the alternatives seem worse, and besides, you can prevent banks from taking risks you don’t want them to take by writing laws and, more importantly, by enforcing them.
Currently, there’s no good argument for holding uninsured deposits in a small bank. T-bills get you 4.5%. Jamie Dimon won’t lose your money. Unless he decides to put it in the failing bank you just pulled it out of, in which case I don’t know what to tell you. Or him.
On Tuesday, while regaling the American Bankers Association, Yellen said that, “Our intervention was necessary to protect the broader US banking system, and similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.”
One more time: The selective approach isn’t going to work. If your bank failed next week and you had uninsured deposits, would you just take the loss and accept Yellen’s determination that your bank didn’t pose a contagion risk? No? Well then why would anybody else?
