People line up outside Silicon Valley Bank headquarters to withdraw funds on March 13, 2023 in Santa Clara, California. (Photo by Liu Guanguan/China News Service/VCG via Getty Images)
The run on Silicon Valley Bank — on which nearly half of all venture-backed tech start-ups in the United States depend — is part of a familiar story. But it’s more than that. Once again, economic policy and financial regulation have proven insufficient.
News of the second largest bank failure in US history came just days after Federal Reserve chairman Jerome Powell assured Congress that the financial condition of American banks was sound. But the timing should not be surprising. Because of the large and rapid interest rate hikes that Powell engineered – perhaps the most significant since former Fed chairman Paul Volcker’s rate hikes 40 years ago – it is predicted that dramatic movements in financial asset prices will cause trauma everywhere in the financial world. system.
But, again, Powell assures us not to worry – even though many historical experiences show us that we should. Powell was part of former president Donald Trump’s regulatory team that worked to dismantle the Dodd-Frank bank regulations enacted after the 2008 financial crisis, to exempt “small” banks from the standards applied to the largest, systemically important banks. By Citibank’s standards, Silicon Valley Bank is small. But it is not small in the lives of millions who depend on it.
Powell said it would be painful for the Fed to keep raising interest rates — not for him or many of his peers in private equity, who reportedly plan to kill for the prospect of buying Silicon Valley Bank’s uninsured deposits at 50 to 60 cents on the dollar. before the government made it clear that the depositors would be protected.
The worst pain will be inflicted on members of marginalized and vulnerable groups, such as young black people. The unemployment rate is usually four times the national average, so an increase from 3.6% to 5% means an increase from 15% to 20% for them. He blithely called to increase such unemployment (false claims that they need to lower the inflation rate) with nary an appeal for help, or even a mention of long-term costs.
Now, as a result of Powell’s callous – and unnecessary – pain advocacy, we have a new set of victims, and the most dynamic sectors and regions of the US will be held back. Silicon Valley start-up entrepreneurs, often young people, think that the government is doing its job, so they focus on innovation, not checking their bank balance every day – which they cannot do. (Full disclosure: my daughter, the chief executive of an education startup, is one dynamic entrepreneur.)
Although new technology does not change the fundamentals of banking, it also increases the risk of opening a bank. It is easier to withdraw funds than before, and social media turbocharges rumors that can spur a wave of simultaneous withdrawals (although the Silicon Valley Bank reportedly just does not respond to orders to transfer money out, making what could be a legal nightmare. ).
Reportedly, the fall of Silicon Valley Bank is not due to bad credit practices that led to the 2008 crisis and that shows a fundamental failure in banks that play a major role in credit allocation. Rather, it is more prosaic: all banks are involved in “maturity transformation”, making short-term deposits available for long-term investments. Silicon Valley Bank has been buying long-term bonds, exposing the institution to risk when the yield curve shifts dramatically.
The new technology also makes the old $250,000 limit on Federal deposit insurance absurd: some companies participate in regulatory arbitrage by dispersing funds through a large number of banks. It’s crazy to reward people who trust regulators to do their job. What does it say about a country when people who work hard and introduce new products that people want are taken down just because the banking system fails? A safe and sound banking system is a sine qua non of a modern economy, but the U.S. isn’t so sure.
As Barry Ritholtz tweeted, “Just like there were no atheists in Fox Holes, there were no Libertarians during the financial crisis.” Many of the crusaders against government rules and regulations have suddenly become champions of the government bailout of Silicon Valley Bank, just as the financiers and policymakers who planned the deregulation that led to the 2008 crisis are calling for bailouts. (Lawrence Summers, who spearheaded financial deregulation as US treasury secretary under president Bill Clinton, also called for a bailout of Silicon Valley Bank — all the more remarkable after he took a strong stance on helping students with debt burdens.)
The answer today is the same as it was 15 years ago. Shareholders and bondholders, who benefit from the company’s risky behavior, must bear the consequences. But Silicon Valley Bank depositors – companies and households that trust regulators to do their job, they are repeatedly reassured the public they do – must be made whole, whether above or below $ 250 000 “insured” amount.
To do otherwise would cause long-term damage to one of the most vibrant economic sectors in the US; whatever one thinks of Big Tech, innovation must continue, including in areas such as green technology and education. More generally, doing nothing would send a dangerous message to the public: the only way to make sure your money is protected is to put it in the “too big to fail” banks that matter. This will lead to greater market concentration – and less innovation – in the US financial system.
After a painful weekend for those who could be affected across the country, the government finally did the right thing – guaranteeing all depositors will be settled, preventing the banks from disrupting the economy. At the same time, the show made it clear that something was wrong with the system.
Some would say that Silicon Valley Bank’s depositors would pose a “moral hazard”. That’s nonsense. Bondholders and bank shareholders are still at risk if they do not properly monitor their managers. Depositors are not supposed to manage the bank’s risk; they must be able to rely on our regulatory system to ensure that the institution calls itself a bank, it has the financial means to pay back what is put into it.
Silicon Valley Bank represents more than a single bank failure. This is emblematic of a profound failure in the conduct of regulatory and monetary policy. Like the 2008 crisis, it is predictable and predictable. Let’s hope that those who helped create this mess can play a constructive role in mitigating the damage, and this time, all of us – bankers, investors, policymakers, and the public – will finally learn the right lesson. We need stricter regulation to ensure that all banks are safe. All bank deposits must be insured. And the cost should be borne by those who benefit the most: the wealthy individuals and companies, and those most dependent on the banking system, based on deposits, transactions and other relevant metrics.
It has been more than 115 years since the panic of 1907, which led to the establishment of the Federal Reserve System. New technology has made panic and banking easier. But the consequences can be more severe. It is time for the policy making and regulatory framework to respond.
This article was first published by Project Syndicate.