Category: “Dead Skunk in The Middle of The Road”

The State

With demands for a bank bailout, Silicon Valley shows its ‘small government’ mantra was just a pose

Michael Hiltzik, Los Angeles Times – March 13, 2023

For decades, the dominant mantra of Silicon Valley’s powerful has been that government is just a drag on their innovative spirit. Get regulators off our backs, they’ve argued, and we’ll improve people’s lives to an indescribable degree.

Not at the moment. The same investors and entrepreneurs who argued for less government and less regulation in the past successfully lobbied for a government bailout of Silicon Valley Bank, which failed Friday as a result of astoundingly imprudent business practices.

Driving their demands were the financing issues facing thousands of SVB corporate and individual customers who collectively had more than $150 billion of their cash on deposit at the bank under conditions that left it largely uninsured against the bank’s collapse.

This specific industry could exceed$30 billion by 2025 The Federal Deposit Insurance Corp. insures individual and business deposits up to $250,000 per depositor. Many of the bank’s depositors had cash balances at SVB of hundreds of millions of dollars each.

Dispensing with that limit, the Federal Reserve, Treasury Department and FDIC announced Sunday that all SVB depositors would have access to all their money on Monday. Previously, the FDIC said it would make only the insured balances available Monday, with the balances to be repaid later and possibly not entirely.

The three agencies said no taxpayer funds would be spent on the rescue. The repayments will come from the sale of SVB’s assets, which include treasury securities, with any shortfall covered by an FDIC assessment on its member banks. The agencies may have concluded that there were enough assets on the bank’s balance sheet to cover all deposits, once the assets are sold.

This isn’t a “bailout” by the government, since SVB’s shareholders may yet be the losers; they’re not covered by the regulators’ relief program.

As it happens, the government has turned out to be the savior of Silicon Valley’s small-government libertarians in this crisis. The FDIC is one of many programs launched during Franklin Roosevelt’s New Deal that preserve Americans’ livelihoods and way of life during a crisis, and that conservatives have been trying to undermine since the 1930s.

As we reported last week, the sudden collapse of SVB resembled almost all bank runs of the past — the accumulation of huge sums of deposits that could be withdrawn on demand, backed by long-term investments that could retain their value only if held to maturity.

On Thursday, the bank announced that it needed to raise more than $2 billion in new capital, largely because long-term securities it had put up for sale had lost billions in value as interest rates rose over the last year or more.

The announcement spooked venture investor Peter Thiel and venture firms, which advised their portfolio companies to pull their cash out of the bank.

The result was an incredible $42 billion in withdrawals initiated that day, a torrent that rendered the bank almost instantly insolvent.

California regulators and the FDIC shuttered the bank Friday morning. When that happened, the shaky foundations of the bank’s business model were exposed to daylight, and the cries for a government bailout of its customers swiftly followed.

The context of these events was a fundamental change in the economics of the high-tech and biotech companies the bank served. As interest rates moved higher, its clients had more difficulty raising funds from private investors and therefore relied more on their cash balances at the bank. Their markets shrank, intensifying the rate at which they were burning cash.

It’s not unusual for a crisis to turn people’s most cherished beliefs on their head. The old joke says a conservative is a liberal who’s been mugged, and a liberal is a conservative who’s been sent to jail. An old military saw has it that “there are no atheists in foxholes,” an insight that investment commentator Barry Ritholtz expands to read, “there are also no Libertarians during a financial crisis.”

One other immutable principle of American capitalism is at play: The goal in business to privatize profits and socialize losses. In other words, when things are good, companies will keep their profits for distribution to shareholders. When things turn sour, the cry is heard for government to step in with bailouts and subsidies.

What’s overlooked in this case is that Silicon Valley Bank’s problems were in part the consequence of a Trump-era deregulation movement in banking that was fully backed by the banking industry and the management of — yes — Silicon Valley Bank itself. More on that in a moment. But first, let’s call the roll of small-government advocates who got their wish for a big-government bailout.

Start with billionaire hedge-fund operator Bill Ackman, who has advocated for self-regulation by the crypto-currency sector and has pushed back against efforts by the Securities and Exchange Commission to regulate one of his investment funds. Ackman went all-in for Donald Trump after Trump’s election in 2016, gushing that the U.S. has been “undermanaged for a very long period of time. We now have a businessman as president.”

In a lengthy tweet Saturday, Ackman flayed banking regulators for “allowing [SVB] to fail without protecting all depositors,” which he called “a-soon-to-be-irreversible mistake.”

He added, “Already thousands of the fastest growing, most innovative venture-backed companies in the U.S. will begin to fail to make payroll next week. Had the gov’t stepped in on Friday to guarantee SVB’s deposits … this could have been avoided and SVB’s 40-year franchise value could have been preserved.”

Then there’s David Sacks, an intimate of Thiel and Elon Musk, who were his partners in establishing and growing PayPal. Sacks and his friends have promoted a worldview that opposes progressive laws and regulations, including those aimed at reining in economic inequality.

Appearing on Megyn Kelly’s Sirius XM satellite show June 7, the day of the successful recall vote against San Francisco’s progressive district attorney, Chesa Boudin — a recall movement Sacks helped to finance — he called Democrats “useful idiots for the Chinese Communist Party.

“By this weekend Sacks was squealing: “Where is Powell? Where is Yellen? Stop this crisis NOW. Announce that all depositors will be safe.” (His references are to Federal Reserve Chair Jerome H. Powell and Treasury Secretary Janet L. Yellen.)

Venture investor Brad Gerstner called in a tweet for the Federal Reserve to “act now to make sure depositors are 100% protected.” In a second tweet, he asserted that the savings of thousands of small investors are at risk “just [because] the system failed.”

That drew a horselaugh from veteran investor Jim Chanos, whose experience as a short-seller has given him a uniquely percipient feel for Wall Street foibles. “The chutzpah here beggars belief,” Chanos replied on Twitter.

Chanos observed, accurately, that it was venture investment firms that actually launched the run on SVB on Thursday, when they suddenly urged their companies to pull their deposits from the bank, triggering the $42-billion outflow. “And they now want the Taxpayer to bailout their investments…?! Capitalism, Silicon Valley-style.”

It’s not only the entrepreneurial brotherhood demonstrating that, to quote what has become known as Miles’ Law, “Where you stand depends on where you sit.”

Consider former Treasury Secretary Lawrence H. Summers, who last year was heard disdaining President Biden’s student loan relief as inflationary. His argument was that the $10,000 to $20,000 in proposed relief “consumes resources” better used to help those who don’t attend college, and invites colleges to raise tuitions.

By Friday, however, Summers was saying that it’s “absolutely imperative” that “all depositors be paid back and paid back in full.” Interestingly, the same cadres who argue that student loan borrowers should have known what they were getting into when they took out their loans were able to overlook that Silicon Valley Bank depositors should have known that deposits beyond $250,000 are uninsured and therefore not guaranteed to be paid back.

(Miles’ law was coined by then-federal budget official Rufus E. Miles Jr. in the 1940s, after he noticed that after his most hard-nosed budget examiner took a job at one of the agencies he had criticized, the examiner became that agency’s most devoted defender against the unwarranted critiques from the budget office.)

Libertarian-minded Silicon Valley types have been trying to blame the bank’s collapse on the Fed. Cryptocurrency promoter Balaji Srinivasan, for example, complained that “Powell said that he wouldn’t raise rates in April, June, July, and Oct 2021 … People trusted him … And that’s how the Fed caused the crisis.”

That’s absurd, of course. The Fed began its sequence of interest rate increases in March 2022 and brought them higher by 4.75 percentage points from then through January this year. At every step the central bank made its intentions crystal clear. By early 2022, people “trusted” that the Fed was on a long-term rate tightening campaign. Absolutely no one had a right to be surprised.

Two key factors in the SVB disaster can’t be overlooked: The incompetence of the bank’s management and the improvidence of its customers.

The value destruction taking place in the bank’s holdings of long-term securities was written in bright red on its ledger books. With the prospect of interest rate increases continuing through 2022 and into this year, its management had no excuse for failing to unwind its holdings well before now instead of waiting.

Under regulations implemented in accordance with the Dodd-Frank banking reform law of 2010 safety-and-soundness standards were tightened for banks with more than $50 billion in assets.

Those larger banks were required to submit annual disclosures to the Fed, meet stricter liquidity and risk management requirements, and undergo “stress testing” that would reveal how they would fare under extreme financial scenarios.

Mid-sized banks launched a vigorous lobbying campaign to raise that threshold. In testimony submitted to the Senate Banking Committee in 2015, Greg Becker, the chief executive of Silicon Valley Bank, called for raising the threshold as high as $250 billion.

Becker’s statement bristled with the buzzwords and catchphrases beloved of Silicon Valley entrepreneurs. He asserted that without the change, the regulations would be so burdensome that “SVB will likely need to divert significant resources from providing financing to job-creating companies in the innovation economy.”

Becker referred to “SVB’s deep understanding of the markets it serves, our strong risk management practices, and the fundamental strength of the innovation economy.”

As it happens, SVB plainly didn’t understand how the markets it serves were vulnerable to lock-step flight from its deposit accounts, had weak or paltry risk-management practices, and failed to recognize that the innovation economy has its ups and downs.

The industry’s lobbying yielded fruit. President Trump raised the Dodd-Frank threshold in 2018. At the signing ceremony, Trump labeled the regulations “crushing.” He said, “Those rules just don’t work.”

Actually, they would have worked well for Silicon Valley Bank, which exceeded the $50-billion asset threshold in 2017 and never reached the $250-billion level, having topped out last year at $211.7 billion in assets. Had the old rules remained in place, it would have become subject to stricter oversight no later than 2018. Regulators might have noticed its rapid growth and the shortcomings of its risk profile. But they never had the chance.

Finally, the customers. SVB evidently required some of its Silicon Valley borrowers to do all their banking through the bank as a condition of their loans. According to its annual disclosures, the bank paid an average of 2.2% on savings and checking accounts last year; that’s higher than most commercial banks, but not high enough to compensate for the risk of uninsured cash deposits.

Some companies have reported uninsured balances of hundreds of millions of dollars sitting at SVB. It’s not unusual for businesses to have sizable balances in bank accounts exceeding the insurance cap. But prudent companies spread their deposits around, so they’re not mortally exposed to the failure of any one depository institution.

Multiple options exist for parking cash, such as investing in short-term government securities, money market instruments and corporate commercial paper. None of these is government-insured, but they offer diversification and a cushion against a single bank’s implosion.

With the debacle apparently resolved, the bank’s clients and their employees can enjoy the peace of mind that comes with a well-regulated banking system. Even at the businesses whose leaders lobbied to make banking less safe for everyone.

Michael Hiltzik is a columnist for the Los Angeles Times.

New York Times – Opinion

Fifteen Years After 2008, Why Do Banks Keep Failing?

Peter Coy – March 13, 2023

The weekend rescue of uninsured depositors in Silicon Valley Bank and Signature Bank was absolutely essential and absolutely frustrating. We have to stop getting ourselves into these messes, people.

If the federal government hadn’t given a blanket of protection to all deposits, companies that had deposits in either of the banks above $250,000, the maximum that’s insured by the Federal Deposit Insurance Corp., would not have been able to pay their workers. Start-ups that bank with Silicon Valley Bank would have been imperiled. “It could have destroyed early-stage biomedical research in this country for a decade,” said Karen Petrou, the managing partner of the consulting firm Federal Financial Analytics, who sits on the board of a biomedical research foundation.

The damage could have been far greater. Depositors at other banks were beginning to panic, worrying that their banks would be next to fail and looking for safer places to stash their cash. We were looking at the early stages of a generalized bank run that would have done serious damage to the U.S. economy. Even a healthy bank can be destroyed overnight if all its depositors demand all their money at once. The only way to arrest the panic was for the government to assure all depositors that there was no need to yank from the bank.

Even after the emergency intervention, markets remained unsettled on Monday. Bank stocks were down. Economists at Capital Economics reported “worrying signs of incipient strains in core money markets.” Interest rates fell as investors speculated that the Federal Reserve might curb its rate-raising campaign to relieve pressure on banks (a concern I wrote about on Friday). A scare such as this one has lasting consequences.

True, the government didn’t bail out everyone involved. Shareholders in the banks are wiped out and members of senior management were fired. That’s fair — and contrasts with what happened during the 2008 global financial crisis, when the government propped up shaky banks while leaving management and shareholders in place.

Whether taxpayers helped pay for the rescue is a matter of semantics. On Monday, President Biden told reporters, “No losses, and this is an important point, no losses will be borne by the taxpayers.” Still, the government — and by extension, taxpayers — is providing a valuable guarantee to the banking system. The fact that any government expenditures will eventually be recouped through higher insurance premiums doesn’t take away from that. Also, the Federal Reserve is promising to support troubled banks by buying bonds from them at face value rather than their current depressed market price. Not a bailout, exactly, but certainly a good deal.

The real question is why this keeps happening. After the global financial crisis, Congress passed and President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Federal Reserve raised safety standards for banks, especially ones that are deemed “systemically important.” There’s a Financial Stability Oversight Council that’s supposed to take a broad view of risks in the system.

It clearly wasn’t enough. It didn’t help matters that bank lobbyists got Congress and regulators to roll back some measures that they regarded as onerous. For example, a 2018 law signed by President Trump — which was passed by Congress with bipartisan support — spared banks with $100 billion to $250 billion in assets from the highest level of scrutiny. Hard to say, but Silicon Valley Bank — which lobbied for the law — might still be with us if it weren’t for that law.

There are lots of things that could be done to improve banking supervision, require thicker capital cushions and so on, but for now I’d like to focus on the question of the day, which is what to do about uninsured deposits.

The theory in banking is that big depositors have the financial sophistication and the incentive to make sure that the banks where they keep their money are safe. Keeping deposits uninsured above a certain threshold is thus supposed to be a kind of market discipline, supplementing the supervision by state and federal regulators. But that was never a realistic expectation for most depositors, who have other things on their minds. Plus, because big depositors know that they’ll be protected when push comes to shove, they have no incentive to seek out safe banks.

This is hardly a new problem. In 1991, Jerome Powell, now the chair of the Federal Reserve, was a senior official in the Treasury Department who was assigned to deal with the collapse of the Bank of New England Corp. As he recounted in a 2013 speech: “We came to understand that either the F.D.I.C. would protect all of the bank’s depositors, without regard to deposit insurance limits, or there would likely be a run on all the money center banks the next morning — the first such run since 1933. We chose the first option, without dissent.”

Under the Federal Deposit Insurance Corporation Improvement Act of 1991, the F.D.I.C. is required to resolve bank failures in the way that incurs the least cost to the deposit insurance fund, even if that means wiping out uninsured depositors. But in practice, uninsured depositors almost never get wiped out because the F.D.I.C. arranges for a stronger bank to acquire the failed one, assuming all of its deposits. The Dodd-Frank Act of 2010 made an explicit exception to the least-cost test for cases of “systemic risk” — that is, if complying with the least-cost test “would have serious adverse effects on economic conditions or financial stability.” That’s the exception that the government invoked for Silicon Valley Bank and Signature Bank.

If market discipline works in theory but not in practice, one alternative is to bow to reality and explicitly insure all bank deposits. It would certainly lessen the number of panics such as the one that killed Silicon Valley Bank and Signature Bank, without giving banks carte blanche to behave irresponsibly. One person who favors that solution is Robert Hockett, a professor at Cornell Law School, who has written two pieces about the idea for Forbes recently. The F.D.I.C. premiums are higher for riskier banks, which makes sense. Given that the F.D.I.C. already takes risk into account, Hockett told me, the $250,000 limit is “vestigial, like the human tailbone.”

Insuring all bank deposits would make banks look more like public utilities, Petrou told me. She said she’d prefer relying more on market discipline, as originally intended. But that ship may already have sailed.

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