Do Biden’s bank bailouts create a ‘moral hazard’?

The Biden administration is insisting its recently announced bailouts of two failed tech-focused banks—Silicon Valley (California) and Signature (New York)—is something else.

But experts in previous government interventions to save failing financial institutions, notably those that crashed and burned in the infamous 2008 “Great Recession,” say that’s exactly what this is—a federal bailout.

Neil Barofsky, overseer of the Troubled Asset Relief Program, the expansive government bailout that rescued the banking industry during 2008’s financial crisis, put it this way to an NPR reporter:

If your definition [of a bailout] is government intervention to prevent private losses, then this is certainly a bailout.

In the same NPR article, Amiyatosh Purnanandam, a University of Michigan corporate economist who studies bank rescues, explained:

If it looks like a duck, then probably it is a duck. This is absolutely a bailout, plain and simple.

In his Tuesday newsletter essay for the New York Times, Pulitzer Prize-winning economist and Times columnist Paul Krugman added:

[T]here are good reasons to feel uncomfortable about this bailout. And yes, it was a bailout. The fact that the funds will come from the Federal Deposit Insurance Corporation (FDIC)—which will make up any losses with increased fees on banks—rather than directly from the Treasury doesn’t change the reality that the government came in to rescue depositors who had no legal right to demand such a rescue.

President Biden has promised to secure all deposits in these banks, even those exceeding the legal statutory ceiling of $250,000 on government-insured bank deposits. The decision reportedly stems from the notion that Silicon Valley and Signature banks fall under the “systemic risk” exception, because the government believes that their failure could pose a serious risk to the overall financial sector.

Banks cover bank-deposit guarantees with insurance premiums, but, as the Wall Street Journal editorial board contended this week, “the insurance fund isn’t intended to backstop deposits of bigger customers with more capacity to weather losses if a bank goes under.”

The Journal reported that 85% to 90% of Silicon Valley Bank’s $173 billion on deposit are uninsured funds over the $250,000 limit.

The cost of guaranteeing Silicon Valley and Signature banks’ deposits, under or over the deposit limit, could reach $15 billion, the Journal estimated. For perspective, note that the US thus far has granted $75 billion in military, financial, and other aid to Ukraine to help it resist Russia’s unprovoked invasion of the sovereign nation.

Krugman and others are concerned about the “moral hazard” of bailing out failing banks above statutory limits—which rescues big investors and depositors who are not legally entitled to a bailout. He points out that Silicon Valley was one of the midsized banks that successfully lobbied for removal of certain federal regulations “that might have prevented this disaster.”

“[T]he tech sector is famously full of libertarians who like to denounce big government right up to the minute they themselves needed federal aid,” Krugman wrote.

The bailouts of all depositors at the two failed banks were announced by the FDIC after “venture capitalists (Democratic donors) and Silicon Valley politicians howled,” he added.

Federal regulators have taken over the operations of both banks while buyers are sought. Top executives have been fired.

Although both President Biden and Federal Reserve Bank Chairman Janet Yelen have insisted this is not a bailout, because “no losses will be borne by taypayers,” taxpayers in the form of US bank depositors will ultimately pay the piper with higher banking fees to offset the bailout’s cost to the FDIC and individual banks.

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However, the 2008 banking crisis was smoothed by massive amounts of bailout money being poured into regular and investment banks that failed after over-betting on “subprime loans” to risky loanees with impaired credit that spectacularly went south. Failing bank CEOs, infamously, received bonuses with federal bailout money during that financial debacle.

Notably, two top Silicon Valley Bank officials previously worked at Lehman Brothers, a New York investment bank that went belly-up and filed for bankruptcy during the 2008 financial meltdown.

Richard Squire, a Fordham University School of Law professor and an expert on bank bailouts, concurs that Biden and Yelen are playing with semantics:

What they mean when they say this isn’t a bailout, is it’s not a bailout for management. The venture capital firms and the startups are being bailed out. There is no doubt about that.

Krugman is wary of where all this act of government largesse will lead:

The bigger question is whether, by saving big depositors from their own fecklessness, policymakers have encouraged future bad behavior. In particular, businesses that placed large sums with S.V.B. without asking whether the bank was sound are paying no price (aside from a few days of anxiety). Will this lead to more irresponsible behavior? That is, has the S.V.B. bailout created moral hazard?

If history and human nature are reliable guides, yes.

We’ve seen this movie far too many times before.