When You Reward Reckless Banking, You Get More Reckless Bankers

Adam Levitin says, “The new Fed facility allows banks to borrow against their Treasuries and agencies at par, not at market value. That’s a way of extending support to banks that have failed at Banking 101 and mismanaged their interest rate risk.” In other words, the government is subsidizing bankers who were so incompetent they didn’t come up with a system to deal with the Fed increasing interest rates, even though increasing interest rates is a normal thing which sometimes happens.

I urge you to read Adam Levitin’s full blog post.

Basically, the government is loaning money to Silicon Valley Bank based on the nominal value of the bank’s treasures, not the real market value. Imagine that a house burned down, but instead of borrowing against the market value of a plot of land with a burned-down structure, someone let you borrow against the value the property had before the fire. That’s what’s going on here. No reasonable financial actor would let someone put a burned-out house as collateral as if it had the value of an intact house—they would only do so as a subsidy. The government claims this isn’t really a ‘bailout,’ that taxpayers aren’t paying for it. Narrowly true in the sense that taxpayers won’t pay through taxes. Instead, the funding for the ‘bailout’ will come from payments made by banks (including the responsible banks which are well-managed), and the banks will pay for this by charging their customers more money. We’re going to pay the taxes to the bank rather than the government.

The public justification for this bailout-which-isn’t-a-bailout, is that companies had payroll accounts at Silicon Valley Bank and that if they can’t pay their workers, those workers will leave, and those companies will go under. That is indeed bad. However, if that were the primary concern, the government could’ve provided a backstop just to the payroll accounts at Silicon Valley Bank. Or, if that weren’t possible, or it was too likely that some payroll accounts would be overlooked, then they could backstop all the uninsured deposits while firing the entire upper management of the bank and banning them from working in the banking sector ever again. The latter is necessary to discourage bankers from becoming incompetent in order to harvest the government benefits when they ruin their own banks.

(I also note that many companies had their payroll accounts with Silicon Valley Bank because their VC investors required them to do so).

I don’t believe this rescue was really about saving workers’ jobs. I believe it was about protecting the wealthy people who were unwise enough to have large uninsured deposits at Silicon Valley Bank. Subsidize the rich people with influence in high places, make the poor unorganized people pay the cost through higher bank fees.

The worst thing is not what’s happening with Silicon Valley Bank in particular, but the incentives this sets up. This sets a precedent that prudent bankers must pay more and reckless bankers will make more money. This is a recipe for financial instability. This will lead to another major financial crash. Such a financial crash might ruin my life. It might ruin your life.

I understand the appeal of papering over problems and kicking down the can to a worse crisis in the future. I’ve done it myself in my personal life. The difference is that my paper-over-festering problems decisions are probably only going to blow up on me and maybe my family—which is bad, my family doesn’t deserve that—but it’s not on the scale of blowing up an entire economy. I’d like to think that if I were in a high-level position to influence banking policy, I’d act like Sheila Bair.

So, what can ordinary people do about this? For starters, we can know what’s going on. That’s the foundation for any little actions we may take. Then we can do what we can to brace ourselves for another financial meltdown (which may be little, depending on our circumstances, but even a little bracing is better than total lack of preparation). Then, we can keep an eye on opportunities to change the politics—and the more people are aware of how this drains their money through higher banking costs and risks their economic futures through financial meltdowns, the better.

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