Why Silicon Valley Bank Shouldn't Have Been Bailed Out

By now everyone is aware that the federal government stepped in to stop the spread of financial contagion in the case of Silicon Valley Bank. The Fed, in partnership with the Treasury Department and the FDIC, came together on Sunday March 12th to insure all the deposits of SVB and offered a liquidity lifeline to all other banks struggling with liquidity issues. Over the past week, many people have voiced their support of these federal government actions, calling them necessary steps to stop financial contagion in the banking industry. I disagree with supporters of such a bailout and hope to make my case as best I can. 

Problem 1: FDIC Insurance to Infinity 

When questioned on the senate floor by Republican Senator James Lankford about infinite FDIC insurance for regional banks, Treasury Secretary Janet Yellen said "A bank only gets that [referring to insurance on all deposits] treatment if a supermajority of the FDIC board, a supermajority of the Fed board, and I in consultation with the president determine that the failure to protect uninsured depositors would create systemic risk and significant economic and financial consequences...and we made that determination with these two banks [referring to SVB and Signature Bank]." One of the problems with this treatment is the 3-tiered system of banking that it creates. 

Before this bailout we had a two-tiered system of banking. Tier 1 consisted of the Systemically Important Banks (SIBs), which included JPMorgan, Wells Fargo, Citi Group, and Bank of America. In the event of a crisis these four banks would most likely be bailed out and depositors would have access to all their cash. Tier 2 banks consisted of every other bank in the economy. These banks didn't have the implicit guarantees that the Tier 1 banks had and thus depositors could lose their money in the event of a banking crisis. As did happen during the Great Recession when 465 banks failed from 2008 to 2012. 

However, with the moves of the FDIC and the subsequent testimony of Janet Yellen, this two-tiered banking system has turned to three-tiers. Bill Ackman, CEO at Pershing Square and supporter of the federal government's intervention in this case, admitted as much when he tweeted "The irony of the [Silicon Valley Bank] intervention is that we now have three tiers of banks. SVB and Signature Bridge Banks - which are now the safest banks with explicit guarantees on all deposits, the SIB banks - which have implicit guarantees on all deposits, and all other banks."

In response to this tweet Peter Schiff, economist and CEO at Euro Pacific Capital, tweeted out "That's the problem with socialism. Government intervention created the problem and now government intervention is making it worse. Now there will be runs on solvent, better managed banks as depositors rush to move their money to the riskiest banks with full government backing."

If small regional banks found it difficult to compete with the big four banks before, the actions taken by the Federal Government have made it that much harder for these banks to compete with those that are bigger than them.

Problem 2: Poor Management Incentivized

The proponents of the bailout will say that this is not a bailout akin to 2008 because the investors, bondholders, and management of SVB are not being bailed out. Although it is far better that these people are not bailed out, even Andrew Ross Sorkin of CNBC admits that this is a bailout. On the same day the FDIC announced their bailout of SVB, Ross Sorkin tweeted "It is a bailout. Not like 2008. But it is a bailout of the venture capital community + their portfolio companies (their investments). That’s the depositor base of SVB. It is the right thing to do in the moment, but there will be ramifications + new regs. VC’s should say thank you."

Although I disagree with Ross Sorkin that it was the right thing to do in the moment, he is correct in saying that it is a bailout of the venture capital community and their various businesses. Poor management at these VC backed tech startups have now been incentivized to take on higher amounts of risk knowing that they are a part of a special community of companies that will be bailed out if their bank gets into trouble. Is there an honest proponent of this bailout that would say that my local bank in Indiana should be bailed out if they find themselves in a liquidity crunch, or is that treatment only for the banks whose depositors have big Twitter accounts and political connections? Give me the criteria in which a bank would be able to fail, and financial contagion not happen? The answer is, it’s only when the VCs on Twitter have a meltdown about the possibility of their favorite tech company losing its money.

Problem 3: Lessons from 2008 Never Learned

As noted by Joseph Wang on Twitter, "In 2008 the banks got rich, went bust, and got bailed out. It was unfair, so we created a regulatory system to prevent it from happening." He continued saying "SVB is a minor bank. We could have let the process play out and show how the system has been improved. But it seems nothing has changed."

Why could we not have let the system play out as Joseph says? The answer is that SVB had very popular depositors that screamed that financial armageddon would be upon us if SVB wasn't bailed out.

Moreover the effects of the 2008 Troubled Asset Relief Program (TARP) legislation, that has been championed by its proponents as a financial windfall for the federal government and a necessary step to stabilize the fragile banking sector at the time, are being seen with SVB. The proponents of the TARP legislation say that the $15 billion that the federal government made from the legislation vindicated state intervention in the baking industry. On the surface they would be correct. The federal government stepped in and stabilized the banking system and made a profit while doing so. The problem is seen in the SVB collapse of today. SVB Financial Group, the parent company to Silicon Valley Bank, received a $235 million portion of the TARP funds in 2008. In a press release by the company on December 18, 2009, it said that they would fully repay the $235 million and had already paid the U.S. Treasury a $10 million dividend. Would Silicon Valley Bank been able to take on the risk it did if it didn't receive a bailout in 2008? Furthermore, the management team at SVB during the 2008 financial crisis consisted of a President by the name of Greg Becker. Mr. Becker not only kept his job after 2008 but was promptly promoted to CEO in 2011. He was the CEO during this most recent collapse and will most likely be tied up in litigation for years to come. Poor management was incentivized in 2008 and has just again been incentivized with the SVB bailout. In this case it isn't the poor management of the bank that gets bailed out, even though consequences will be almost non existent for the management team at SVB, its the management teams of the depositors at SVB.

Problem 4: Redistribution of Financial Risk and Moral Hazard

Finance 101: no matter how you choose to invest your money, there will always be a degree of risk involved. Although we can try to pretend that FDIC insurance completely absolves the depositor from doing proper research on their bank, the simple fact is that there is inherent risk in the banking system for depositors (due to the fractional reserve system). As Ben Shapiro said on his show last Wednesday, "When the federal government decreases risk of a certain bank failing, they are not decreasing the risk, they are redistributing the risk. You [meaning the taxpayer] are paying for it... Now the risk is going to be redistributed across the entire economy, because the idea is that if we don't redistribute the risk over the entire economy than the institution fails and if that institution fails then there will be bleed over to other institutions." Why should someone not involved in the banking system at all have to share the risk of a bank going under with the management team at David Sachs favorite VC company. Similar to how Obamacare redistributed the cost of health care from those less affluent and healthy to those who had means and were healthier, bank bailouts do the same thing. 

Problem 5: Return of QE

The American people have gone through over a decade of quantitative easing policies (4 cycles since 2008). With the onset of inflation, the Fed began to raise rates and began to decrease its balance sheet in mid-April of 2022. The Fed's balance sheet declined from nearly $9 trillion in mid-April 2022 to $8.3 trillion on March 8th, 2023. However, over the past week $300 billion has been added to the Fed's balance sheet. 

The problem here is that it was QE that really was the start of this crisis. It was easy money policies and the injection of money into the American economy that caused inflation. Making the bonds held by banks to lose value and make them more susceptible to bank runs. 

 

Problem 6: Bank Term Funding Program (BTFP)

On top of the infinite FDIC insurance on all deposits at SVB the joint statement by the Fed, Treasury, and FDIC mentioned another important part of their bailout, the Bank Term Funding Program (BTFP). In their own words the BTFP will "offer loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution's need to quickly sell those securities in times of stress." The key sentence in that statement is that the assets that banks have will be valued at par. Meaning that if a bank is holding a large amount of fixed rate long term US treasuries yielding 1.5% (which would current be underwater be a great deal right now), instead of those assets being valued at a loss a bank can now borrow against the original value of those assets. Further incentivizing bad behavior from the management at banks. 

To make this more concrete, if I purchased a brand-new Ford Pickup in 2005 for $45,000 and wanted to borrow against it today, I would be lucky to get $25,000. Now let's say that someone said they would lend you $45,000 if you put the truck up as collateral. That is essentially what the Fed is doing with the BTFP. 

Side note: I am well aware that if a treasury is held to maturity there is no loss, and the investor gets the full-face value. The truck analogy isn't perfect, but it works to show the reasoning behind the program and make it applicable to someone's personal life.