Over the weekend, another bank, Signature Bank, a popular crypto lender, followed Silicon Valley Bank over the cliff. And like SIVB, its creditors were also given unlimited retroactive insurance on their callable-on-demand loans to the bank, aka deposits.

The government is anxious for these bailouts not to be called bailouts. But they are gifts to certain parties that took known risks. Let’s not be under any illusions … deposits up to $250,000 were already insured. This ceiling was simply tossed aside like a mere inconvenience, and the money to make whole big depositors is being created from nothing … plainly inflationary. So it’s not the ordinary American that’s receiving federal largess; it’s the ordinary American who’s providing it.

This recalls the Fannie and Freddie bailouts of the summer of 2008. The federal housing giants’ securities were not guaranteed by the full faith and credit of the United States. Investors received higher yields than Treasury investors in compensation for their greater risk.  So when these agencies were taken into conservatorship and their securities retroactively effectively converted into Treasuries, it was a gift. MBS investors were bailed out at the expense of ordinary Americans.

We could grant that maybe some relief was called for in both cases. Maybe 80, even 90 cents on the dollar, but 100%? Then what good was it to have been more prudent to have actually bought safer Treasuries and accepted the lower yields? What good was it to have restricted deposits to FDIC insured limits? What good is FDIC insurance at all? Deep pocketed investors just got it for free.

What do you call it when the rules are changed in the middle of the game? Rule of law is hardly the first phrase that comes to mind.

If there’s any law at all involved, it’s of the ex post facto kind.

Some comments on the markets. A few weeks ago we wrote

”We’ve seen blips and stretches of this expected relative performance but so far they have generally been offset by blips and stretches of the opposite. Aside from the advance notice given by the YC & SS, such turning points typically come with little warning, can happen fast, and can be hard to distinguish from minor, soon-to-be-reversed excursions before they’re well advanced. Not being fond of living on the edge of my seat, I prefer to maintain the stock:gold&treasuries under:over-weight. When its time to shine comes, it will be hard to miss.”

It did happen fast and we didn’t miss it. Gold and treasuries have certainly done their job so far in this crisis. The bailouts have so far limited losses for risk investors, but markets have nevertheless still managed to discern some difference between risk and safety. When the rules of the game can be changed instantly and retroactively, there can be no assurance that reason and prudence will confer reliable advantages, but for now I’m still comfortable overweighting safety.

21 thoughts on “Bailout

  1. jk says:

    i’m less critical of the decision to pay out uninsured deposits. sure, $250k is more than almost any individual or couple should keep in a bank account, since they can do so much better with a cd or tbill. but companies may need transaction accounts in the millions just to meet payrolls.

    1. Milton Kuo says:

      I fully disagree and I am a person who might have lost a little bit of money if Silicon Valley Bank’s depositors’ return of money was dependent on how much money could be raised in asset sales. There were many contributing factors to the failure of Silicon Valley Bank and none of them is excusable although I don’t know if any of them is illegal. I suspect shareholders and perhaps bondholders may have enough grounds to file a lawsuit, though, against the management.

      Firstly, the bank intentionally hired unqualified people into its executive ranks. From unnecessary minorities whose only qualification is that they are minorities (they seemed to spend a lot of time and money on company time and perhaps using company money to promote their victimhood) to people who have questionable histories (the Chief Administrative Officer was the former Chief Financial Officer of Lehman Brothers.)

      Secondly, there was some sort of agreement between the bank, the venture capitalists, and the corporate depositors that required that the depositors keep almost all of their funding in the bank. I am not certain of the details but what I’ve read are: 1. The bank owned equity stakes in some venture-backed companies and it’s possible that for their equity investment, they required the company to deposit their money with the bank 2. Either the venture capitalists or the companies were given somewhat preferential terms on borrowing. Why should we bail out this cabal of self-dealing that ultimately blew up because it was too incompetent to properly manage risk?

      Thirdly, as detailed by others who examined Silicon Valley Bank’s balance sheet in previous quarters, it was the height of stupidity to be put so much of the bank’s deposits into long-term (10+ year) bonds. Despite all the media lies that the banks “did the ‘right’ thing” buying U.S. government guaranteed bonds, agency debt, and mortgage backed securities, anybody who’s even marginally qualified (I guess I would be in that marginally-qualified class even though I do not have any training or experience in accounting, finance, or economics) knows that you cannot have that huge a mismatch between long-term assets and short-term liabilities. To cap it all off, the bank engaged in another act of galactic stupidity when it bought $88B or so of those long-term bonds at an all-time high in human history where the yield was 1.63%! In the bond bubble, when faced with such low rates in bonds or accepting essentially 0% interest in multiple savings accounts (all under the FDIC-insured limit), I bitterly accepted a 0% return despite galloping inflation. What is the excuse of bank executives and risk management departments who likely have elite college degrees and tens of years of experience?

      And finally, the companies that had very large deposits at Silicon Valley Bank (Roku had nearly $500M deposited there.) Do these companies not have treasurers or other qualified personnel who manage this kind of risk? I can understand very small companies that are running relatively leanly (maybe) but for the larger companies, why should taxpayers be on the hook for saving them when they evidently hired people (treasurers and staff) to collect a paycheck and do no work?

      Perhaps the only bailout of the depositors that I would be willing to accept would be one where deposits that are less than 60 days old will be made whole. This exception being made for companies who need that cash to pay out large amounts of money (large payrolls, expensive equipment or rent, etc.) Depositors who parked large quantities of cash for months or years on end should be forced to sweat bullets for a few months.

      As it is, the BTFP does nothing to solve this problem while creating even more moral hazard. Banks are able to borrow from the Federal Reserve pledging good collateral (USTs, agency debt, government guaranteed MBS) but at a potentially fictitious value (par.) The loans are for a one-year duration after which I assume the loan must be repaid. Is the Fed indicating that we are headed back to ZIRP again because how else are the banks in trouble going to be able to raise enough money to buy back those assets that are underwater? Maybe the Fed will just extend the duration of the loan or allow the bank to pay back the loan and then borrow from the Fed again?

      Let’s call the neverending bailouts what they truly are: affirmative action for the rich and connected. Without this affirmative action, they would be out of a job and likely out of a career. In the 2008 crash, if the Federal Reserve had allowed the insolvent banks to be wiped out (destroy shareholders, destroy bondholders, fire all executive management, file criminal prosecutions that would result in convictions and ban them from ever working in the field again), these incompetent and/or corrupt people would never work in the industry again (such as the former Lehman Brothers executive). Furthermore, harsh penalties would give pause to others who would want perpetrate some sort of crime or exceed the limits of their ability.

  2. Bill Terrell says:

    All true, JK. I’ve focused on the negatives of this decision, if only to provide some counterweight to the uncritical approval it gets in so much other coverage. But that still leaves questions. Like why then was FDIC insurance limited to $250,000 in the first place? And what is the usual means of handling losses exceeding this amount? Have depositors always received 100 cents on the dollar? If not, how is it decided who does and who doesn’t? If so, what is the point of FDIC insurance? Given the obvious failure of regulators, what happens if you remove the incentive of depositors to watch how the bank is handling their money?

    But that’s just the plumbing. Let’s take out our macroscopes and look at the big picture.

    The purpose of an economy is to produce the goods and services that people want and need. Healthy capital markets reward efforts to do this at the least cost in resources.

    Our financial system however has devolved to channel rewards to people shorting the currency. Borrow money, buy something else with it, and you’re guaranteed to profit via a decline in the value of your short position.

    The better this works the worse the economy gets at producing those goods and services. Well connected players just find it easier and more profitable to game the financial system. Left unchecked, the ultimate result is no one has to work … as long as they’re certain it will lose value, everybody can just short the currency and get rich. Farmers can stop growing food, truckers can stop hauling it to market, builders can stop building housing, doctors can stop treating the sick, teachers can stop educating the young…

    Everyone is rich but starving.

    This is why currency depreciation (inflation) can’t continue without interruption. Currency must sometimes rise in value (deflation) and bankrupt the shorts (indebted). This at least serves as a check on financial speculation by taking out the free riders. Remove the consequences and you clear the path to rich but starving. Your once prosperous economy is now dead, and so is everyone in it.

    Fractional reserve banking is just one form of free riding. It allows the banker to lend money out at term while promising depositors they can still call their loans at any time. Crises have occurred ever since it was permitted and will continue as long as it is permitted.

    Okay so you want to put $25,000,000 in an account insured for only $250,000? Fine. But you have to give some specified advance notice for withdraws over a specified amount. That you can’t borrow money overnight and lend it out for thirty years is logic so elementary a third grader can understand it. Maybe even an Econ PhD.

  3. jk says:

    we shouldn’t confound borrowing with withdrawing one’s own deposits. and we shouldn’t confound depositors with shareholders and bondholders. shareholders and bondholders [and preferred owners] should be wiped out to allow depositors to recover their deposits. but, in general, if we say depositors must independently assure themselves of the ability of their banks to deliver withdrawals, we are creating a recipe for the extinction of every bank that’s not too big to fail.

    1. Bill Terrell says:

      Absolutely JK … withdrawing one’s own deposits isn’t borrowing. It’s calling a loan to the bank. It’s the bank that’s fooling around with borrowed money.

      I don’t agree though that if you were going to lend millions of dollars to a bank, knowing that only $250K was insured, that you’re excused from due diligence. There are firms in the business of rating the soundness of banks and no excuse for financial professionals handling large sums of money to be careless.

      If this weren’t the case, then the question remains: What is the point of FDIC insurance on deposits up to $250,000? Why is there any limit at all? If it’s all going to be covered anyway, the whole program is misleading and redundant and ought to be dispatched.

      Do the same with fractional reserve banking. Banks should not be lending out funds that are simultaneously pledged to a depositor. It’s fundamentally fraudulent. Why should J6P be subsidizing the ill-gotten gains of bankers?

      Sure, that’s the way things are done, but the way things are done has been exploding the wealth gap, impoverishing the working class, generating recurring crises …

  4. jk says:

    ratings are shopped and unreliable. the only reliable bank for uninsured deposits are the systemically important banks.

    1. Bill Terrell says:

      So highly paid CFOs overseeing billions in deposits are exculpated from due diligence? Required to rely on ratings paid for by the rated? Is there some reason they can’t find or form agencies that work for them? Possibly confidence that the results their malfeasance will be socialized?

      Given the fact that a solution exists for the underlying problem, subsidizing a system that has exploded the wealth gap, impoverished millions of working class families and resulted in recurring crises in order to fraudulently pad profits for a financial elite is indefensible.

  5. jk says:

    nothing prevents a cfo from doing their own due diligence on a bank, but they can save a lot of time and effort by going with a systemically important bank.

    1. Milton Kuo says:

      Systemically important banks should have been broken into many much smaller banks. Also, rather than wasting everybody’s time with the complicated, toothless Dodd-Frank Act (over 1,000 pages), the highly effective, short and simple Glass-Steagall Act (~18 pages) should have been re-enacted.

    2. Bill Terrell says:

      A systemically important bank like Credit Suisse? Apparently it is now in the cross hairs.

    1. Bill Terrell says:

      So your defense of the status quo is that it’s the way things are.

    2. Milton Kuo says:

      We don’t live in that universe but must we tolerate endless hirings of incompetent people in critical positions that ultimately put every American at risk? The typical American probably doesn’t have two nickels to rub together and thus is adequately served by the FDIC’s guarantee. For those with more money and especially for large institutions with departments of people specially tasked with managing capital, they’re supposed to understand how to manage the risk of losing a large pot of money.

      Without destroying investors (uninsured depositors are essentially investors) in badly-governed institutions, the bailouts will never end and the dynamism of the U.S. economy will disappear as everything becomes either a de facto government job or a really lousy private sector job. (See various third world countries to see examples of that dynamic.)

      “Capitalism without bankruptcy is like Christianity without hell.” The benefits possible through capitalism will be lost or corrupted without the regulating force of failures.

  6. jk says:

    here’s paul krugman’s take:

    Now, you could argue that S.V.B.’s depositors felt safe because they somewhat cynically believed that they would be bailed out if things went bad even if they weren’t entitled to any help — which is exactly what just happened. And if you believe that argument, the feds, by making all depositors whole, have confirmed that belief, creating more moral hazard.

    The logic of this view is impeccable. And I don’t believe it for a minute, because it gives depositors too much credit.

    I don’t believe that S.V.B.’s depositors were making careful, rational calculations about risks and likely policy responses, because I don’t believe that they understood how banking works in the first place. For heaven’s sake, some of S.V.B.’s biggest clients were in crypto. Need we say more?

    And just in general, asking investors — not just small investors, who are formally insured, but even businesses with millions or hundreds of millions in the bank — to evaluate the soundness of the banks where they park their funds is expecting too much from people who are, after all, trying to run their own businesses.

  7. jk says:

    krugman went on:

    The lesson I would take from S.V.B. is that banks need to be strongly regulated whether or not their deposits are insured. The bailout won’t change that fact, and following that wisdom should prevent more bailouts.

    And you know who would have agreed? Adam Smith, who in “The Wealth of Nations” called for bank regulation, which he compared to the requirement that urban buildings have walls that limit the spread of fire. Wouldn’t we all, even the ultrarich and large companies, be happier if we didn’t have to worry about our banks going down in flames?

    1. Bill Terrell says:

      Krugman makes a nice case for insuring bank deposits. But that’s not the issue here. The problem is making up the rules as you go along. ex post facto. That’s not rule of law, it’s rule by fiat. Aka tyranny. He also makes a nice case for regulating banks. Again irrelevant. Changing the rules in the middle of the game – even after the game is over – doesn’t figure in.

      Who will give me home insurance after it’s already burned down? Will Krugman take up my cause, arguing I shouldn’t be expected to assess the risk?

      Let’s hear from a real expert, former FDIC Chair Sheila Bair, who contends that this move sets a “dangerous precedent”:

      “The uninsured depositors of SVB are not a needy group. They are a ‘who’s who’ of leading venture capitalists and their portfolio companies. Financially sophisticated, they apparently missed those prominent disclosures on the bank’s websites and teller windows that FDIC insurance is capped at $250,000,”

  8. cb says:

    Finster said: ” and the money to make whole big depositors is being created from nothing … plainly inflationary. ”
    Where is the money coming from? Is it not being provided fron the FDIC’s saved pool of funds that was collected as insurance premiums from the insured banks?

    (Terrific commentary by Milton Kuo and Bill Terrell)

    1. Bill Terrell says:

      I think I was the one that said that, so I’ll respond. The proximate source for the bailout money is indeed the FDIC, which aims to recover the funds by upping premiums for other banks … the prudent will be punished. Big picture though, the Fed’s balance sheet expanded, which is creating money from nothing. The “inflationary“ comment is a big picture inference independent of the details of the plumbing.

  9. says:

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