No, It Isn’t A ‘Bailout’ – And It Is Time To Afford Risk-Priced Insurance To ALL Bank Deposits IN FULL.
Assembly line workers inside the Ford Motor Company factory at Dearborn, Michigan. (Photo by ... [+] Hulton Archive/Getty Images)
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From its inception in 1933 until just before home prices started their catastrophic nosedive in 2006, the Federal Deposit Insurance Corporation (FDIC) had a strange way of funding itself. It levied assessments on insured banks only when the Deposit Insurance Fund (DIF) fell below certain thresholds, in order, in effect, to replenish it.
What made this strange – indeed perverse – was that it worked pro- rather than counter-cyclically. After all, the DIF declined most when bank failures came in waves – that is, precisely when banks were afflicted by financial contagion. Replenishment accordingly assessed banks at the times they could least afford it.
Mindful that financial stability rests upon counter-cyclical, not pro-cyclical action by the public, and mindful as well that assessments should correlate rationally with the actual risks taken on by banks with varying investment strategies, Congress reformed the system with legislation in 2005 that went into effect one year later.
Since then, banks are insured by a fund that is funded by regular premiums that are both (a) risk-priced and (b) paid in on a regular basis – just like anyone else who purchases any other kind of insurance policy. The only significant difference is that the FDIC, unlike private sector insurance firms, doesn’t serve ‘two masters’ – it exists only to protect bank depositors and assure systemic stability, not to maximize (or even earn) profits.
The 2005-06 changes went a long way toward making our system of bank deposit insurance more rational than it had previously been. It is no longer pro-cyclical, and it is no longer as vulnerable to moral hazard as it previously was – precisely because more hazardous investment strategies bring about more expensive insurance premiums – again, just like private sector insurance.
There remains, however, one glaring anachronism in our FDI system, and last week’s failure of Silicon Valley Bank (SVB) throws it into bold relief: we continue to insure bank deposits only up to a $250K cap. This is irrational, counterproductive, and altogether out of place now that we risk-price deposit insurance.
The old ‘capped coverage’ regime was a sensible concomitant of the old FDI assessment scheme. Because we didn’t risk-price deposit insurance before 2005, it made sense before then to limit possible taxpayer exposure by imposing insurance maxima. But now that we risk-price, there is simply no reason to cap. Banks that need more insurance simply can pay for more insurance, just as any of us can purchase more expensive insurance on a $500K house or less expensive insurance on a $250K house.
In addition to being vestigial and no longer necessary, the old cap regime – in effect, an FDI counterpart to the human tailbone – has become positively perverse, at least inasmuch as we want, after 2008, banks to be both (a) ‘boring’ again, and (b) once again in the business of financing production in primary markets rather than speculation in secondary financial and tertiary derivatives markets.
Consider SVB’s plight of last week and this weekend. Yes, it was boneheaded for its management not to hedge against interest rate risk or hold more Tier 1 capital to avoid incremental portfolio liquidations in the event of a once-in-half-a-century rate spike like that now wrongheadedly wrought by Jay Powell. But so far as we know there were no underperforming loans on SVB’s books and the bank was solvent.
Apart from the failure to hedge, moreover, SVB was doing precisely what we have wanted our banks to do after 2008 and especially since making a national project of what I call ‘Making America Make Again’ – that is, productive revitalization. For SVB lent to producers in the primary markets rather than speculating on price movements in the secondary and tertiary markets, while investing all excess in literally the safest of safe assets – Treasurys and high-rated MBS.
Indeed, apart from the loans – which, again, were all well-performing – SVB’s balance sheet just was the Fed balance sheet. Isn’t that precisely what we want in our banks. In effect, SVB was a tech sector credit union in all but name – a sort of club in which tech firms lent to and borrowed from one another just as I and my fellow members of the World Bank / International Monetary Fund Federal Credit Union do.
Sure, it might have been smarter for members to broker their deposits across multiple fully insured accounts, but it’s not clear that this was an option for them. For SVB, which was the only game in town, appears to have discouraged that, and the relevant depositors are in any case firms with large operating budgets for which $250K accounts are too small to function as real transaction accounts.
What, then, to do going forward? How do we keep banks like SVB, rather than handing them over to the Wall Street ‘Big Five,’ while also avoiding debacles like that of last week?
I think the answer is obvious. First, remove altogether the arbitrary and now-anachronistic cap on insurance coverage. Charge banks accordingly for the higher coverage – as effectively required by law since 2005. Second, regulatorily require either more sensible rate-risk hedging than was practiced by SVB’s management, require thicker equity buffers, or both. And third, as should go without saying, don’t rescue shareholders, and claw-back any suspiciously timed bonus or dividend payouts to, as well as proceeds of stock sales by, shareholder or managers.
style="background-color: white; color: #777777; font-family: "Open Sans", sans-serif; font-size: 15px; margin: 0px 0px 15px; vertical-align: baseline;">Done.
Our nation is now embarked on a most promising, indeed exciting, adventure. We are aiming at last to reverse four decades of outsourcing and consequent productive atrophy, in order once again to lead the world in all of the primary manufacturing industries of tomorrow. We are reversing the past decades’ ‘financialization’ and destructive obsessions with secondary and tertiary speculation, to return to real primary market production.
A critical role in this modernization will be played by bona fide industrial banks like SVB. It is accordingly time to modernize our deposit insurance system in keeping with that development. A Republic of Producers must be a republic with producer banks
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