March 30, 2023

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Was this a bailout plan? Skeptics descend upon Silicon Valley bank’s response.

A sweeping package aimed at containing damage to the financial system in the wake of high-profile failures has raised questions about whether the federal government is bailing out Wall Street again.

And while many economists and analysts agreed that the government’s response should not be seen as a “bailout” in key ways — investors in bank stocks would lose money, banks would be closed — many said it should lead to scrutiny of how the banking system is regulated and supervised.

The reckoning came after the Federal Reserve, Treasury and Federal Deposit Insurance Corporation announced Sunday that it would make sure all depositors at two large, failing banks, Silicon Valley Bank and Signature Bank, are paid in full. The Fed also announced that it would lend to banks against Treasuries and many other asset holdings, with securities treated as if they were worth their original value — even though higher interest rates have eroded the market price for such bonds.

The measures were intended to send a message to America: There is no reason to withdraw your money from the banking system, because your deposits are safe and financing is plentiful. The aim was to avoid bank inflows that could devastate the financial system and the broader economy.

It was not clear on Monday whether the plan would work. Shares of regional banks plunged, and nervous investors snapped up safe-haven assets. But even before the ruling came out, lawmakers, policy researchers and academics began debating whether the government had taken the right step, whether it was going to encourage future risk-taking in the financial system and why it was necessary in the first place.

“The Fed just wrote interest rate risk insurance for the entire banking system,” said Stephen Kelly, a senior research fellow at the Yale Financial Stability Program. And that, he said, could stoke risk going forward by suggesting that the Fed will step in if things go wrong.

“I would call it saving the system,” Mr. Kelly said. “It lowers the threshold for predicting where emergency steps will begin.”

While the definition of “bailout” is not clear, it is usually applied when an institution or investor is rescued through government intervention from the consequences of taking a reckless risk. The term became a swear word in the aftermath of the 2008 financial crisis, after the government engineered a bailout of major banks and other financial firms using taxpayers’ money, with little or no consequence for executives who made bad bets that shut down the financial system. to the abyss.

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President Biden, speaking from the White House on Monday, tried to make clear that he doesn’t view what the government is doing as bailing out in the traditional sense, given that investors would lose money and taxpayers wouldn’t be on the hook. no losses.

“Investors in banks will not be protected,” Biden said. They took a risk on purpose, and when that risk doesn’t pay off, the investors lose money. This is how capitalism works.”

He added: The taxpayers will not bear any losses. Let me repeat: the taxpayers will not suffer any losses.”

But some Republican lawmakers were not convinced.

Sen. Josh Hawley of Missouri said Monday he is introducing legislation to protect customers and community banks from new “special appraisal fees” that the Federal Reserve said would be imposed to cover any losses for the FDIC’s Deposit Insurance Corporation, which is currently being implemented. Used to protect depositors from losses.

“What basically happened with these ‘special assessments’ of SVB coverage is that the Biden administration found a way to get taxpayers to pay for the bailout without even taking a vote.” Mr. Hawley said in a statement.

The government’s action on Monday was an apparent bailout for a group of financial players. Interest rate risk-bearing banks, and perhaps their large depositors, were sheltered from losses – which some observers said constituted a bailout.

“It’s hard to say this isn’t a bailout,” said Dennis Kelleher, co-founder of Better Markets, a prominent advocacy group for financial reform. “Just because taxpayers aren’t in trouble yet doesn’t mean something isn’t a bailout.”

But many academics agreed that the plan was more about preventing a large-scale and destabilizing bank run than bailing out any company or group of depositors.

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“The big picture, this was the right thing to do,” said Christina Paragon-Skinner, an expert on central banking and financial regulation at the University of Pennsylvania. But she added that she could still encourage financial bets by promoting the idea that the government would step in to clean up the mess if the financial system ran into trouble.

“There are questions about moral hazard,” she said.

One of the signals the bailout sent to depositors was: If you owned a large bank account, the moves indicated that the government would step in to protect you in a crisis. This may be desirable – several experts said Monday that it might be smart to review deposit insurance to cover accounts larger than $250,000.

But it could give large depositors less incentive to withdraw their money if their banks take too much risk, which in turn could give financial institutions the green light to ease up on caution.

That may be worth new safeguards to protect against future risk, said William English, a former director of monetary affairs at the Federal Reserve who is now at Yale University. He said that he believed that the operation of banks in 2008 and recent days made it clear that the system of partial deposit insurance is not really working.

“Market discipline doesn’t really happen until it’s too late, and then it gets really sharp,” he said. “But if you don’t have that, what is the risk-reduction for the banks?”

It wasn’t just the bailout’s side effects that were of concern Monday: Many onlookers noted that the failure of banks, especially a Silicon Valley bank, indicated that bank supervisors may not have been keeping a close eye on vulnerabilities. The bank grew very quickly. It had plenty of clients in one volatile industry — technology — and it didn’t seem to have managed its exposure to rising interest rates carefully.

“The Silicon Valley bank situation is an abject failure of regulation and supervision,” said Simon Johnson, an MIT economist.

The Federal Reserve responded to that concern on Monday, announcing that it would conduct a review of Silicon Valley bank supervision. The San Francisco Federal Reserve Bank was responsible for overseeing the failed bank. the The results will be published publicly On May 1, the central bank said.

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“The events surrounding Silicon Valley Bank require a comprehensive, transparent and prompt review,” Federal Reserve Chairman Jerome H. Powell said in a statement.

Mr. Kelleher said the Justice Department and the Securities and Exchange Commission should look into potential wrongdoing by Silicon Valley bank executives.

“Crisis doesn’t just happen – it’s not like the Immaculate Conception,” Mr. Keeler said. “People take actions ranging from stupid to reckless to illegal to criminal that cause banks to fail and cause financial crises, and they must be held accountable whether they are bank executives, board members, venture capitalists, or anyone else.”

One of the big looming questions is whether the federal government will prevent bank executives from taking out the large compensation packages, often known as “golden parachutes,” which tend to be written into contracts.

The Treasury Department and the FDIC have no comment on whether these payments will be restricted.

Several experts said the fact that problems at Silicon Valley’s bank could endanger the financial system — and would require such a large response — points to the need for tougher regulation.

While the now struggling regional banks are not large enough to face the toughest levels of regulatory scrutiny, they were deemed important enough to the financial system to warrant strong government intervention.

“Ultimately, what has been demonstrated is that the explicit guarantee extended to universal banks has now been extended to everyone,” said Renita Marcellin, director of legislation and advocacy at Americans for Financial Reform. “We have this implied guarantee for everyone, but not the rules and regulations that have to accompany those guarantees.”

The situation means that “concerns about moral hazard, concerns about who the system is protecting, are front and center again,” said Daniel Tarullo, a former Fed governor who was instrumental in creating and implementing financial regulations after the 2008 crisis.