The Investment Scientist

A Bank Rescue That Seeds The Next Crisis?

Posted on: March 15, 2023

There is so much to write about the Silicon Valley Bank (SVB) collapse and the subsequent government rescue plan. Let me start by saying that I do agree that the government’s action has arrested a panic that could lead to a domino of bank collapses. In today’s article, I’d like to present my thought that the rescue mechanism as it is now could lead to more problems down the road that one day might become an even bigger crisis. 

The first part of the rescue program is that the FDIC will make all deposit amounts whole, despite only $250k being insured. This new obligation balloons the FDIC’s liability way beyond its ability to fulfill. As of the end of 2022, the FDIC only has $128B available. SVB’s deposits alone total $178B. A bank run always arises from the loss of confidence. What if depositors arrive at the rational conclusion that the FDIC can not bail out all of the deposits at all of the troubled banks? The bottom line is this: at some point, the promise that you buy only $250k worth of insurance on your deposit but get unlimited insurance from FDIC will stretch credulity so much that depositors will lose confidence in the FDIC’s promise. And then what?

The second part of the rescue program is that the troubled banks have direct access to the Fed’s money printer. They can pledge their treasuries, their mortgage-backed securities (MBS) and other agency debts (let’s call them government bonds) that have marked-to-market losses to the Fed and get the full face value of these bonds as cash. Let me give you an example. SVB has $91B (face value) in MBS that is only worth $75B now because rates have gone up a lot. If SVB were forced to sell the securities in the open market, they would get $75B, but they can pledge these securities to the Fed for $91B cash. This would surely crank up the Fed’s money-printing machine in an environment where inflation has yet to be tamed. This could also incentivize banks to speculate on government bonds, as opposed to lending to real businesses. A loan to a real business can not be pledged to the Fed for cash as opposed to government bonds. On top of that, speculation on government bonds comes with this great benefit: If you bet right, you keep the profit; if you bet wrong, the Fed will print money to make up your loss. What bank would ever want to lend to real businesses again?

I hope I am wrong on both counts. Those folks in the Fed, the US Treasury, and the FDIC are way smarter than I am. It’s hard to imagine they did not think this through. 

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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