There is another way to look at this. I have seen objections to the claim that the bailout "won't cost the taxpayer a penny" that run "yes, but all bank depositors will have to pay for this in the long run in the form of higher insurance premiums". That strikes me as right from a positive perspective ... and also from a normative one? If…
There is another way to look at this. I have seen objections to the claim that the bailout "won't cost the taxpayer a penny" that run "yes, but all bank depositors will have to pay for this in the long run in the form of higher insurance premiums". That strikes me as right from a positive perspective ... and also from a normative one? If bank depositors shouldn't pay for deposit insurance, then who should?
Stepping back for perspective, in order to operate as an ongoing concern, it is necessary as a matter of arithmetic for a bank to earn more on its assets than it pays for its liabilities. According to orthodox financial theory, the only way to do this is to take more risk on the assets than is being sold in the liabilities. In principle, any bank must be subject to failure if its depositors withdraw their deposits in a coordinated way. The only way a bank has of controlling this risk is to break the possibility of coordination by diversification. This requires not only a large number of depositors but a large variation in their type. This runs counter to the specialization that, as you point out, makes mid-size regional banks viable.
I would like to know which end of this Baker is willing to sign on for. Would he prefer America to be banked by a small number of large national banks that charge a small deposit insurance fee? That is perfectly viable. Or would he prefer a larger number of more specialized but more vulnerable banks? That is also viable - with the support of more expensive insurance. But you can't have the benefits of both and the costs of neither.
A couple of points re the illusion this a cost free
1) as someone who actually had the job of pricing deposits for a large bank yes you do look at fdic insurance -- it is a real cost after all . But the caveat is of course you also have to be competitive in the market
2) I do believe but I am digging in my memory that fdic insurance costs are tax deductable.. this is a straight forward burden sharing with non bank taxpayers who make up the difference in addition to any reduction in profitability from point 1
The depositors got something they did not deserve for a non zero cost -- though the number is tbd based on the asset sales and how fdic is split between taxpayers depositors (though rates ) and bank (through impact on earnings) .
The larger issues for me are three fold:
1) svb was not a normal bank but a non diversified creature of Silicon Valley . The withdrawals were not random events but coordinated via vc emails yet there is no accountability
2) i also worked in the cash management function for a large bank and one would normally not see large deposit balances in deposit accounts -- was this some weird anomaly with balances not swept into secure things like t bills?
3) we will have to see the full impacts on the banking system. This is not 2008 when the needs were clear. Have we changed the rules of the game where deposit insurance limits really don't exist anymore ? With what impacts? Will runs become the norm since there are no consequences for depositors?
The interesting question to me is: what happens to the repo market if any corporate account can make a safe deposit without having to handle collateral? I guess we'll find out.
If depositors are safe (full insurance), there is never a need for a run. That is Brad's point, and also a major part of the government's point in what they have chosen to do for SBV depositors
Thanks it's clear that it eliminates bank runs but without other regulatory changes increases chance of bank failures and their costs since there is one less check on bank lending behavior. It assumes either shareholders or regulators double down on oversight in some way . After the savings and loan crisis (I am old enough to have been involved in the issue), one thought for example was to change bank capital structure to include a tier of short term debt so that the market would frequently have to "vote" on bank viability . Another option is to increase bank capital and or tighten loan standards and oversight in general . My point overall is you have a system of risk management with costs --nothing is free and you have to look at the whole picture
Yes, there should be a price to pay. And it needs to be assessed at the proper point in the financial process.
My view is that point is not 'on the depositors.' Because if it is, then I need to bank with the biggest, most diversified bank I can find.
Costs are already assessed on the failed bank's shareholders (typically get zero) and bondholders (often get zero or a small % recovery).
I think we do want there to be smaller, specialized banks. These banks can better understand the risks of their loan customers' businesses. And SVB was apparently good at that - though in recent years terrible on the risk management side for their own portfolio assets.
I think we want community banks, which know their local customers and know who is a good loan risk and who is not. They will loan to small businesses that a giant bank will sneer at, because the giant bank can't know all of its customers as well as that. My brother-in-law is on the board of a very small community bank in Midwestern farm country. They know all of their loan customers very well, and can and do carry a very small loan loss reserve.
I don't want too much consolidation in the banking industry. Among other things, giant banks have very loud political voices in the regulatory process, an obvious and large negative externality.
And then - I just discovered that the small community bank I was referencing has just been bought up by a slightly larger community bank. So the bank goes from a one branch small-town bank to an eight-town mini-region bank. Consolidation - it's everywhere.
The annoying thing is that the rules have been changed at least since 2008, though probably earlier. Depositors over the nominal insured limit of only one bank during that crash were denied complete coverage, but that was a Black owned bank so an exception was made. Maybe we need to mark the rules to practice and start thinking through the ramifications.
As a capitalist, I used to think of the banking system as an element of private enterprise, but these days it is more of a utility or natural monopoly. After each collapse, smaller banks are merged into larger banks and those larger banks have been regulated more tightly. If this continues, we will have one big bank by 2100. Given this would be the endpoint of a long trend towards consolidation, perhaps we should embrace it and just have the Federal Reserve operate as a bank with retail operations.
That would leave plenty of room for venture capital and the private sector while better isolating the economy from its vicissitudes. It makes more sense than restoring Glass-Steagall which served well in a very different era.
I could see the Fed operating the entire payment system. The argument is serious. But what would be on the asset side of the balance sheet? If it stuck to govvies, the cost of credit would go up, since it wouldn't be funded by cheap bank deposits. If it extended credit to real people and businesses, the political pressure to lend to the, uh, right people would be enormous.
This is kind of what Morgan Ricks wants to do, although IIRC he would subcontract the credit allocation out to bank-like firms funded by discount window loans. This would reduce the political economy risk. By enough?
There is another way to look at this. I have seen objections to the claim that the bailout "won't cost the taxpayer a penny" that run "yes, but all bank depositors will have to pay for this in the long run in the form of higher insurance premiums". That strikes me as right from a positive perspective ... and also from a normative one? If bank depositors shouldn't pay for deposit insurance, then who should?
Stepping back for perspective, in order to operate as an ongoing concern, it is necessary as a matter of arithmetic for a bank to earn more on its assets than it pays for its liabilities. According to orthodox financial theory, the only way to do this is to take more risk on the assets than is being sold in the liabilities. In principle, any bank must be subject to failure if its depositors withdraw their deposits in a coordinated way. The only way a bank has of controlling this risk is to break the possibility of coordination by diversification. This requires not only a large number of depositors but a large variation in their type. This runs counter to the specialization that, as you point out, makes mid-size regional banks viable.
I would like to know which end of this Baker is willing to sign on for. Would he prefer America to be banked by a small number of large national banks that charge a small deposit insurance fee? That is perfectly viable. Or would he prefer a larger number of more specialized but more vulnerable banks? That is also viable - with the support of more expensive insurance. But you can't have the benefits of both and the costs of neither.
A couple of points re the illusion this a cost free
1) as someone who actually had the job of pricing deposits for a large bank yes you do look at fdic insurance -- it is a real cost after all . But the caveat is of course you also have to be competitive in the market
2) I do believe but I am digging in my memory that fdic insurance costs are tax deductable.. this is a straight forward burden sharing with non bank taxpayers who make up the difference in addition to any reduction in profitability from point 1
The depositors got something they did not deserve for a non zero cost -- though the number is tbd based on the asset sales and how fdic is split between taxpayers depositors (though rates ) and bank (through impact on earnings) .
The larger issues for me are three fold:
1) svb was not a normal bank but a non diversified creature of Silicon Valley . The withdrawals were not random events but coordinated via vc emails yet there is no accountability
2) i also worked in the cash management function for a large bank and one would normally not see large deposit balances in deposit accounts -- was this some weird anomaly with balances not swept into secure things like t bills?
3) we will have to see the full impacts on the banking system. This is not 2008 when the needs were clear. Have we changed the rules of the game where deposit insurance limits really don't exist anymore ? With what impacts? Will runs become the norm since there are no consequences for depositors?
The interesting question to me is: what happens to the repo market if any corporate account can make a safe deposit without having to handle collateral? I guess we'll find out.
If depositors are safe (full insurance), there is never a need for a run. That is Brad's point, and also a major part of the government's point in what they have chosen to do for SBV depositors
Thanks it's clear that it eliminates bank runs but without other regulatory changes increases chance of bank failures and their costs since there is one less check on bank lending behavior. It assumes either shareholders or regulators double down on oversight in some way . After the savings and loan crisis (I am old enough to have been involved in the issue), one thought for example was to change bank capital structure to include a tier of short term debt so that the market would frequently have to "vote" on bank viability . Another option is to increase bank capital and or tighten loan standards and oversight in general . My point overall is you have a system of risk management with costs --nothing is free and you have to look at the whole picture
Yes, there should be a price to pay. And it needs to be assessed at the proper point in the financial process.
My view is that point is not 'on the depositors.' Because if it is, then I need to bank with the biggest, most diversified bank I can find.
Costs are already assessed on the failed bank's shareholders (typically get zero) and bondholders (often get zero or a small % recovery).
I think we do want there to be smaller, specialized banks. These banks can better understand the risks of their loan customers' businesses. And SVB was apparently good at that - though in recent years terrible on the risk management side for their own portfolio assets.
I think we want community banks, which know their local customers and know who is a good loan risk and who is not. They will loan to small businesses that a giant bank will sneer at, because the giant bank can't know all of its customers as well as that. My brother-in-law is on the board of a very small community bank in Midwestern farm country. They know all of their loan customers very well, and can and do carry a very small loan loss reserve.
I don't want too much consolidation in the banking industry. Among other things, giant banks have very loud political voices in the regulatory process, an obvious and large negative externality.
And then - I just discovered that the small community bank I was referencing has just been bought up by a slightly larger community bank. So the bank goes from a one branch small-town bank to an eight-town mini-region bank. Consolidation - it's everywhere.
The annoying thing is that the rules have been changed at least since 2008, though probably earlier. Depositors over the nominal insured limit of only one bank during that crash were denied complete coverage, but that was a Black owned bank so an exception was made. Maybe we need to mark the rules to practice and start thinking through the ramifications.
As a capitalist, I used to think of the banking system as an element of private enterprise, but these days it is more of a utility or natural monopoly. After each collapse, smaller banks are merged into larger banks and those larger banks have been regulated more tightly. If this continues, we will have one big bank by 2100. Given this would be the endpoint of a long trend towards consolidation, perhaps we should embrace it and just have the Federal Reserve operate as a bank with retail operations.
That would leave plenty of room for venture capital and the private sector while better isolating the economy from its vicissitudes. It makes more sense than restoring Glass-Steagall which served well in a very different era.
I could see the Fed operating the entire payment system. The argument is serious. But what would be on the asset side of the balance sheet? If it stuck to govvies, the cost of credit would go up, since it wouldn't be funded by cheap bank deposits. If it extended credit to real people and businesses, the political pressure to lend to the, uh, right people would be enormous.
This is kind of what Morgan Ricks wants to do, although IIRC he would subcontract the credit allocation out to bank-like firms funded by discount window loans. This would reduce the political economy risk. By enough?
How true. The potential for political mischief is impressive.