Rules and Regulations for Thee and Not for Me

“The very men who were arguing the government should protect all the depositors’ money, not just that protected under the FDIC, have been vocal in opposing both government regulation of their industry and government relief for student loan debt, suggesting that they hate government action…except for themselves.”

March 12, 2023, Letters from an American, Professor Heather Cox Richardson

At 6:15 this evening, Secretary of the Treasury Janet L. Yellen, Federal Reserve Board Chair Jerome H. Powell, and Federal Deposit Insurance Corporation (FDIC) Chairman Martin J. Gruenberg announced that Secretary Yellen has signed off on measures to enable the FDIC to fully protect everyone who had money in Silicon Valley Bank, Santa Clara, California, and Signature Bank, New York. They will have access to all of their money starting Monday, March 13. None of the losses associated with this resolution, the statement said, “will be borne by the taxpayer.”

But, it continued,

“Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.”

The statement ended by assuring Americans that “the U.S. banking system remains resilient and on a solid foundation, in large part due to reforms that were made after the financial crisis that ensured better safeguards for the banking industry. Those reforms combined with today’s actions demonstrate our commitment to take the necessary steps to ensure that depositors’ savings remain safe.”

It’s been quite a weekend. 

On Friday, Silicon Valley Bank (SVB) failed in the largest bank failure since 2008. At the end of December 2022, SVB appears to have had about $209 billion in total assets and about $175 billion in deposits. This made SVB the sixteenth largest bank in the U.S., big in its sector but small compared with the more than $3 trillion JPMorgan Chase. This is the first bank failure of the Biden presidency (while Donald Trump Jr. tweeted that he had not heard of any bank failures during his father’s presidency, there were sixteen, eight of which happened before the pandemic). In fact, generally, a few banks fail every year; it is an oddity that none failed in 2021 or 2022. 

The failure of SVB created shock waves for three reasons. First, SVB was the major bank for technology start-ups, so it involved much of a single sector of the economy. Second, only about $8 billion of the $173 billion worth of deposits in SVB were less than the $250,000 that the FDIC insures, meaning that the companies who had made those deposits might not get their money back quickly and thus might not be able to make payrolls, sparking a larger crisis. Third, there was concern that the problems that plagued SVB might cause other banks to fail, as well. 

What seems to have happened, though, appears to be specific to SVB. Bloomberg’s Matt Levine explained it most clearly: 

As the bank for start-ups, which have a lot of cash from investors and the initial public offering of stock, SVB had lots of deposits. But start-up companies don’t need much in the way of loans because they’ve just gotten so much cash and they don’t yet have fixed assets. So, rather than balancing deposits with loans that fluctuate with interest rates and thus keep a bank on an even keel, SVB’s directors took a gamble that the Federal Reserve would not raise interest rates. They invested in long-term Treasury bonds that paid better interest rates than short-term securities. But when, in fact, interest rates went up, the value of those long-term bonds sank.  

For most banks, higher interest rates are good news because they can charge more for loans. But for SVB, they hurt.

Then, because SVB concentrated on start-ups, they had another problem. Start-ups are also hurt by rising interest rates because they promise to deliver returns in the long term. This is fine so long as interest rates stay steadily low, as they have been now for years. But as interest rates go up, investors tend to like faster returns than most start-ups can deliver. They take their money to places that are going to see returns sooner. For SVB, that meant their depositors began to need some of that money they had dumped into the bank and started to withdraw their deposits. 

So SVB sold securities at a loss to cover those deposits. Other investors panicked as they saw SVB selling at a loss and losing deposits, and they, too, started yanking their money out of the bank, collapsing it. Banks that have a more diverse client base are less likely to lose everyone all at once.

The FDIC took control of the bank on Friday. On Sunday, regulators also shut down Signature Bank, based in New York, which was a major bank for the cryptocurrency industry. Another crypto-friendly bank, Silvergate, failed last week. 

Congress created the FDIC under the Banking Act of 1933 to restore trust in the American banking system after more than a third of U.S. banks failed after the Great Crash of 1929, sparking runs on banks as depositors rushed to take out their money whenever rumors suggested a bank was in trouble, thus causing more failures. The FDIC is an independent agency that insures deposits, examines and supervises banks to make sure they’re healthy, and manages the fallout when they’re not. The FDIC is backed by the full faith and credit of the government, but it is not funded by the government. Member banks pay insurance dues to cover bank failures, and when that isn’t enough money, the FDIC can borrow from the federal government or issue debt.

Over the weekend, the crisis at SVB became a larger argument over the role of government in the protection of the economy. Tech leaders took to social media to insist that the government must cover all the deposits in the failed bank, not just the ones covered under FDIC. They warned that the companies whose deposits were uninsured would fail, taking down the rest of the economy with them. 

Others noted that the very men who were arguing the government should protect all the depositors’ money, not just that protected under the FDIC, have been vocal in opposing both government regulation of their industry and government relief for student loan debt, suggesting that they hate government action…except for themselves. They also pointed out that in 2018, under Trump, Congress weakened government regulations for banks like SVB and that SVB’s president had been a leading advocate for weakening those regulations. Had those regulations been in place, they argue, SVB would have remained solvent.

It appears that Yellen, Powell, and Gruenberg, in consultation with the president (as required), concluded that the collapse of SVB and Signature Bank was a systemic threat to the nation’s whole financial system, or perhaps they concluded that the panic over that collapse—which is a different thing than the collapse itself—was a threat to the nation’s financial system. They apparently decided to backstop the banks to prevent more damage. But they are eager to remind people that they are not using taxpayer money to shore up a poorly managed bank.

Right now, this appears to leave us with two takeaways. The Biden administration has been considering tightening the banking regulations. They were loosened under Trump. It seems likely that the need for the federal government to step in to protect the depositors at SVB and Signature Bank will make it much harder for those opposed to regulation to keep that from happening. There will likely be increased pressure on the Biden administration to guard against helping out the wealthy and corporations rather than ordinary Americans.

And, perhaps even more important, the weekend of panic and fear over the collapse of just one major bank should make it clear that the Republicans’ threat to default on the U.S. debt, thus pulling the rug out from under the entire U.S. economy unless they get their way, is simply unthinkable.