Three weeks after the collapse of Silicon Valley Bank, what had looked like an emerging banking crisis has settled into a tentative equilibrium. While equity values for banks and other financial firms have fallen, concerns over a wider capital-markets conflagration have abated. Alongside the Biden administration’s desire to sound the “all clear”—as in the president’s statement on March 24 that “we’ve done a pretty damn good job”—markets have coalesced around the consensus belief that government action has, at least for now, averted a larger crisis.

But even if a catastrophic outcome isn’t imminent, it’s critical to understand exactly what happened and why. So far, the press has tended to focus on the regulatory, institutional, and political elements of the crisis. Regulatory coverage considers a supervisory regime that characterizes certain banks as systemically significant and otherwise oversees the activities of all regulated financial institutions. Institutional coverage spotlights the risk-management failures of SVB and other banks caught in a classic asset/liability mismatch amid an inflationary, rising-interest-rate environment. And political coverage points to SVB’s close ties to the venture-capital community, as well as its prioritization of sustainability and ESG.

Yet this leaves out a more important story. Wrongheaded bank management and poor execution can do only so much harm, and hurt mostly private market actors, assuming adequate regulatory guardrails and competent banking supervision undertaken in the public interest. Our banking regulatory regime must therefore be regarded as a failure.

Interest-rate increases to tame inflation, along with the end of 15 years of cheap money, were hardly unknowable or unforeseeable risks. The 2008 financial crisis led to legislative and regulatory changes designed to shore up the U.S. banking system and avoid a repeat of the institutional failures and widespread market disruption of that period. We are now learning in real time that the success of legislative and regulatory actions depends on the clear-headedness with which they are conceived and the deftness with which they are executed.

Here, the regulatory, corporate, and political spheres overlap. The events of last month have exposed the incoherence of our current financial regulatory regime and the degraded quality of its actual examination and oversight capabilities. Instead of prudential regulation, the U.S. is governed by a muddled, reactive corporatism.

One troubling feature of the government response is the potential harm created by its ambiguity over safeguarding bank deposits. Both the Federal Reserve and the Treasury Department have suggested that they will make whole uninsured depositors going forward—beyond the explicit writ of current Federal Deposit Insurance Corporation guarantees—if doing so is deemed necessary to stem a larger bank run and avoid more bank failures.

Tactical ambiguity may work in sports or geopolitics, but in regulation it risks doing more harm than good. Regulators are supposed to be referees who enforce the rules. A tacit but uncertain deposit backstop can yield one of two potential bad outcomes in a crisis: either the government doesn’t stand behind uninsured deposits, and the system fails; or it does, and thus it socializes losses, leaving the taxpayer on the hook. Such ambiguity encourages the moral hazard that clear, acknowledged, and respected rules are specifically designed to prevent. And an implied but unstated commitment to support all banking institutions, or at least their depositors, could result in the government picking winners and losers. Treasury Secretary Janet Yellen’s comments on March 21 justified backstopping uninsured deposits when necessary to combat contagion and wider systemic risk. But a tacit market guarantee traveling under the guise of a “systemic risk exception”—applied on a discretionary basis, in which political officials determine which institutions survive while others fail—deserves the label of crony capitalism.

Calls for more financial regulation overlook these downsides. The government’s policy of implicit universal deposit guarantees risks further inflaming our volatile populist moment. At the same time, the ambiguity over universal protection continues to drive deposit flows to the largest financial institutions, believed to be too big to fail. Taken together, the government’s actions can lead only to a more concentrated banking sector with greater, yet less effective, regulation. The recent collapse of Swiss giant Credit Suisse may be a harbinger of what is to come. Concentration, post hoc public-sector market intervention, and expanded loss socialization will move the U.S. banking sector several steps down the path of functional nationalization.

Absent a sharp reversal in administration policy and a revival of prudential banking regulation, the United States faces the prospect of continued market instability and rising populism, not to mention the consequences of placing the financial plumbing of a modern economy in the hands of a federal government that remains captive to political whims that have little to do with sound banking. What could possibly go wrong?

Photo: AlexSecret/iStock


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