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Bro-Bank Blues

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Bro-Bank Blues

It’s easy to blame an out-of-control-tech sector for recent financial failures, but Washington created the monster. March 13, 2023
Economy, finance, and budgets
Politics and law

Last year, when FTX founder Sam Bankman-Fried lost control of the massive cryptocurrency Ponzi scheme he had allegedly created, he ran home to mom and dad. A federal judge granted him bail on the multiple criminal charges he faces after his professor parents promised to keep an eye on their mischievous boy in their Palo Alto house. Now, all of move-fast-and-break-things Silicon Valley is running home to mom and dad because the Valley actually broke something that it needed. The only thing keeping hundreds of start-ups, as well as some more established tech firms, afloat right now is the fact that the federal government has bailed out all large depositors in the West Coast tech industry’s favored financial institution, Silicon Valley Bank (SVB). This state of affairs seems ironic, but it’s not. The trillions in easy money the federal government has pumped into the economy since the 2008 financial crisis in turn created the undisciplined tech sector.

The collapse of Silicon Valley Bank last Friday isn’t particularly interesting. A financial institution created 40 years ago to serve the emerging California tech world, SVB failed for the same reason that failed banks typically fail: it borrowed short-term, taking in money from depositors, and lent long-term. This strategy works—all banks do it—but SVB took it too far, too fast, with zero room for error. The bank’s deposits had tripled in just four years, the Financial Times reported, to nearly $200 billion. The bank took advantage of its status as being just under the threshold for heightened federal regulation to take enormous risk. It invested its short-term deposits—that is, money that customers could withdraw at any time from their checking and savings accounts—in long-term Treasury bonds, at a time when doing so was dangerous. The Federal Reserve has been raising interest rates, meaning that the value of older Treasury bonds issued at lower interest rates—the bonds that SVB held—was falling.

That might have been okay, except that SVB’s customers withdrew their money just as the value of SVB’s Treasury bonds was falling. Depositors asked for their money back partly because, as start-up investment has dried up in recent months, due partly to the rising interest rates, the tech firms face their own funding squeeze. These withdrawals forced SVB to sell its Treasury investments at a significant loss. That, too, could have been okay (sort of): banks around the country are nursing $600 billion in such losses.

Except: unlike at most banks, most of SVB’s depositors had more than $250,000 held at the bank. That’s above the FDIC’s normal insurance guarantee in case of bank failure. As word traveled through Silicon Valley that SVB was in distress, these large depositors began to yank their money—so quickly that, last Friday, regulators seized the bank. On Sunday night, regulators seized another medium-large bank, Signature, with a similar profile: large uninsured deposits, a tech-heavy customer base. In an effort to prevent runs on other mid-size banks, the FDIC said Sunday night that it would retroactively protect all depositors at the two failed banks, not just smaller, insured, depositors. The Federal Reserve and the Treasury Department also said that banks facing similar situations—having to sell Treasury securities to meet deposits—could instead borrow from the Fed (or “meet the needs of all their depositors,” in the Fed’s pleasant phrase) using the Treasury securities as collateral.

Yes, these steps represent a bailout, despite President Biden’s words to the contrary. (Hint: anything federal regulators do all of a sudden, on a Sunday night, is a bailout.) As with all bailouts, compelling reasons exist to take the steps in the short term: companies parked money at SVB just to pay their employees and suppliers, and allowing everyday payments to be disrupted just means more tech-industry layoffs and turmoil, at a time when the industry is already laying off hundreds of thousands of people.

The government also doesn’t want to create a panic by which depositors withdraw money from all medium-size and smaller banks. The U.S. needs mid-size banks, including banks that specialize in particular industries. Signature Bank, before it ventured into crypto, was a specialized lender to midscale residential-property owners in New York City. We don’t want to end up with just one giant, implicitly government-guaranteed, bank.

Yet compelling reasons can also be given not to bail out large depositors. Individuals and small businesses with deposits larger than $250,000 are supposed to be at least minimally sophisticated, understanding that their large deposits don’t enjoy FDIC insurance. It’s likely a good idea to raise this limit, perhaps significantly, so that small businesses don’t have to fret over their payrolls, keep track of more than a dozen bank accounts, or move all their money to JPMorgan Chase. But guaranteeing all deposits, including deposits of hundreds of millions of dollars, creates the conditions for more risk-taking, with future, large depositors not caring if banks take undue risk with their money. In fact, our too-big-to-fail era started nearly four decades ago, with the Reagan administration’s bailout of the Continental Illinois bank, in 1984. That first-ever bailout—of all depositors and bondholders—effectively subsidized financial-industry risk. The result was more financial-industry risk, along with reckless borrowing and lending. That led to bailout after bailout, culminating in the 2008 global financial crisis.

Plus, letting the tech industry squirm for a few days might not have been a bad thing. Before the government stepped in Sunday night, entrepreneurial financial firms were already offering to lend money to companies that had their money stranded at SVB. Such lending would use as collateral large depositors’ eventual share in the share of SVB’s remaining assets, once regulators sell them off. Because they are risky, these loans levy a high interest rate.

Fine, maybe teach the tech bros a lesson: you wanted to take risk, well, here’s the risk you took, without even knowing it. The tech industry has been contemptuous of all guardrails, just as the pre-2008 financial industry was. The conventional wisdom is that in September 2008, the federal government made a mistake in letting Lehman Brothers fail, igniting a global panic. But without that panic, voters would never have understood what a brittle disaster the financial industry really was.

The broader problem, though, is that just as the government had created that brittle 2008 financial industry in the first place, with the too-big-to-fail regime that had begun in 1984, the government also created today’s self-satisfied tech industry. How did SVB’s deposits triple in less than half a decade? Why did Signature Bank start dabbling in crypto? Why on earth did anyone ever trust Sam Bankman-Fried to do anything?

The culprit is all the money the federal government has pumped into the financial system over the past 15 years. After the financial crash of 2008, the Treasury and the Federal Reserve wanted to revive the economy by spurring yet more cheap lending and borrowing, ignoring how it was cheap lending and borrowing that had crashed the economy in the first place; household debt levels already stood at record highs. To encourage even more of the same, the Fed created even more cheap money. In early September 2008, the Fed’s balance sheet—roughly speaking, the money it had created out of thin air to support the economy—was slightly below $1 trillion. By the end of the year, it had swelled to $2.3 trillion. By 2015, the balance sheet had topped out at $4.5 trillion. That year, the Fed started to mop up some of that money, gingerly increasing interest rates. But even before Covid-19 hit, the central bank was backing away from this strategy, worried that higher rates would cause a recession. In March 2020, the Fed responded to Covid by repeating its 2008 strategy: print money. By April 2022, the Fed’s balance sheet had reached nearly $9 trillion. That is a lot of ink.

All that money had to go somewhere. Where did it go? Into sky-high stock and housing values, yes. Into Louis Vuitton bags. Into food and energy inflation that nearly reached double digits last year. But mostly, it went into a bloated tech sector that had already run out of ideas. Crypto, and SBF’s catered Bahamas compound, are the most spectacular examples. But companies outside of crypto burned money, too. Thanks to cheap money, companies such as WeWork and Uber were able to generate multibillion-dollar losses in the real-estate and for-hire car industries respectively for years. DoorDash and Grubhub could deliver deli sandwiches to people too lazy to pick them up themselves. These activities are not particularly new or innovative; the innovation was to make them unprofitable, in many cases by offering a service below cost to attract more customers.

Even with such frivolous ventures attracting money, SVB tellingly couldn’t find enough tech-industry borrowers. This dearth of good ideas, relative to the money available to fund them, is why SVB instead invested so much of its cash in long-term Treasury bonds. SVB effectively took the government’s money and lent it back to the government—and still went under.

Now, the money that went into the tech industry, and into the housing market and the stock market and new-car purchases, too, is coming out. Over the past year, the Fed, in trying to quash inflation, has begun raising interest rates, in effect draining back out some of the money it had pumped into the economy. Crypto has turned into a wealth-destruction machine. Workers at even established tech firms are suffering mass layoffs.

Yet, just as with the tech companies that blithely parked their deposits at SVB, the risk we don’t see is the real risk. In an economy that has been dependent on cheap borrowing and lending for decades, making borrowing and lending more expensive is a dangerous task. On Monday, despite the turmoil in the financial system, the stock market was actually up for much of the day, then closed flat. Why? More SVBs are out there—a lot more, and bigger ones—and investors just don’t think the Fed has the stomach to keep interest rates high enough, for long enough, to find them. Investors are betting on a bailout to bail us out of all of our previous bailouts.

Photo by NOAH BERGER/AFP via Getty Images

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