Yet Another Bailout

The FDIC will provide unlimited deposit insurance for Silicon Valley Bank and Signature Bank and the Fed will accept depreciated securities at par value from banks seeking emergency funding.

It is interesting to contemplate how much crazier financial panics would be if markets were open constantly without interruption. In our technologically advanced age, there is nothing to prevent markets from operating continually. But markets were closed over the weekend and politicians had ample time to contemplate how to address the loud tantrums of fragile crony capitalists reacting to the failure of Silicon Valley Bank. Despite the spin from politicians, the answer was yet another massive bailout for the financial system — a giant band aid on a gaping systemic wound.

As the weekend began, my intent was only to point out the fact that any market participant or regulator with a basic ability to read financial statements could have seen the issues with Silicon Valley Bank by reading the company’s 10-K which was published just two weeks ago. I did not plan to follow up with another article, but I admit to getting annoyed with pathetically fragile so-called capitalists pleading for a bailout. Surprisingly, those articles were among the most popular pieces I have ever published. It seems incomplete to not write about the outcome of the situation.

In a joint statement, Treasury Secretary Janet Yellen, Federal Reserve Chairman Jerome Powell, and FDIC Chairman Martin Gruenberg announced that all deposits at Silicon Valley Bank would be protected by FDIC insurance and that access to funds would be restored today. Additionally, the joint statement announced that Signature Bank would be shut down with all depositors fully protected by FDIC insurance. Shareholders of the banks and other unsecured creditors will not be protected. Losses incurred by the deposit insurance fund will be recovered by a special assessment on banks. The statement asserts that “no losses will be borne by the taxpayer.”

In addition, the Federal Reserve issued a separate press release announcing that additional funding will be made available to other banks to provide liquidity in the event of withdrawal of deposits. The Fed’s Bank Term Funding Program will offer loans of up to one year in length for eligible financial institutions that pledge treasury securities or agency debt and mortgage-backed securities as collateral. These collateralized securities will be valued at par rather than at fair market value.

The joint statement justified the bailout of depositors at Silicon Valley Bank and Signature Bank by citing the systemic risk exception indicating that officials believed that allowing deposits over $250,000 to be at risk of loss could create systemic risks for the overall economy. As I noted in my article yesterday, uninsured deposits were likely to realize substantial recovery over time as the FDIC wound down operations by liquidating securities and selling loan portfolios.

The FDIC’s action to fully protect deposits means that uninsured deposits will now receive full and immediate recovery with losses borne by the entire banking system (and, by extension, the real economy) through a special FDIC assessment.

I will not reiterate my comments from yesterday’s article other than to say that government officials offered no argument for citing the systemic risk exception, nor was any insight provided into why the FDIC radically changed its approach to the situation between Friday afternoon and Sunday evening.

In the coming days, we will likely learn far more about the behind the scenes lobbying and other political maneuvering that took place to achieve this result. It will also be interesting to see which politicians and regulators involved in last night’s decisions are financially rewarded by the industry with cushy sinecures such as board seats or lucrative speaking fees at venture capital conferences. Chances are that the saviors of the industry will receive more than fleece vests with venture capital firm logos.

The bottom line is that government has bailed out large depositors with the ultimate beneficiaries being the venture capitalists who funded firms that irresponsibly concentrated deposits in financial institutions that were insolvent when measuring their assets at market value. The Fed’s willingness to play make-believe by accepting treasuries and mortgage-backed securities at par as collateral for loans is intended to provide liquidity for other financial institutions and prevent further bank runs. In reality, it will also save venture capital firms from portfolio losses.

Interestingly, the initial mainstream media reporting on Signature Bank omitted the fact that former Congressman Barney Frank, co-author of the Dodd-Frank Wall Street Reform and Consumer Protection Act, has been on the company’s board of directors since 2015. This morning’s Wall Street Journal article on Signature Bank’s failure does include a statement from Mr. Frank on the bank’s collapse which he blamed on the panic surrounding Silicon Valley Bank. He is quoted as saying that “we were fine until the last couple of hours on Friday.” While Mr. Frank is likely to lose the value of the shares of Signature Bank that he owns, presumably some consolation will be provided by the $121,750 of cash compensation that he received as a board member in 2022.

Prior to the announcement of the massive bailout last night, there were articles indicating that startups and other businesses were racing to secure other sources of cash for payroll and other immediate expenses. Some founders were pledging personal funds to meet payroll. Others were talking to investors who might be able to provide emergency funding. In short, capitalism was being practiced in an effort to save companies that, while otherwise sound, needed temporary liquidity. What a relief it must be for the industry to no longer face such daunting pressures.

By swooping in last night, the government has obviated the need for painful steps in the venture capital community and removed market pressure from the equation. While government officials stated that taxpayers will bear no burden, the reality is that the direct costs of the bailout will be borne by the entire banking system and, by extension, the overall economy. There is no magic wand that allows depositors at Silicon Valley Bank and Signature Bank to be made whole without socializing losses.

It is always tempting to designate the latest government bailout as the final step that crosses the Rubicon. In reality, what we have seen over the past fifteen years represents a series of steps that dramatically weakened market signals. The Federal Reserve, by holding interest rates at zero far beyond the financial crisis and far beyond the pandemic crisis set the stage by eliminating the effects of financial gravity. We have been bearing the consequences and will continue to bear the consequences.

Far from being “one last time”, what the government did last night will only encourage further irresponsible business practices and precipitate the need for further bailouts. In the short run, financial markets are likely to respond to the latest financial opioid injection with relief. My reaction is more along the lines of disgust.

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