What better name for a bank that took too much risk than “Silicon Valley Bank”? Now it has failed, but instead of bringing down key culprits, the federal government has stepped in to rescue its explicitly uninsured depositors. The feds promise “no loss shall be borne by the taxpayer”, but they have a funny definition of taxpayer which excludes the prudent banks which now remain burdened with an increased “assessment” by the government – this is not certainly not a tax.
The federal government is indeed partially responsible for this, playing its typical role of both arsonist and firefighter – but not because of a failure of regulation. How many institutions are more regulated than a California bank? (Or to go back, more regulated than failed savings and loan associations thousands?) Regulators don’t have the insight or the incentive to anticipate such things but, alas, they have the power to make matters worse.
Yes, we have even more moral hazard as we constantly “privatize the gains and socialize the losses” by bailing out the biggest risk takers. But we also have the Federal Reserve artificially holding interest rates down for years in order to inflate the economy and facilitate government borrowing. With interest rate closer to market reality, bank balance sheets no longer look so bright. And Silicon Valley Bank tried to outplay the competition (or just didn’t know what it was doing), taking way too much risk assuming low interest rates were forever and failing to hedge a change. A general solution is to prevent the Fed from setting interest rates and let the bankers do it themselves, but there will always be private actors who will take excessive risks.
The bible of monetary policy – by Walter Bagehot Lombard Street – says it would be better to have no central bank at all but, if you have a lender of last resort – and this is his most famous advice – you lend freely at high interest against good titles. This is exactly what one would expect from a private lender with sufficient capital (indeed, in the UK at the time, the central bank was private). Illiquid banks get money. Insolvent banks do not. Silicon Valley Bank tried to get private backing, and everyone with their own money at stake thought it was too risky. So the taxpayer – sorry, the assessment payer – inherits the biggest problems in the system.
But what about the risk takers themselves? Silicon Valley Bank executives took the success all the way and even sold millions of dollars worth of stock just before the receivership. Now the government promises that the managers and owners will be wiped out, but they will be able to keep all their old gains. A classic historic regulation that is the greatest caution the banking industry has ever seen is to hold managers and owners personally liable if their bank fails – let the creditors figure out who was responsible.
We are also talking about sophisticated business people who put their money in an insolvent bank, partly because they got extra returns or other social benefits. While the tech world laments to discover how many people “root themselves against technology” – or their woke ideology – they should realize that some of us are rooted for accountability instead. We rely on uninsured depositors to keep bankers honest. But apparently no more.
A traditional thought is that it is a lie that money can be in two places at once (freely available in your current account AND lent by the bank) and therefore the reserve requirement should not be 10% but 100%. In such a situation, in the absence of fraud, any bank is solvent. You have two options: either you have full access to your money at all times (but you will probably have to pay for such security, as you would if you were storing money in a safe) OR you can buy bonds (where you get interest but don’t have access to it).
Of course, in the unlikely event that we return to asset-backed currencies, a free banking system (especially its Scottish variant at the time of Adam Smith) has proven that it can be self-policing even without reservations – private actors then have a personal reason to denounce the irresponsibility of their peers. In the meantime, we will most likely suffer the vagaries of a system that both props up government and robs capitalism of its most powerful incentives – that anyone can both reap the rewards and suffer the consequences of their own shares.
Grant Starrett is a real estate investor in Murfreesboro, Tennessee. He received his BA in history from Stanford and a JD from Vanderbilt. His writings have appeared in the Wall Street Journal, National Review, etc. and he also writes bi-weekly book reviews for a sub-stack distributed through GrantReadsBooks.com