The system worked: The optimal number of bank failures is not zero
Timothy P. Carney
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Silicon Valley Bank’s failure and Signature Bank’s collapse are the fallout of inadequate regulation, many liberals argue.
Todd Phillips at the Roosevelt Institute writes this: “Due to the rollback of several key Dodd-Frank provisions and an emphasis by lawmakers in 2018 that midsize banks receive lighter oversight than large banks, regulators did not supervise these banks sufficiently. This allowed them to get into a financial position where they could not withstand runs. Additional congressional action is needed to close these regulatory gaps.”
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Republicans, who tend not to like more regulations and enjoy blaming Biden administration officials, put the blame on inadequate enforcement of existing rules.
Sen. Tim Scott (R-SC), the top Republican on the Senate Banking Committee, asked, “What were the supervisors thinking?” He concluded, “By all accounts, our regulators appear to have been asleep at the wheel.”
The premise of both of these typical accounts is that if everyone had done their job, and if proper rules had been in place, these banks wouldn’t have failed. And the deeper premise is that in a well-regulated economy, banks don’t fail.
That’s folly.
My brother John reminds us that regulators aren’t supposed to prevent all business failures:
“But is it the purpose of bank regulation to ensure that no banks fail? That is not how we think about the non-financial sector of the economy. Businesses fail constantly. We have a large bankruptcy code and an entire court system to handle bankruptcies, which are often the result of business failures. Among tech founders, failure is taken as a rite of passage. “The traditional view of bank regulation was not that it was a guard against bank failure but a system of limiting the damage of bank failure. The role of supervisors was not to order banks to adopt certain views of risk but to advise them on inadequate controls or overlooked weaknesses.”
Banks are more regulated than other businesses in part because a bank failure can cause regular people to lose all their money, which would be very bad. But in this case, the banks failed, and the only real losers were the people who invested in the bank — and investors losing money is very much part of capitalism.
Regulators stepped in when the banks were crumbling, closed the banks, arranged their sale, and reopened them. There was no domino effect. Contagion was stopped. The system, in other words, worked.
Democrats shouldn’t try to create a regulatory structure that prevents business failure. That would be so strict that we would have no innovation and no competition.
Republicans shouldn’t speak as if regulators have magical powers to prevent what is inevitable in a free market: business failure.
Capitalism is a system of both profit and loss. Sometimes that means businesses go under.