It’s been three years since regulators came to the rescue of Silicon Valley Bank’s beleaguered depositors.
Fearing losses from the bank’s troubles would set off runs elsewhere, the Federal Reserve, along with the Federal Deposit Insurance Corporation, bailed out every account, including those with balances far exceeding the usual $250,000 insurance limit. This intervention may have contained the panic, but it was also a reminder of a long-held suspicion: Money held at a bank Washington considers important will always be safe.
The principle of “too big to fail” has drawn the ire of the nation’s smaller community and regional banks. After all, even if they are carefully run, how can they compete with the implicit guarantee enjoyed by their bigger competitors? Nervous customers will always have a reason to move their money to Wall Street.
Now, Congress is stepping in. The reintroduced Main Street Deposit Protection Act would attempt to compensate for this imbalance by allowing almost all banks to offer up to $5 million in federal deposit insurance on certain checking accounts. Alas, universalizing this “too big to fail” threatens to create terrible incentives and leave taxpayers picking up the pieces.
Proponents of the bill focus on small businesses. A company may need more than $250,000 in its checking account in order to make payroll. If a regional bank fails, this can put otherwise healthy businesses at risk. Protecting checking accounts with larger balances, so the argument goes, would reassure employers and make them less likely to ditch a smaller bank at the first sign of trouble.
But the legislation doesn’t reserve the higher level of coverage for payroll or even for small companies in general. It applies to everyone. This means a wealthy individual or an investment fund could obtain exactly the same insurance. A measure supposedly designed to safeguard small employers would therefore offer a taxpayer-backed guarantee of millions of dollars belonging to people and institutions that, frankly, can look after themselves.
This wider reach also creates a moral hazard on the banks’ side. Large depositors currently have a reason to care about the state of a bank’s finances because their money can be lost if it goes under. Corporations and investment funds employ armies of advisers who can spread balances among many institutions and move money when confidence fails. The possibility of losing a big customer is a great incentive for banks to make good choices.
Once taxpayers are on the hook, though, the calculus changes. If depositors expect to be bailed out regardless of the bank’s condition, their departure becomes less likely, and managers are under much weaker pressure. Regulators remain responsible for policing banks, although, as Silicon Valley Bank showed, they don’t always force a change before the damage is done.
Supporters of the bill are right that “too big to fail” has distorted competition. The expectation of a bailout makes bigger banks a more attractive bet, particularly in times of crisis. But extending that principle across the entire banking system would only spread terrible incentives and heap risks on taxpayers rather than creating better incentives for financial institutions.
Congress should attack the privilege itself. The largest banks already issue loss-absorbing debt and prepare “living wills” explaining how they can be resolved. Lawmakers should strengthen those arrangements and narrow the systemic-risk exception used to protect Silicon Valley Bank’s uninsured depositors. A failed bank’s shareholders and long-term creditors should bear the cost while its essential operations are transferred or wound down.
The rescue of Silicon Valley Bank was a crisis decision made during a bank run. The Main Street Depositor Protection Act would turn the expectation created by that rescue into a permanent feature of the entire banking system. It would also protect wealthy individuals and investment funds at the expense of taxpayers. Neither is a good outcome.
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The federal insurance limit should be the same at every bank. Ordinary savers would remain protected. Large depositors would retain a reason to examine where they put their money, and bank managers would retain a reason to keep it.
Congress cannot abolish banking risk. It should instead ensure private investors and sophisticated depositors continue to bear it and focus its attention on increasing competition in the sector at large.
Jack Rowlett is a contributor with Young Voices and a prolific writer on policy. He writes the Build Vector Substack.