Over the past weekend, US politicians have been scrambling to bail out two mid-tier banks: Silicon Valley Bank (SVB) and Signature Bank. Yes, they were rescues. I wish the Biden administration wouldn’t try to claim otherwise. And yes, investors ran out of money. But legally, deposits are only insured up to a maximum of $250,000. The federal authorities did large account holders a huge favor by deciding to return all depositors their entire funds.
It is true that any losses – it is not clear whether any of the banks defaulted or simply did not have enough money to handle a deposit rush – cannot be offset by higher traditional interest rates. The money comes from the Federal Deposit Insurance Corporation, which gets the funds back if necessary through higher fees at the banks. But those fees are passed on to customers, so in reality the taxpayers are the ones who end up paying.
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Well, was it a bad decision? I’ve heard four basic types of criticism. One is ridiculous. Two are doubtful. But that last one worries me a bit, although I think it’s probably wrong. Let’s start with the ridiculous. On the right of the political spectrum, many have subscribed to the claim that the SVB went bankrupt because it was too socially racially conscious, which is only slightly more absurd than the claim that such awareness causes derailments. For what it’s worth, no, SVB did not differ from other companies in its concern for diversity or the environment. And banks have been failing for centuries, long before HR departments began incorporating social responsibility buzzwords into their mission statements and policies. So when we talk about awareness of social and racial inequalities, it tells us nothing about bank failures, but much about the intellectual and moral bankruptcy of the contemporary American right.
Let’s move on to other more serious criticisms. There’s a reasonable argument, with which I broadly agree, that SVB’s bankruptcy doesn’t pose a systemic threat like the bankruptcies of various financial institutions, starting with Lehman Brothers, in 2008. So what? Well, one answer is that SVB, like it or not, is now playing a key role in what might be termed the tech sector’s financial ecosystem. In particular, if deposit holders were unable to access their money, even temporarily, many tech companies would have been unable to pay their paychecks and bills, potentially causing lasting damage. The truth is that killing the cryptocurrency business would have been a public service, but there are also many good things that could go wrong. In that sense, the bailout of SVB was somewhat similar to that of General Motors and Chrysler in 2009, also on the grounds that it would preserve a crucial piece of the economic ecosystem. And although the car rescue was sharply criticized, in retrospect it seems to be the right step, even if it ended up costing taxpayers billions.
A third criticism is that the federal authorities have established the policy that all deposits are insured for all purposes without imposing stricter regulations on what banks can do with those deposits. In doing so, they have created an incentive for companies to take irresponsible risks. But policymakers have not everywhere explicitly guaranteed all deposits, and so far, at least, we are seeing a flow of funds from smaller banks to larger, more regulated banks. We don’t like that; Whatever is said about financial institutions, they are not angels. But overall, it appears that the system is limiting, not expanding, the risks it takes.
That brings me to a criticism I take seriously, although I probably think it’s false: claims that bank failures are undermining efforts to control inflation. It is true that the bankruptcies have caused investors to reconsider the Federal Reserve’s policy stance: a rate hike at the next meeting, previously taken for granted, now appears uncertain and markets are pricing in the possibility of rate cuts, while two-year money prices (a good indicator of Fed policy) fall. In addition, some sensible people I speak to warn about financial dominance, where the Fed prioritizes protecting Wall Street over stabilizing inflation.
But given how the banking system is reacting to the SVB affair, there are actually good reasons for the Federal Reserve to limit rate hikes, at least for a while. The US Federal Reserve tried to cool down the economy. Well, banks’ heightened risk sensitivity and the shift of deposits towards more regulated companies are likely to cool the economy even if the Fed doesn’t hike rates. Some financial reports are even forecasting a recession. And market inflation forecasts, if anything, have come down.
The aftermath of the banking problems has further clouded an already grim economic picture, and it will be some time – perhaps forever – before we know if policymakers made the right decision. But right now I’m hearing a lot of doomsday rhetoric that doesn’t seem justified in any way given the facts.
Paul Krugman He is a Nobel laureate in economics. © The New York Times, 2023. Translated from news clips
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