Cream for me, crumbs for thee
As the working man is losing his job and paying more on his mortgage, his taxes are deployed to ensure that “very rich, very influential people” don’t have to feel their share of the pain.
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BritanniQ doesn’t usually like commenting on American domestic affairs; however, the collapse of Silicon Valley Bank — and the subsequent Silicon Valley Bailout — is worth reviewing (and in more length than usual) because it has much to say about an economic system that also prevails on this side of the Atlantic. To describe what happened, let us start with the very basics. To make money, a bank borrows short and lends long. It borrows short-term from the markets (through selling shares and bonds in itself) and from businesses and individuals (who effectively give the bank loans by depositing money with it). The bank then lends out these funds long-term to housebuilders, to businesses, and to the government, all of which will over time pay to the bank a higher rate of interest than the bank gives those who lend to it. Hey presto, a profitable business model!
A bank is able lend out almost all the money depositors lend to it, because it knows that not all depositors will want their money back at the same time. A bank run is what happens when they do. Bank runs are often psychological: nobody wants to be the last person to ask for their money back, so as soon as one starts, even healthy banks can be rapidly dragged into insolvency. To prevent this, the Federal Deposit Insurance Corporation (FDIC) insures all US bank deposits up to a certain limit, meaning that people would always get back their money below that limit, even if the bank went bust. Above that limit (currently a whopping $250,000), deposits are still essentially loans to a bank and thus at risk of default like any other loan.
In some ways, Silicon Valley Bank (SVB) was unusual. Many of its depositors were tech startups. Such companies are usually unprofitable for several years, and require significant injections of capital to get going. They get this from Venture Capitalists who invest in startups knowing that many will fail but that only a couple need to take off to make it all work (buying just 0.1% of Amazon in the mid nineties pays for a lot of failed investments, because that single tiny stake would now be worth a billion dollars). These startups then dump that Venture Capital money in a bank (oftentimes, it seems, in SVB) to live off for the coming years.
The problems started because SVB used that money to invest US Treasuries (US sovereign debt bonds) and Mortgage Backed Securities (also a bond, but backed by the mortgage payments of ordinary people rather than the faith and credit of the US Treasury). These assets are usually super safe, but SVB bought at the peak of the market at high prices. When the Fed started increasing interest rates, the prices of these investments declined (another way of saying higher interest rates is lower bond prices), so the value of SVB’s investments (assets) dropped below its liabilities, forcing it to start liquidating (turning illiquid investments into liquid cash) some of these assets and trying to raise capital to cover the difference. A few savvy Venture Capitalists (perhaps led by Peter Theil) were spooked by this and started withdrawing their deposits and instructing the companies they’d invested in to do likewise. Word spread: the bank run was on.
At this stage, the avowed libertarians of Silicon Valley demanded that the government — an unnecessary evil in the libertarian/objectivist book — help them. And not just help them make payroll or pay the bills, but give them all their money back. To be clear, there is only one good reason to bail out these people. A bank whose handsomely remunerated executives cannot even negotiate something as basic as a Fed tightening cycle without imploding isn’t worth the salt. More importantly, depositors knew the FDIC limit for fully guaranteed deposits and knew they could pay for excess deposit insurance, but didn’t, knowing the risk.
In fact, as Sheila Bair, the former Chair of the FDIC, wrote in a concise and remarkably clear opinion column for the Financial Times, the only justification for bailing out depositors would be if not taking action posed systemic risks — i.e., the bank’s failure, or the financial losses suffered by these depositors, would cause a cascade of failures elsewhere, taking with them the healthy, well run institutions and the cautious, well meaning depositors, and thence the entire economy. Yet, as she points out, SVB represents “a minuscule part of the US’s $23tn banking system. Is that system really so fragile that it can’t absorb some small haircut on these banks’ uninsured deposits?” The argument that it was right and proper to bail out the depositors because we expect money back from a bank when we deposit it doesn’t hold water either.
“The uninsured depositors of SVB are not a needy group. They are a “who’s who” of leading venture capitalists and their portfolio companies. Financially sophisticated, they apparently missed those prominent disclosures on the bank’s websites and teller windows that FDIC insurance is capped at $250,000. Some start-ups that banked at SVB argued they needed their uninsured deposits to make payroll. But under the FDIC’s normal procedures, they should have received a sizeable dividend this week to help with their cash flow needs.”
Adam Tooze goes farther. “SVB’s depositors were in no regular sense, depositors. They are badly run and ill-advised businesses that for obscure reasons parked huge cash balances in a highly vulnerable bank.” They were bailed out because they “are very powerful, very rich and very influential people who own a narrative that makes them indispensable to one vision of America’s future.”
And that’s the morally repugnant bottom line. When the Federal Reserve increases interest rates, everybody in the USA suffers (as they do in Britain when the Bank of England hikes rates). Share and bond prices drop, companies go out of business, mortgage payments rise, and people lose their jobs. Indeed, all this suffering is the entire point: central banks raise interest rates to reduce inflation, and the mechanism by which that works is that financial hardship crushes demand. Less demand for the same amount of labour and goods means reduced wages and prices, and thus lower inflation. But even as the working man is losing his job and paying more on his mortgage, his taxes are deployed to ensure that “very rich, very influential people” don’t have to feel their share of the pain.
This is a bitter pill to swallow, but let’s call it what it is: corruption. That’s certainly what the IMF and our own bankers call it when judging an emerging economy whose government rewrites the rules on the fly and uses taxpayer funds to save favoured groups from the pain everybody else is suffering during economic hard times. So that’s what we should call it here. And guess what? The bailout of very rich, very influential people has done little to stabilise the banking sector, which was still under huge pressure at the time of writing.
