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Poof. And just like that two banks no longer exist.
The collapse of Signature Bank and Silicon Valley Bank rightly made headlines. When entities that hold billions upon billions of dollars disappear, it can be unsettling.
But it is healthy.
One of the principles of our economic system, operating correctly, is creative destruction. Psychologically, it is scary to watch businesses fail. Fear of loss weighs heavier on the human psyche than love of gain.
In a way, a capitalist system depends on periodic destruction, like forests evolved to have periodic wildfires. The fire itself engulfs flora and fauna. Yet from the literal ashes new life comes forth.
The federal response to Silicon Valley Bank’s failure is akin to a wildfire being managed into a controlled burn. The owners of the bank got torched. That’s the deal. Reward requires risk. Risk is real. Sometimes you are on the wrong side of it, as the former owners of SVB found out.
Yet controlled burns can go awry and have unintended effects. Time will tell whether the federal government’s response creates new problems.
With Silicon Valley Bank, Washington rode to the depositors’ rescue. Normally, accounts are insured up to $250,000. That insurance comes at a cost. If you – or, more likely, a business – has more than that, it is outside the limits. There are ways to provide more security, but they come at either cost or complexity.
The Biden administration threw that rule out the window. They bailed out the deposit accounts. Many of those were held by well-connected start-up businesses in the tech sector.
But everything comes at a cost. Silicon Valley Bank was illiquid, but probably not technically insolvent. It owned a lot of assets. As those are sold off, the liability incurred as part of the bailout will be reduced. It is possible they may be offloaded in an orderly manner that fully pays back the depositors. That is the best case scenario.
The more likely outcome is that there will be a shortfall. So who is going to pay for it?
Washington may make the FDIC foot the bill. The FDIC is funded by banks through special assessments. So local community banks in Maine – owned as mutual companies, not by investors – will need to chip in to pay for Silicon Valley Bank’s failures.
The dollars may be small, but the principle looms large. Why are well-run banks being punished for an investor-owned bank’s failure? Particularly when that was never the deal before?
The nature of reserve banking means no bank can survive a run. As a systemic reform, there may be some logic in changing the rules to expand FDIC insurance to cover all deposits. If that is the decision, it needs to come with appropriate financial planning.
Yet the Biden Administration is playing whack-a-mole and hoping to catch up later.
Some banks and businesses need to die off to make way for new growth. That is the nature of the economy. Investors in poorly run organizations need to suffer the consequences.
The answer is not asking others to pay to save them from themselves.
The Biden administration needs to move forward quickly. If the new normal will be that all deposits are guaranteed to 100 percent, put that plan on the table. Explain how you will fund it. It could be a great idea with a major stabilizing effect.
Until then, uncertainty will continue to exist in the market. If a different bank fails, will their depositors receive a bailout? Or will the accounts of businesses go “poof”? The rules say the latter. History says the former.
These are incredibly complex challenges. President Joe Biden won his campaign for the White House by promising competence. It’s time to step up.
Before the next bank goes poof.