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Federal Response to Bank Failures Spurs Debate

S.J. Steinhardt
Published Date:
Mar 14, 2023

Experts and commentators observing government regulators' actions in response to the collapse of two failed banks are debating whether Washington is “bailing out” Wall Street, The New York Times reported.

Investors in the banks’ stock will lose their money, and the banks have been closed, but some banking experts interviewed by the Times said that the failures of Silicon Valley Bank and Signature Bank should focus attention on banking regulation and supervision.

President Joe Biden assured Americans that they “can have confidence that the banking system is safe. Your deposits will be there when you need them,” adding that taxpayers would not be responsible for the banks’ losses. “Investors in the banks will not be protected,” he said. “They knowingly took a risk and when the risk didn’t pay off investors lose their money. That’s how capitalism works.”

On Sunday, in a joint statement by Treasury Secretary Janet Yellin, Federal Reserve Chair Jerome Powell and Federal Deposit Insurance Corporation (FDIC) Chair Martin Gruenberg, the Federal Reserve announced that it “will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.” The Fed also announced that it would offer banks loans against their Treasury securities and many other asset holdings, treating the securities as though they were worth their original value, despite their erosion in value due to higher interest rates, the Times reported.

"The Fed is doing what the Fed is supposed to do. The FDIC is doing what the FDIC is supposed to do in conformance with the law," Rep. Patrick McHenry (R-N.C.), chair of the House Financial Services Committee, told CNBC, Reuters reported, adding that Americans should "have confidence in their financial system."

Debate has already begun on whether these actions, designed to restore confidence in the banking system and to avoid a bank run, will succeed.

“The Fed has basically just written insurance on interest-rate risk for the whole banking system,” said Steven Kelly, senior research associate at Yale School of Management's Program on Financial Stability, told the Times. “I’ll call it a bailout of the system. It lowers the threshold for the expectation of where emergency steps kick in.”

Dennis Kelleher of financial reform advocacy group Better Markets agreed. “It’s hard to say that isn’t a bailout,” he told the Times. “Merely because taxpayers aren’t on the hook so far doesn’t mean something isn’t a bailout.”

The term “bailout” became a pejorative one after the 2008 financial crisis, in which taxpayer money was used to rescue big banks and financial firms, without any punitive or monetary actions against the executives who were deemed responsible for the failures.

“Crises don’t just happen,” Kelleher told the Times. “People take actions that range from stupid to reckless to illegal to criminal that cause banks to fail and cause financial crises, and they should be held accountable whether they are bank executives, board directors, venture capitalists or anyone else.”

One prominent observer who disagreed with the regulators’ actions said that they set a “dangerous precedent.”

“At combined assets of $300B, these two banks represent a minuscule part of the US’s $23T banking system,” former FDIC Chair Sheila Bair wrote in The Financial Times. “Is that system really so fragile that it can’t absorb some small haircut on these banks’ uninsured deposits? If it is as safe and resilient as we’ve been constantly assured by the government, then the regulators’ move sets dangerous expectations for future bailouts.”

“The mere fact that regulators designated two midsized banks as systemic implies they think the system is fragile,” she wrote. “My instinct tells me that most regional and community banks are basically sound. The main thing we have to fear is fear itself cascading into bank runs that will force otherwise healthy banks to collapse.”

On the other hand, some academics interviewed by the Times found the plan to be more about preventing a bank run than anything else.

“Big picture, this was the right thing to do,” Christina Parajon Skinner, an expert on central banking and financial regulation at the University of Pennsylvania, told The Times, but “[t[here are questions about moral hazard,” meaning that the actions could lead people to believe that the government would come to the rescue in a similar situation.

Others saw a failure of oversight. “The Silicon Valley Bank situation is a massive failure of regulation and supervision,” Simon Johnson, an economist at the Massachusetts Institute of Technology, told the Times. Sen. Elizabeth Warren (D-Mass.) wrote in an opinion piece in the Times, saying, "In the aftermath of the 2008 financial crisis, Congress passed the Dodd-Frank Act to protect consumers and ensure that big banks could never again take down the economy and destroy millions of lives. ... Greg Becker, the chief executive of Silicon Valley Bank, was one of the ‌many high-powered executives who lobbied Congress to weaken the law. In 2018, the big banks won. With support from both parties, President Donald Trump signed a law to roll back critical parts of Dodd-Frank. Regulators ... then made a bad situation worse, ‌‌letting financial institutions load up on risk."

In response to the bank’s failure, the Fed announced that it would conduct a review. In addition, the U.S. Department of Justice has opened its own an investigation into the collapse of Silicon Valley Bank, the Times reported. And Securities and Exchange Commission (SEC) Chair Gary Gensler has said that his agency would be “particularly focused” on “identifying and prosecuting any form of misconduct that might threaten investors, capital formation or the markets more broadly, ” The Washington Post reported.

“At the end of the day, what has been shown is that the explicit guarantee extended to the globally systemic banks is now extended to everyone,” Renita Marcellin, legislative and advocacy director at Americans for Financial Reform, told the Times. “We have this implicit guarantee for everyone, but not the rules and regulations that should be paired with these guarantees.”