When Silicon Valley Bank failed in March 2023, the actual legal rule was that th Federal Deposit Insurance Corporation (FDIC) insured bank deposits only up to $250,000. This is plenty for just about every household. But a number of businesses had much larger sums on deposit at the bank, and when these businesses became concerned that the bank wasn’t financially security, they started pulling out those deposits–and this bank run then caused the bank to be shut down. For a more detailed discussion of these events, see my earlier post “An Autopsy of Silicon Valley Bank from the Federal Reserve.”
The federal bank regulators were concerned that other firms were showing signs of pulling out deposits from other banks, and they announced that to stabilize the US banking system, they would guarantee all deposits–even those above the $250,000 limit. Was that decision appropriate? Raghuram Rajan and Luigi Zingales make the case against in “Riskless Capitalism” (Finance & Development, June 2023). They write:
Did uninsured depositors in the failed Silicon Valley Bank (SVB) need to be saved? The argument is that even though everyone knew that deposits over $250,000 were uninsured, if uninsured depositors had not been made whole, panic would have coursed through the banking system. Large depositors’ withdrawals from other banks would have compromised financial stability.
Perhaps! But if large depositors are always protected in the name of financial stability, why aren’t they at least charged the insurance fee that burdens the insured deposits? There are many low-cost ways for corporate treasurers to mitigate the risk of having money in a transaction account at a bank. They can keep only the amount needed to meet payroll and other immediate transactions in a demand deposit (checking) account and put additional soon-to-be needed cash in liquid money market funds. Yet too many firms did not practice elementary risk management. Streaming device maker Roku had more than $450 million in deposits at SVB, according to Reuters. While shareholders in SVB were deservedly wiped out and management let go, large depositors enjoyed riskless capitalism as the government changed the rules to benefit them.
A haircut could have been imposed on SVB’s large depositors. Based on past interventions by the Federal Deposit Insurance Corp (FDIC) this would have cost uninsured depositors about 10 percent of their balances. A few red-faced corporate treasurers would have justifiably lost their jobs. And if there were signs of contagion to other banks, the government could have announced a blanket implicit guarantee for all deposits, as US Treasury Secretary Janet Yellen eventually did. But the FDIC would have saved $20 billion and retained the principle that at least some of those who took risks paid the consequences. SVB would then be seen as capitalism penalizing the incompetent, rather than as an aberration—setting a precedent that will likely engender more attempts at riskless capitalism.
More generally, as the Federal Reserve’s own investigation put it, SVB failed “because of a textbook case of mismanagement by the bank.” If so, flighty uninsured demand deposits can be a feature, not a bug, in the system. If uninsured depositors pay attention, they can shut down incompetent or greedy bank management quickly, saving the taxpayer immense sums. If they are anesthetized because regulators invoke the tired argument that “this is not the time to worry about moral hazard,” uninsured depositors will not pay attention in the future.
The government decision was made after immense lobbying, including many cries for help from venture capitalists. David Sacks, of Craft Ventures, tweeted, “I’m asking for banking regulators to ensure the integrity of the system. Either deposits in the U.S. are safe or they’re not.”
It’s important to remember that the choices here were not all-or-nothing. The federal regulators could have saved $20 billion by imposing losses of 10%–and provided some useful incentives for large bank depositors to pay attention to their corporate cash, as well. In addition, the payments that banks make for deposit insurance could be scaled so that banks with a greater share of very large deposits would pay more.
But the final paragraph I quoted from Rajan and Zingales crystalizes some of the key issues. Rules aren’t supposed to be changed after-the-fact to benefit businesses. Venture capitalists are supposed to know something about finance. When they start saying that “either deposits are safe or they’re not,” they seem to be stating that they were unaware that deposit insurance, by law, only went up to $250,000.
It’s perhaps useful to consider a hypothetical scenario: Say that a venture capital fund has done all of its due diligence, and determines that investing $50 million in a certain company is a good idea. In this hypothetical, the money is being sent to the company in an armored car, when it is suddenly hit by a passing disintegration ray from an alien spaceship. The money is gone–but it’s a sunk cost unrelated to the business prospects of the company. If it was previously worthwhile to invest $50 million in this company, it’s still worth making the same investment. It’s not a surprise that the venture capitalists wanted to rewrite the rules avoid any losses at all in the Silicon Valley Bank debacle. But venture capitalists like to pride themselves on providing useful oversight for the firms in which they invest, and in the basic task of managing corporate cash jammed into large accounts at Silicon Valley Bank, they badly fell down on a basic aspect of the oversight they claim to provide.