Silicon Valley Bank customers listen as FDIC representatives leave, speak with them before the opening of SVBs headquarters in Santa Clara, California, March 13, 2023. – US President Biden sought to reassure Americans about the nation’s banking system on Monday, while insisting that emergency measures would not be paid for by additional taxpayers. last week, the second-largest bank failure in history, and New York regulators took control of Signature Bank on Sunday. (Photo by NOAH BERGER/AFP) (Photo by NOAH BERGER/AFP via Getty Images)
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Last week, Treasury Secretary Scott Bessent and Senator Bill Hagerty (R-TN) participated in The Wall Street Journal to defend their proposal to increase the Federal Deposit Insurance Corporation limit from $250,000 to $10 million; In addition to many other problems with the proposal, their latest defense falls flat from the very first sentence.
They note that “billions of dollars in deposits fled from regional and community banks to the biggest banks” during the banking panic of 2023. It is assumed that people moved their deposits because they believed that the biggest banks enjoyed tacit government support (they were too big to fail). Because this tacit support (allegedly) creates an unfair advantage for larger banks, Bessent and Hagerty argue that raising the FDIC cap is necessary to level the playing field and strengthen small banks.
At best, their story is incomplete.
As researchers from the New York Fed report it turned out In May 2023, almost all of these deposit outflows were concentrated in the 30 so-called super-regional banks (those with total assets between $50 billion and $250 billion), but the nearly 4,000 banks with assets of less than $100 billion “were relatively unaffected.” If any part of America, small town or big city, is really at risk of collapse when these 30 super-regional banks lose deposits, it’s a real mystery what the other 4,000 banks are doing.
Outflows occurred before 2023
However, their argument is even shakier. For starters, this outflow was an acceleration of a trend that began (roughly) in the spring of 2022.
Before Silicon Valley Bank (SVB) failed In March 2023, people withdrew about $500 billion of their deposits from the banking system. And during this round of outflows, banks did not replace those deposits with new capital lending. Most likely, the level of deposits was still artificially elevated in the wake of the COVID-19 pandemic.
Then, as the NY Fed paper reports, people pulled another $450 billion in deposits after SVB failed. This time, however, most of the outflow occurred during the weeks after the government is invoked the systemic risk exception (SRE) to cover uninsured deposits. For those who insist that more government support is needed to quell the panic, this sequence of events does not support their narrative.
Their argument doesn’t get any better from there.
While this later round of deposits initially flowed from the super-regional to the larger banks, many of these depositors soon moved their deposits out of the banking system as a whole. Obviously, if these depositors were so panicked and dependent on tacit government support for the very big banks to fail, they would not have moved their money out of the banking system.
Another fun fact is that during this post-SVB failure period, the banks did offset deposit outflows with new lending. And in this case, they used the private and public agencies that already existed, outside of the SRE situation, to satisfy their need for precautionary liquidity. That is, they relied on credit from the Federal Home Loan Bank and Federal Reserve system.
Thus, while there was a net outflow of deposits after the failure of the SVB, banks used the institutions in operation to provide emergency liquidity when such events occur. (These institutions could, perhaps, work together even better less government support and better rules, but that’s best left for another column.)
Outflows do not warrant an increase in the FDIC cap
Either way, Bessent and Hagerty’s basic justification for raising the FDIC cap doesn’t really apply. But they want to implement a plan that would protect the banking sector with the Federal Home Loan Banks, the Federal Reserve, special federal authority to guarantee uninsured deposits, and explicit support for the less than 1 percent of accounts that don’t already have FDIC coverage.
Their plan extends “too big to fail” to smaller banks and extends to “too big to lose customers”. Their rationale expressly assumes that the federal government must step in to keep banks from losing deposits, even though the federal government is already a provider of emergency liquidity.
At its core, their plan suggests that the federal government should expressly protect the 30 super-regional banks from losing customers at the risk of the typical American worker losing his job. That’s a huge leap.
Taking the plan to its logical conclusion is even worse. It implies that the government should protect all businesses from losing customers. Call it what you will, this is not a free enterprise.
The fact that some banks are bigger or more successful than others does not justify tilting the system against those banks. And, to the extent that special government advantages made these banks bigger and more successful, the best solution is to get rid of those advantages.
Raising the FDIC cap expands a bad system
The FDIC system was the original sin in banking, so revamping it is a great place to start. For nearly a century, FDIC insurance has been used to justify increased federal involvement in banking, including the ridiculously complex regulations that No seems to work very well. This latest FDIC expansion will magnify all of these problems, make the system more fragile, and force millions of Americans to shoulder the costs.
Bankers should be allowed to be bankers, just as any business owner should be allowed to run their business. If the banks can build their business on uninsured depositors, more power to them. If it turns out that they really do need some sort of deposit insurance, then the private markets should be allowed to provide as robust a solution as possible. That’s what financial markets do, and the more we rely on FDIC insurance, the less likely we’ll ever see private financial markets function as they should.
The truth is that some banks now want more special protection based on the bumpy road they faced in 2023. But that road was bumpy, at least in part, because of the federal system we have. Expanding this system is the wrong solution, and the broader implications endanger the US economy in ways few recognize.
The logic behind this latest expansion suggests that people should use their money based on what government officials fear might happen to someone else, rather than their own views on the best risk-reward trade-off. This inversion elevates a vague concept of the “greater good,” defined by whoever is in power, above the freedom of the individual. Again, this is not free enterprise.
The math for this new proposal doesn’t work either. Raising the FDIC coverage limit from $250,000 to $10 million protects a very concentrated few Americans, not the average American worker or small business. If members of Congress want to do more to protect the average American, they will lower the FDIC cap and limit government involvement in the financial markets.
