Now that the bailout of the Silicon Valley Bank depositors at 100 percent rather than the nominal $250,000 limit has been announced, it is difficult to discern whether the primary motivation is avoidance of future bank runs by small businesses and the like, or an old-fashioned effort to reward the wealthy friends of the Democratic Party in Silicon Valley. (It will be interesting to see the effect of the bailout in terms of 2024 campaign contributions.) It may be the case that the former is the central goal of Fed Chairman Jerome Powell, while the latter is of greater interest to such academic politicians as Treasury Secretary Janet Yellen.
But it is not difficult to perceive the deeply perverse long run effects for the economy. The 100 percent bailout for the depositors obviously will be the new normal, as no bureaucrat or politician will be willing to risk a repeat of the 2008 Lehman Brothers debacle. Accordingly, the moral hazard problem — the enhanced incentive for bank risk-taking engendered by deposit insurance, supposedly neutralized by the Dodd-Frank regulatory deus ex machina — will be exacerbated enormously. As in 2008, the bureaucrats and politicians cannot allow any such behavior, out of fear of another system-wide crash. The obvious political solution will be more regulation.
“More regulation” ought simply to mean (much) greater capital requirements for the banks; if they make investments massive and massively unwise, it is their shareholders who will bear the burdens. But that is unlikely to prove the Beltway’s preferred solution, in that it does not expand the powers of policymakers to allocate resources. What we actually will see is vastly greater micromanagement of bank investments and loans, ostensibly to reduce excessive risk-taking, but actually to reward friends and punish enemies as the central dynamic driven by the political incentives inherent in democratic institutions.
Think of this as a vast expansion of environmental, social, and governance investing. It will be profoundly politicized. It will yield substantial reductions in the returns to investments, that is, economic productivity. The ensuing efforts by the capital market to find ways to circumvent the regulations might work, more or less, but cannot be efficient in the aggregate in that they will result from artificial constraints imposed by government. But it will be a boon for all the usual suspects, as a myriad of formal and informal requirements will be imposed upon bank investment and operations decisions. Fossil fuel projects? Nope. Ditto for payday lenders, manufacturers of firearms, and industries not unionized. More left-wing activists on the boards of directors? Yup. More “lending” (translation: corporate donations) to “community” groups, more financial support for international left-wing non-governmental organizations, and on and on. The SVB debacle portends a return of Operation Choke Point.
Notice that in the wake of the SVB failure, massive deposit shifts now are being observed toward banks perceived as too big to fail, that is, too big for government to limit deposit insurance to a measly $250,000, or at all. Translation: Too big for government to allow bank use of deposits (capital investments) deemed too risky by bureaucrats and politicians. Too big to allow depositors with large uninsured deposits to impose discipline on the given bank’s investment decisions.
Too big, therefore, to allow such investment decisions to be determined by expected returns, that is, by capital productivity. “Safety” actually has little to do with this dynamic; notice that SVB’s capital was oriented heavily toward safe and liquid government bonds and mortgage-backed securities. And then longer-term interest rates began to rise as a result of the Fed’s efforts to rein in inflationary pressures. Prices for those securities declined, short-term deposits (liabilities) could not be covered, and voilà: “Safety” turned out not to be defined correctly by all the smart guys.
So there now is a massive capital shift toward banks regulated more- rather than less heavily, an outcome that will exacerbate the regulatory implications of deposit insurance no longer limited to some dollar figure. The upshot — the larger certainty — is a sharp increase in the degree to which bank investments will be politicized, and therefore a reduction in the productivity of capital. The long-term capital share of net national income is about 30 percent, with about 70 percent earned by workers. An increase in the allocation of capital driven by regulatory constraints is certain to reduce the returns to investment and thus the size of the capital stock, labor productivity, and wages. In the aggregate, the larger implication of the SVB debacle is a reduction in economic growth and thus an economy smaller rather than larger, with all of the adverse social and economic effects certain to ensue. Such are the fruits of crisis creation and crisis avoidance by Beltway operators.
