Joint statement by the Fed, Treasury, and the FDIC:
"Today we are taking decisive actions to protect the U.S. economy by strengthening public confidence in our banking system. This step will ensure that the U.S. banking system continues to perform its vital roles of protecting deposits and providing access to credit to households and businesses."
The government is bailing out corporate depositors of Silicon Valley Bank and Signature Bank. The announcement will stop a contagion of withdrawals from banks, i.e. a "run." Businesses with deposits greater than $250,000 will get FDIC protection. The banks' stockholders will be wiped out, but the depositors--even large ones--will be made whole.
Let me review how banking works. For some people this will be condescendingly obvious. For others, it will be a useful reminder. People know different things.
Banks take in deposits and then re-lend most of that money, making money on the spread between what they pay depositors and what they earn from loans they make. Banks serve depositors by storing their liquid money. Paychecks go in, mortgage payments go out. The bank keeps track of that money flow. For most individuals, that $250,000 insurance is ample. But many businesses keep a balance well above $250,000 to receive deposits and pay employees and vendors. Their intention is still to be depositors, not at-risk investors.
Normally the pool of parked money is predictable-enough that the bank can lend out most of it. A bank's loan portfolio is not liquid and stable in value the way checking account deposits are, which is a risk for banks. So they keep some cash in reserve to meet unexpected withdrawals.
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| Two-year Treasury rate |
The problem for Silicon Valley Bank is that they matched too many of their deposits from technology companies with two-year and three-year government bonds. This year's rapid rise in interest rates means that the current re-sale value of these bonds is less than face value.
U.S. government bonds change price on their journey toward maturity. SVB's portfolio of government bonds lost value because when they bought them a year ago interest rates on two and three year Treasuries were about 2%. Today they are about 4.6%. If SVB needs to sell their three-year bonds to meet redemptions, those bonds still have two years until maturity. Someone buying those bonds expects to earn the current return on two-year bonds. The buyer will pay a discounted price reflecting the difference between 2% and 4.6% for the remaining two years. That price is about 96 cents on the dollar.
In an orderly and slow withdrawal of deposits the bank would hold the bonds to maturity and enjoy the 2% they earned. But if too many depositors want their money now, they must sell at present value. That total value is less than SVB owed depositors. Businesses with more than $250,000 in deposits became at risk. Worse, in the chaos of a failing bank, the business' money would be tied up, the accounting uncertain, and employees and vendors would not get paid on time. It would be chaos for them.
There was "career risk" for the company comptrollers and treasurers if their company lost money and bills did not get paid on time. The prudent--necessary--thing to do was withdraw deposits now from a questionable bank. That created the contagion.
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| Contagion risk |
So the Federal Reserve, the FDIC, and the Treasury did what they had to do. They assured the large depositors they would get all their money back. They protected the banking system. It was the right thing to do because it was the necessary thing to do. Chaos in the banking system doesn't just affect the wealthy. It affects everyone who gets a paycheck, pays a mortgage, or operates a business.
18 comments:
Great Explanation, but did a Tweet start the run? Tweet's starting runs on banks, very dangerous.
If I am understanding you correctly, the Government is once again bailing out a lot of very wealthy people, on the taxpayers dime, thus privatizing profits and socializing losses. It seems to me that the only ones really taking a hit are the taxpayers, as the stockholders who lose their money will on all likelihood find tax advantages in this debacle, and are most likely cushioned from being homeless or hungry by their other investments.
Thanks, Ed. Mostly I will answer your question "no." I wrote the post in order to show that that presumption, which is widespread and very powerful and persuasive, is wrong.
The stockholders in Silicon Valley Bank will be wiped out. Some of the people who will have invested will be wealthy, some poor. But they invested in stocks and will have lost it all.
The people the government is making whole are the businesses who deposited money in SVB presuming it to be a normal safe bank and a place to park money while they paid bills and got income. If a company--e.g. an independent grocery store or an auto body shop--has more than a couple dozen employees, or buys things wholesale and sells them retail, then they will almost certainly have a bank balance of over $250,000. After all, a Sherm might have $250,000 a month payroll. He would pay food venders $100,000 time and again. He would need a bigger float than would a retiree like me, getting a SS check and paying out utility bills.
The government assured them that they did not need to bail out of the bank to keep from having frozen accounts. Eventually those people would probably get back 95 cents on the dollar of their deposits, but it would be disastrous for employees and stiffed vendors and landlords, some of whom expect payday to be payday, not a promise to pay in six or ten weeks once things get straightened out. Or in three years after the bankruptcy judge figures out how much of a haircut everyone gets.
T/he Fed et al. made sure depositors felt like depositors. If businesses went broke because they were sued by employees and vendor and landlords because of a payment-system freeze, then there would be a rush out of regional banks like KeyBank, Umpqua, etc. and businesses who just wanted to be a depositor and have a place to get income and pay bills would all move their business to a half dozen or so banks. It is bad enough to go broke because you made a bad decision with your business. But to go broke because your employees quit because their checks didn't arrive because the bank the business used was tied up in litigation is an avoidable error.
You avoid it by putting all your money in one of a few banks. We would create chaos, then monopolies.
Peter Sage
Omigosh, the financial system is intertwined with the government!
I'm not an economist, and I'll be the first to admit to being daunted by the complexity of the financial landscape, but I always had a feeling that those low interest rates masked fundamental weakness, invited bad actors and would cause chaos when it became necessary to raise them to combat inflation. It was a scenario that may have been alleviated with less drama except for the perfect storm of a corrupt administration and COVID.
Is it safe to say that some banks push risk to the edge in order to keep profits and the stock price up? Seems to be a recurring theme...
Oh, and I guess it's just a coincidence that it's also a recurring theme that a Democratic administration will need to fix it.
Great explanation, Peter.
I wish an explanation like that would stop political demagogues from deploying “bailing out the rich“ rhetoric, but it probably won’t. 🙁😡
I appreciate your explanation, but still have questions; The Government (allegedly the people) is bailing out businesses which employ other people, etc. Is the Government going to claw back the bonuses SVB was busy paying it's executives just before collapsing, or recover the millions of dollars the CEO of SVB made by selling his stock a week or so before the Collapse ? And will the Government ever recover any of the money its using to prop up the businesses harmed by the collapse of SVB.
Doesn't this all mean they should raise the maximum FDIC insurance? Has $250k been the number since the 30's?
And I would like demagogues to stop employing "woke" as a slur and curse, but they probably won't.
Ed,
There needed to be some name for the ideology of weaponized sensitivities currently being referred to as “woke”. Is it the word you are concerned with, or the opposition to the ideology?
Opposition to the ideology is in no way dishonest or inaccurate in the same way that calling what Biden just did “bailing out the rich“ would be.
I know the subject of banking is under discussion. But it seems to me the investors all bought low to wait and the sell high to enjoy a profit. Should we worry about their shattered dreams? The little guy parked his money in the wrong sock. Should we worry about his judgement? What was his real intention in trying to play with the big boys? Ooops they took him to the cleaners. Should we care?
Speaking of woke . “Woke “ people are compensating for their racism from which they will never escape. Those who are disgusted with “wokers” are already hardened racists who don’t give a shit about their prejudices and revel in their “realistic” “common sense” smugness. All “woke” and “unwoke” are mostly of the privileged “white” elite tribe and have time to practice this nonsense and name calling.
Ralph is having a fine old time, projecting his fantasies onto those who think differently from him. It’s so much easier to do that than to pay serious attention to other perspectives.
That's right, Ed. 'Woke' is a nefarious ideology that believes in equal justice for all and being respectful to everyone. You can see how conservatives might find that offensive.
I thought about how to reply to this overnight. My remark said that I hope demagogues would quit using "Woke" as a pejorative slur. Apparently, I pricked your conscience. Mr. Trigoboff, if the shoe fits, wear it.
Ed Cooper
Vietnam Veteran
WOKE and Proud of it
Just as they did in 2008, they are already blaming "Woke" for the collapse of SVB;
https://www.esquire.com/news-politics/politics/a43306271/silicon-valley-bank-woke/
To those who believe in facts, "woke" is an adjective derived from African-American Vernacular meaning "alert to racial prejudice and discrimination". To those who believe in “alternative facts,” it means whatever they don’t like. To them, it’s a slur. To normal folks, it’s a compliment.
Listen to the podcast, Mike. Listen the atrocious invective and slurs that are being directed by the “woke” against J. K. Rowling, and see if you can still stick to your simple but inaccurate assertion.
“Woke” may once have meant that in the past, but words change over time. “Don we now our gay apparel“ doesn’t quite capture the spirit of Christmas the way it used to.
Those who spew atrocious invective and slurs are a basket of deplorables, whether left or right, but it has nothing to do with woke other than the right using it as their slur du jour.
And I guess “gay“ still means happy and carefree in your world, with no connotations whatsoever of sexual orientation. Fair enough, but things are different in the world the rest of us inhabit.
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