Biden bailout a step toward government control of banking system

Economists warn that President Biden’s extraordinary action to make more than $200 billion in additional government funds available to customers whose deposits were not covered by federal insurance at two collapsed banks is the first step toward government control of the banking system.

The Federal Deposit Insurance Corp. (FDIC) covers deposits up to $250,000 per account to prevent bank runs and failures. But on Sunday, Mr. Biden approved blowing past that limit to cover the huge amount of uninsured deposits at the two banks

That guarantee both potentially stretches the FDIC’s Deposit Insurance Fund (DIF) to its breaking point and establishes a “moral hazard” precedent that the government will bail out any bank of significant size. 

It is also the most extensive government intervention in the banking system since the 2008 financial meltdown.

Steve H. Hanke, a professor of applied economics at Johns Hopkins who served on former President Reagan’s Council of Economic Advisers, says this moves the banking sector closer to a public utility or government-backed entity.

“With the Biden bank bailout, and it is a bailout, banking is becoming a government-backed business — if that’s what you call a business,” he said. “And if that’s not bad enough, the Biden administration has just injected another massive infusion of moral hazard into the banking system, as have past Republican and Democratic administrators. Who picks up the moral hazard tab? Taxpayers do.”

A “moral hazard” is when banks or other entities are incentivized to take more risk because someone else, like taxpayers, will foot the bill if things go badly. Moral hazard risks become even stronger if the institution is seen as “too big to fail,” which would justify tighter government regulation and control over the bank market.

Morris Pearl, a former managing director at BlackRock and chairman of the Patriotic Millionaires, a group that advocates for higher taxes on the wealthy, said it’s merely a “small step” because the government already regulates the industry as heavily as it does public utilities.

“Banks have been highly regulated in many ways like public utilities for years. A basic checking account is more-or-less a necessity of modern life. It is in the same category as electricity or telephone service,” he said, adding that increased government intervention is not a “huge change.” 

Amid fears that more financial institutions could collapse, Mr. Biden sought to project calm in a speech from the White House. 

He insisted the U.S. financial system was secure despite the second-and third-largest bank failures in the nation’s history occurring within two days of each other.

“Americans can have confidence that the banking system is safe. Your deposits will be there when you need them. Small businesses across the country that deposited accounts in these banks can breathe easier knowing that they will be able to pay their workers and pay their bills,” the president said.

Regulators on Friday closed Silicon Valley Bank after depositors swarmed the bank to withdraw all their funds at once. With $209 billion in assets, Silicon Valley Bank is the second-largest bank to fail since Washington Mutual collapsed at the height of the 2008 financial crisis.

On Sunday, regulators in New York took possession of Signature Bank and the FDIC was appointed as its receiver. With roughly $110 billion in assets, it is the third-largest bank failure in U.S. history.

Despite Mr. Biden’s attempts to downplay potential economic calamity, bank stocks plummeted Monday. 

First Republic Bank “led” the decline, losing 61.8% of its share value while PacWest Bancorp dropped 45% and Western Alliance Bancorp lost more than 47%. Other financial firms felt the heat with Bank of America’s stock tumbling by 5.8% while Charles Schwab’s shares dropping by 11%.

Some bank stocks were halted repeatedly throughout the day because of such volatile trading.

Also Monday, the Federal Reserve announced that it would review its own previous supervision of Silicon Valley Bank.

Michael Barr, the Fed’s vice chair for supervision who will lead the probe, said it will be a “careful and thorough review” with the goal of learning from the experience.

Still, Mr. Biden reassured Americans that their deposits were safe outlining steps his administration has taken to protect the financial system. 

He said the management at Silicon Valley Bank has been fired and investors who pumped money into it will not be protected.

“They knowingly took a risk,” Mr. Biden said of the investors. “When the risk didn’t pay off, investors lose their money. That’s how capitalism works.”

While Mr. Biden insisted to taxpayers that the uninsured deposits will be covered by the DIF, Republicans and some economists remain skeptical.

The DIF is funded by fees from banks as well as the government’s earnings on interest from bank investments in Treasury securities and bonds. 

It currently has $128 billion in it, which a Treasury official said was “more than fully sufficient” to cover depositors at the collapsed Silicon Valley Bank and shuttered Signature Bank.

“No losses will be borne by the taxpayers. Instead, the money will come from the fees the banks pay into the Deposit Insurance Fund,” Mr. Biden said.

Republicans and some economists said they don’t see how taxpayers won’t end up bailing out the wealthy customers of both banks. 

Silicon Valley Bank and Signature Bank have uninsured customer deposits that far exceed the funds in the DIF.

The FDIC insures only the first $250,000 in deposits in covered accounts, which include almost all savings and checking accounts.

But any amount over that — and all but the smallest of small-business accounts will have more than $250,000 — is uninsured. Also cryptocurrency and such accounts as stock or bond investments are categorically excluded from FDIC coverage.

Silicon Valley Bank had $173 billion in total deposits and the vast amount — roughly $152 billion — was not covered by the FDIC, according to regulatory filings.

Meanwhile, more than $79 billion of $88 billion in total deposits at Signature Bank were uninsured at the end of last year, regulatory filings show.

Combined, that’s a whopping $240 billion in uninsured deposits the government must pick up — nearly twice the $128 billion in the DIF. 

Treasury officials said any losses to the DIF would be repaid in full by raising fees on the system’s banks.

Additionally, the Treasury Department’s Exchange Stabilization Fund will provide $25 billion to backstop the Fed’s loan program.

However, the banks now being charged higher fees by the FDIC will likely pass those costs on to consumers in the form of higher costs, reduced service, and increased ATM or overdraft fees.

“The public is always on the hook for any Fed program, no matter how much government insists costs won’t be borne by taxpayers,” former Rep. Justin Amash, Michigan independent, said on Twitter.

Even so, Republicans and some economists say that’s not enough for the DIF to cover the losses incurred by Signature and Silicon Valley Bank.

“Joe Biden is pretending this isn’t a bailout. It is. Now depositors at healthy banks are forced to subsidize Silicon Valley Bank’s mismanagement. When the Deposit Insurance Fund runs dry, all bank customers are on the hook. That’s a public bailout,” said former South Carolina Gov. Nikki Haley, now a Republican presidential hopeful.

Ms. Haley added that depositors should be covered by selling off Silicon Valley Bank’s assets, not through the public.

Sen. Tim Scott of South Carolina, the top Republican on the Senate Banking Committee, said the emergency moves encourage reckless investments by banks because now banks will expect that the government protects them.

“Building a culture of government intervention does nothing to stop future institutions from relying on the government to swoop in after taking excessive risks,” Mr. Scott said.

Democrats and some economists say the move is necessary to shore up the nation’s financial system and avert a major financial system collapse.

Sen. Chris Coons, Delaware Democrat, said the administration’s actions should give Americans “confidence that their federally insured deposits are safe and that our banking system is resilient.”

“I commend the Biden administration’s swift actions to address challenges posed by the closure of Silicon Valley Bank and Signature Bank to shore up our banking system as a whole,” Mr. Coons said in a statement.

Lawmakers on both sides of the aisle are calling for a special investigator to get to the bottom of what happened. In his remarks, Mr. Biden hinted that he was on board with such a measure.