This week’s theme on the Retirement Quick Tips Podcast is: Why Banks Are Going Bust & What To Do About It

 

Today I’m talking about the problem with bank bailouts and moral hazard, and how stoping a contagion in the banking system today leads to more problems in the future because of moral hazard. 

 

On Sunday, March 12th, regulators announced that they would give depositors of Silicon Valley Bank access to their funds, not just those that were covered by FDIC insurance. This is important because roughly 97% of all deposits at SVB were not covered by the FDIC insurance limit, and the millions of dollars that some depositors had a SVB would have been reduced to $250,000 overnight. 

 

Since regulators stepped in to back all deposits, the next question is:Are all uninsured deposits now covered by government guarantees?

 

No. The regulators said they were making an exception for SVB and Signature (which also collapsed at the same time as SVB). 

If you recall from September 2008, it was the government’s refusal to bailout Lehman Bros after their collapse, that is widely accepted as the tipping point of the Global Financial Crisis. But 6 months prior to that, Bear Stearns collapsed and was bailed out. 

So its likely that Lehman, AIG, and other troubled banks with garbage balance sheets assumed that they could be bailed out too. And if they made that assumption, they would have been slow to act. It’s possible that Lehman could have found a buyer as things started to head south to prevent a bankruptcy. And they certainly would have taken on less risk with their CredDefSwaps and other risky investments if they didn’t have the backstop of the government. 

This played out the same way for SVB. By the time SVB tried raising capital to keep things afloat, it was too little too late, and it was too far gone. 

When the regulators step in it’s controversial, because it creates what is known as a “moral hazard”. It’s like the parents who will always bail their kids out no matter what. When the kids know this, they feel untouchable and certain kids will take advantage of the situation by doing crazy and stupid stuff and feel invincible all the while. Well as you and I both know, that behavior, if it continues will catch up to you someday with often catastrophic consequences.  

That’s moral hazard, and the same is true for banks if the government will always backstop them in a crisis. They and their customers have no incentive to manage their risk or act prudently, because Daddy Government will always step in and save the day. That poor incentive structure and the risky behavior encourages is scary when the US Financial system is put to the test as a result. 

Banks and regulators should have learned more from the 2008 financial crisis, but SVB is proving that’s not always the case. Especially in the banking world, where it seems like the management made poor decisions and mistakes. These mistakes were in plain view of regulators months ago when they started racking up the losses, but nothing was done about it, and here we are today. 

So when you once again have regulators stepping in to backstop all deposits, unfortunately no one learns from their mistakes and we can expect more of the same in the future. 

That’s it for today. Thanks for listening! My name is Ashley Micciche and this is the Retirement Quick Tips podcast.    

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