Banking authorities ignored their post-2008 rulebook to contain the new financial catastrophe. Treasury Secretary Janet Yellen tore it up on Tuesday by announcing a de facto guarantee of all $17.6 trillion in U.S. bank deposits. Regional bank stocks rose, but this marks the end of market discipline in U.S. banking.
“Our action was required to preserve the larger U.S. banking system,” Ms. Yellen told the American Bankers Association conference. “And similar sanctions might be required if smaller institutions experience deposit runs that threaten contagion.”
Banks are safe for depositors
This is near enough for government work. Dodd-“systemic Frank’s risk” provision enables the FDIC guarantee uninsured deposits. The exemption applies if banks collapse and systemic danger is real. The Treasury Secretary said regulators will stretch that provision again to avert bank runs under her watch. Ms. Yellen would face congressional criticism if she explicitly guaranteed all uninsured deposits, but she currently implies it.
If “the situation is stabilizing, and the U.S. financial system is healthy,” why does she need to give this assurance? Because bank depositors and investors worry the problem is worse than she states.
Clear capital norms, strong regulation, and market discipline to punish irresponsible activity are needed for a robust financial sector. The U.S. has none of those.
Risk-weighted capital rules have inflated bank health. Silicon Valley (SVB), Signature, and First Republic banks suffered from interest-rate risk due to the Dodd-Frank regulatory framework. Dodd-too-big-to-fail Frank’s banks reduced market discipline. Ms. Yellen is now advising uninsured depositors to relax.
The Demise of Market Discipline for Financial Institutions
Even if the injury isn’t apparent, the effects will be far-reaching. If their savings won’t go, bank CEOs won’t manage cautiously. Big depositors won’t bank with many banks. Like SVB, poorly managed banks with greater client incentives may concentrate deposits and risk.
Deposits should be insured for small firms with more than $250,000 in cash, according to Sen. Elizabeth Warren. “The billion-dollar depositor is the exception,” she told Roll Call.
Most mom-and-pop firms have less than $250,000 in the bank. Hedge funds, legal companies, and well-funded startups are her tiny enterprises. VCs should have done due diligence before investing in SVB, but many didn’t.
SVB and Signature uninsured depositors should have taken a little loss to discipline the market. Contrary to the Administration. It promotes riskier bank management and reduces depositor, investor, and creditor caution, causing moral hazard.
The Government claims their participation was one-time. But, authorities establish market expectations that they will repeat their actions. If not, market fear will force them. Biden officials are crossing a Rubicon without congressional consent.