WASHINGTON — A sweeping package aimed at containing the damage to the financial system following high-profile defaults has raised questions about whether the federal government will bail out Wall Street again.
And while many economists and analysts agreed that the government’s response should not be viewed as a crucial “bailout” – investors in the banks’ shares will lose their money and the banks have been shut down – many said it should scrutiny of how should lead The banking system is regulated and supervised.
The settlement came after the Federal Reserve, Treasury Department and Federal Deposit Insurance Corporation announced Sunday they would ensure all depositors in two major failed banks, Silicon Valley Bank and Signature Bank, are repaid in full. The Fed also announced that it would offer banks credit against their Treasury bonds and many other asset holdings, treating the securities as if they were worth their original value — even though higher interest rates have eroded the market value of such bonds.
The actions should send a message to America: there is no need to pull your money out of the banking system because your deposits are safe and funding is plentiful. It was about averting a bank run that could wreak havoc on the financial system and the economy in general.
It was unclear on Monday whether the plan would work. Regional bank stocks plummeted and nervous investors snapped up safe haven assets. But even before the verdict was announced, lawmakers, policy researchers and academics had begun to debate whether the government had made the right move, whether it would encourage future risk-taking in the financial system, and why it was even necessary.
“The Fed basically just bought interest rate risk insurance for the entire banking system,” said Steven Kelly, a senior research associate at Yale’s Financial Stability Program. And that, he said, could fuel future risk appetite by implying that the Fed will step in if things go wrong.
“I call it a bailout of the system,” said Mr. Kelly. “It lowers the threshold for anticipating where emergency response will begin.”
Although the definition of “bailout” is poorly defined, it is typically applied when an institution or investor is rescued from the consequences of reckless risk-taking by government intervention. The term became a dirty word after the 2008 financial crisis, after the government bailed out major banks and other financial firms with taxpayers’ money, with little to no consequences for the executives who made bad bets that brought the financial system to a brink.
President Biden tried to make it clear Monday at the White House that he didn’t view what the administration was doing as a bailout in the traditional sense, as investors would lose their money and taxpayers would not be hooked on any losses.
“Investors in the banks will not be protected,” Mr. Biden said. “They knowingly took a risk, and if the risk doesn’t pay off, investors lose their money. That’s how capitalism works.”
The Sinking of the Silicon Valley Bank
One of the most prominent lenders in the world of tech startups collapsed on March 10, forcing the US government to step in.
He added: “Taxpayers are not bearing any losses. Let me repeat that: no losses will be borne by taxpayers.”
But some Republican lawmakers weren’t convinced.
Senator Josh Hawley of Missouri said Monday he was introducing legislation to protect customers and community banks from new “special valuation fees” that the Fed said would be levied to cover any losses of the Federal Deposit Insurance Corporation’s deposit insurance fund, which is currently in use to protect depositors from losses.
“Basically, what happened with these ‘special assessments’ to cover the SVB is that the Biden administration found a way to make taxpayers pay for a bailout without casting a vote,” Hawley said in a statement.
The government’s action on Monday was a clear bailout for a number of financial players. Banks that took on interest rate risk, and possibly their large depositors, were protected from losses in what some observers called a bailout.
“It’s hard to say that this isn’t a bailout,” said Dennis Kelleher, co-founder of Better Markets, a prominent financial reform advocacy group. “Just because taxpayers aren’t on the hook yet doesn’t mean something isn’t a bailout.”
However, many scholars agreed that the plan was more about preventing a widespread and destabilizing bank run than it was about bailing out a single company or group of depositors.
“Big picture, that was it,” said Christina Parajon Skinner, an expert on central banking and financial regulation at the University of Pennsylvania. But she added that it could still encourage financial bets, reinforcing the idea that the government would step in to clean up the mess if the financial system got into trouble.
“There are questions about moral hazard,” she said.
One of the signals the bailout sent to depositors: if you have a large bank account, the moves suggested the government would step in to protect you in a crisis. That might be desirable — several experts said Monday it might be wise to revise deposit insurance to cover accounts worth more than $250,000.
But it could give big depositors less incentive to withdraw their money if their banks are taking big risks, which in turn could give financial institutions the green light to be less cautious.
That could require new safeguards to guard against future dangers, said William English, a former director of monetary affairs at the Fed who is now at Yale. In his opinion, the bank runs in 2008 and in the past few days have shown that a system of partial deposit insurance does not really work, he said.
“Market discipline comes in when it’s too late, and then it’s too sharp,” he said. “But if you don’t have that, what limits banks’ risk tanking?”
On Monday, it wasn’t just the side effects of the bailout that caused concern: Many observers suggested that the collapse of the banks, and Silicon Valley Bank in particular, indicated that banking regulators may not have been monitoring vulnerabilities closely enough. The bank had grown very quickly. It had many customers in a volatile industry — technology — and didn’t seem to have managed its exposure to rising interest rates carefully.
“Silicon Valley Bank’s situation is a massive regulatory and oversight failure,” said Simon Johnson, an economist at the Massachusetts Institute of Technology.
The Fed responded to those concerns on Monday, announcing that it would conduct a review of Silicon Valley Bank’s oversight. The Federal Reserve Bank of San Francisco was responsible for overseeing the failed bank. The results will be released on May 1, the central bank said.
“Events surrounding the Silicon Valley bank require a thorough, transparent and expeditious review,” Fed Chair Jerome H. Powell said in a statement.
Mr Kelleher said the Justice Department and the Securities and Exchange Commission should investigate possible wrongdoing by Silicon Valley Bank executives.
“Crises don’t just happen – they’re not like the Immaculate Conception,” Mr. Kelleher said. “People take actions ranging from stupid to reckless to illegal and criminal that fail banks and cause financial crises, and they should be held accountable, whether they are bank executives, board members, venture capitalists or anyone else.”
A big looming question is whether the federal government will prevent bank executives from receiving hefty compensation packages, often known as “golden parachutes,” which are usually written into contracts.
Many experts said that the fact that troubles at Silicon Valley Bank could threaten the financial system – and require such a big response – suggested a need for tighter regulation.
While the regional banks that are now struggling are not large enough to face the most intense regulatory scrutiny, they have been deemed important enough to the financial system to warrant aggressive government intervention.
“Ultimately, it has become apparent that the explicit guarantee given to global systemically important banks is now being extended to all,” said Renita Marcellin, legislative and advocacy director at Americans for Financial Reform. “We have that implied guarantee for everyone, but not the rules and regulations that should be paired with those guarantees.”
Daniel Tarullo, a former Fed governor who was instrumental in setting up and enforcing financial regulation after the 2008 crisis, said the situation meant that “concerns about moral hazard and concerns about who the system is protecting are back to the fore stand”.