The depositors at Silicon Valley Bank and Signature Bank, the two midsized banks whose recent collapse spurred tumult on Wall Street this week, ranged from big companies and glitzy startups to regular families and workers. Perhaps some of the more sophisticated customers should have been savvy enough to see that the banks had problems, but be honest — would you know how to scrutinize a bank’s balance sheet to determine if it was a safe place to keep your cash?
The decision by the Biden administration to make whole all the depositors — even those not legally entitled to the government’s deposit insurance — was both fair and smart. Some of SVB’s tech-bro clients are not exactly sympathetic figures, but ultimately it’s not the account-holders’ fault that the bank failed. The people who anxiously lined up at the SVB location in Wellesley this week didn’t deserve to lose their savings. And the administration’s fast action may help prevent the collapse of the two banks from burgeoning into a full-fledged financial crisis.
But the way the government rushed to the aid of the banks’ clients should also raise a question: If the federal government is going to cover all deposit accounts anyway, why not drop the fiction that it doesn’t? In theory, government deposit insurance stops at $250,000. By removing that limit, the government would make official what history suggests it’s likely to do anyway in the event of big bank failures. Doing so would also send a calming message to bank customers while allowing the government to charge banks for the insurance it seemingly already provides to large accounts.
Here’s how this all started: Silicon Valley Bank, a favorite of tech companies, had an unusually large number of accounts with balances over the $250,000 cutoff. The bank poured a lot of its assets into long-term government bonds — usually a low-risk investment but one that’s negatively impacted by high interest rates in the short term. And so when the Federal Reserve hiked interest rates, those bonds lost value, leading the bank’s customers to worry that the bank might be unable to honor their large deposits, many of which included their companies’ payrolls. So they started withdrawing their money, and a run on the bank ensued.
The panic among depositors spread beyond Silicon Valley Bank, and Signature Bank saw its customers begin to withdraw their money as well. And so the federal government quickly stepped in. (Stepped in for the depositors, anyway; the bank’s executives and investors will, appropriately, lose their shirts.)
One of the obvious questions for regulators now is: How is it that the United States’ financial system is so robust that it boasts the largest share of the world’s stocks but is also so fragile that it is apparently put wholly at risk from the failure of a single midsized bank? Clearly, the federal government must put stronger regulations in place that improve banks’ risk management. And calls to repeal Congress’s 2018 deregulation law are certainly warranted. After all, had Congress not rolled back part of the earlier Dodd-Frank Act, which passed after the 2008 financial crisis and required banks like SVB to be subject to regular stress tests, regulators would have likely caught some of that bank’s problems sooner and pushed it to course correct before it was too late. (Notably, the CEO of Silicon Valley Bank had successfully lobbied Congress to exempt his bank from that level of scrutiny.)
But there’s also an uncomfortable truth that lawmakers and the Federal Deposit Insurance Corp. have to address. By bailing out uninsured depositors, regardless of how big their accounts were, the government has essentially rendered the FDIC’s cap meaningless.
The reason that the federal government says that it will limit deposit insurance to cover $250,000 and nothing more is to prevent what economists call a moral hazard. The theory is simple: If depositors are guaranteed that they will not lose a penny if their bank goes under, then they won’t go through the trouble of making sure that a financial institution is sound before parking their assets there. That, in turn, would encourage bank executives to engage in riskier behavior because they don’t have to compete for prudent depositors.
But what good is that cap if the government repeatedly lifts it when crisis strikes? Indeed, as in 2008, the government has again shown that it will bail out uninsured depositors when push comes to shove. And even when that cap exists, depositors have not necessarily shown themselves to be good promoters of market discipline anyway. The media company Roku, for example, had nearly half a billion dollars deposited in Silicon Valley Bank and failed to notice any problems with the bank’s books, despite some being glaringly obvious in retrospect.
And so now that the federal government has made clear that it will insure all deposit accounts, even those above $250,000, shouldn’t lawmakers consider making it official? While that sounds like they would be making permanent a policy of bailing out the wealthy when times get tough, the reality is that this is the de facto policy, and by officially lifting the cap, the FDIC can actually charge banks and big depositors for the insurance it already provides them. That would minimize any risk of pushing some of the cost of recovering deposits onto taxpayers by boosting the government’s deposit insurance fund. And the FDIC can use that expanded insurance to promote better risk management by conditioning it on compliance with certain regulatory standards.
Lifting the FDIC’s cap could prevent a bank run like last week’s. Even though Silicon Valley Bank made bad decisions, it wasn’t facing insolvency until panic among its depositors set in and they started withdrawing their money en masse. If those depositors knew their money was insured, they would have been more patient about the bank’s long-term bond investments, which would have eventually stabilized. And as for the moral hazard that would set in for depositors under a new insurance regime, the current system hasn’t exactly proved to be any better, and shareholders, who would remain uninsured, can still impose some market discipline. Regulators can also find the right balance by not necessarily making the deposit insurance unlimited and tiering the percent of deposit recovery based on the size of accounts. For instance, the FDIC could guarantee 100 percent of deposits under $250,000, 90 percent of deposits under $1 million, 80 percent of deposits under $10 million and so forth. (Those numbers are to illustrate an example, not provide an economically sound tier system.)
Ultimately, though, if lawmakers choose to go down that road and lift the FDIC cap, that kind of system would require strong oversight and effective regulators. And another important question that these bank failures raise is whether federal regulators were asleep at the wheel. While it’s true that Congress’s 2018 law exempted midsized banks from some supervision, how did the feds not notice that one of those banks almost doubled its size in 2021 , all while being especially vulnerable to a bank run by having nearly 90 percent of its depositors uninsured? That’s a question that needs to be answered before regulators are tasked with more oversight and relied on to create a less risky financial system.
Thankfully, these bank failures have so far been contained. But that’s not necessarily a guarantee. Lawmakers should seize this opportunity to fix the financial system before the next crisis unfolds.
Editorials represent the views of the Boston Globe Editorial Board. Follow us on Twitter at @GlobeOpinion .