Would our Government bail out the depositors of a badly run bank?

Behind the phrase “moral hazard” which is being heavily used in relation to the Fed and SVB, is the question posed by the title of this blog.

Full on capitalism allows poorly run banks to fail and tells depositors it is more fool them that they put their eggs in that banks basket. Back in the day, if your bank got robbed , the folks in the neighborhood lost their money. That’s how banking developed in the USA.

Since banks stopped storing their deposits in gold , they’ve looked for a different store of value and Silicon Valley Bank got the store of value spectacularly wrong. It put its trust in Government Bonds but its depositors wanted more than the fixed interest those bonds paid.

So the US Government has intervened and bailed out the depositors, who happen to be important for the Government’s economic strategy, being their drivers of growth.

Suddenly a crisis of bank management becomes a global banking crisis and a hedge fund manager is  calling  out President Biden for “breaking down capitalism before our very eyes”.

People are queuing outside American Banks and Japanese Banks, fearful of a contagion that could see their non-insured deposits frozen or even lost.

World stock market are shaken , this from today’s FT..

Traders in Tokyo said they were expecting a second day of massive equity market support from the Bank of Japan to fend off a deeper rout. Japan’s Topix Banks index was down as much as 7.8 per cent, on track for its worst day in more than three years, while the Topix fell more than 3.1 per cent.

If there is contagion, it is in the US banking sector which looks jittery

Is this a crisis caused by fear of moral hazard?

Robert Armstrong decides it isn’t but for different reasons than you might suppose.

Does the authorities’ resolution of SVB and Signature risk moral hazard, and how worried should we be about this? There is a great deal to say about this, most of it hard to say it until we have more details about how the resolutions will work (a sale of SVB is still possibleapparently) and whether more banks will need to be resolved. That uninsured depositors have been promised 100 cents on the dollar sure looks like the top of a slippery slope, but we will wait and see.

But part of the fear of moral hazard is based on an incorrect view of how companies work. If uninsured depositors expect to be bailed out, the thinking goes, depositors will behave recklessly. They just throw their money into any damn bank, removing an important incentive for banks to manage themselves prudently. That is, lower deposit costs for well-managed banks create more profits for shareholders, so banks will be motivated to manage prudently, maximising profits over the long run.

This view is largely based on the archaic idea that public companies are run for the benefit of their owners, the shareholders. They are not. They are run for the benefit of the people who are doing the running, that is, the management team. Shareholders have to hope, or work to ensure, that management’s interests line up with their own. Banks are prudent, in other words, because the executives want to get paid a lot for as long as they can, not because if they are imprudent deposits will become expensive and the share price will fall, or anything like that.

(As a side note, the SVB failure is surely proof that even the CFOs of the “smartest” companies do not pay attention to, or do not understand, the risk profiles of the the banks where they keep their companies’ money.)

If you believe that public companies are operated in order to get executives paid as much as possible for as long as possible, then you also believe that a lot of the work of incentivising prudence is done by firing management teams and wiping out their shareholdings when things go wrong, as has happened with SVB and Signature. This does not provide a perfect incentive for prudence, but it’s a start

How is this touching the UK?

All this in the days leading up to Jeremy’s first proper budget is not very settling for the UK economy . We hope that the acquisition of SVB’s UK arm by HSBC will not give HSBC the headaches the acquisition of HBOS gave Lloyds in 2008.  The hope is that the due diligence done over the weekend (limited as it must have been) was proportionate to the complexity of the problem that HSBC was taking on.

The reports of what happened over the weekend show a UK Government rather better at managing the detail than we have come to expect.

Here is an extract from the Sky News report which opens explaining just how grim things had looked for the depositors at SVB (UK) throughout this weekend…

Then, in the early hours of Monday morning, things started to change.

HSBC, which had surfaced in the negotiations so late that it hadn’t even been given a codename, emerged as a serious buyer.

It wanted certain assurances – that it wouldn’t face onerous anti-money laundering checks for its new customers and that it wouldn’t have to take responsibility for any previous misconduct at SVB UK – but it was willing to buy SVB UK for £1.

By about 1am on Monday, the Bank’s staff, bleary-eyed after a marathon weekend, realised that the worst seemed to have been averted.

HSBC was serious. The lawyers set to work on the contracts.

SVB UK would carry on operating, under the ownership of HSBC, who would gradually incorporate it into their business.

The thousands of customers – tech founders who had been facing potentially catastrophic consequences – would have all their deposits protected.

No public money would be deployed. It was, in the circumstances, about the best possible outcome.

So how should we feel about what is happening?

On the one hand,  the episode illustrated the strength of Britain’s bank resolution system. A disaster was averted. No public money was deployed.

In the US, the Federal Reserve was forced to intervene and signal that it was standing behind customer deposits. The American parent faced insolvency; no buyer was found. By contrast, the UK’s response looked like a triumph.

However, the episode asks the UK its own questions.

First, the financial system remains vulnerable to these unexpected shocks.

Second, there are question marks about why tech firms put quite so much money – way more than was insured by deposit protection – into a single bank, and especially about the fact that some were reportedly coerced to do this by their financial backers.

Third, given this was yet another earthquake triggered in large part by rising interest rates (the first being Britain’s liability driven investment pensions crisis last autumn), what other bombs are buried in the system?

The final concern is that even as it helped confront this bank collapse, the Treasury is making plans to overhaul Britain’s financial regulation.

Its proposals will, say the BOE and PRA, pare back some of the controls and rules imposed after the financial crisis.

We need a banking system that works, currently we have one. We should think carefully before loosening controls.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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4 Responses to Would our Government bail out the depositors of a badly run bank?

  1. John Mather says:

    The LDI fiasco has similar roots. Who is taking that cost?

  2. Eugen N says:

    This is banking business Henry!

    Banks have to lend money, they attract money for very short duration, and have to lend for 3+ years. Sometimes they do it on fixed interest rate, not because they are keen on it, because this is what consumers of credit want. And with high competition when markets are awash with money printed by Central banks, consumers get what they want.

    There is always a risk of a run on the bank. No bank could pay all their customers at once. Central banks could offer more liquidity and take some high rated assets from commercial banks and offer funds instead, but it cannot be done for all the loans.

    In the end this was due to increases in interest rates, which reduced the value of the loans by 10% – 20%. Some banks managed to hedge this, at a cost, and risk was taken by other (investment banks etc). But the loses have not disappeared, they are in the banking system. Some are marked to market, some do not, unless the assets get sold. Selling banking assets (loans, mortgages, etc) is not that easy either and there will aways be a discount to the market value.

    The issue here is how well capitalised these banks are. Some like HSBC managed to squeeze $2 billion of additional capita just before the turmoil. The price it paid is high, 8% per annum. But under the terms, if CET 1 capita drops, it can transform this bond into common stock.

  3. Tim Simpson says:

    Hello Henry,

    Whatever the rights and wrongs of the above, I enclose a link to a CityWire article of yesterday:

    Whatever the rights and wrongs are of Shorting, this chap obviously knows his stuff when reviewing Banks performances etc. My question is: if it was so easy for him to spot the doubtful probabilities, why didn’t the US Bank Authorities and act earlier. as a precaution?
    Kind regards,
    Tim Simpson

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