Editor’s Note: Nicolas Véron is a senior fellow at Bruegel and at the Peterson Institute for International Economics, two policy research organizations in Brussels and Washington D.C. respectively. He has investments in Silicon Valley companies. The opinions expressed in this commentary are his own. View more opinion on CNN.
On Sunday, the US Treasury, Federal Reserve and Federal Deposit Insurance Corporation (FDIC) jointly announced a package of actions to stop the turmoil from Silicon Valley Bank’s insolvency and Signature Bank’s near collapse. As details gradually emerge about the process that led to that decision, it appears likely that a primary motivation was to rescue Silicon Valley from what might have been a severe downturn.
On the face of it, these actions have been successful in the short term. The sense of panic has largely receded, there is no indication of an accelerating deposit run and market prices rebounded (though they’re down again due to shares of Credit Suisse crashing over ostensibly unrelated news). Startups that feared they wouldn’t meet this week’s payroll deadline have been reassured. Order is being gradually restored.
But at least one of the steps taken will also have long-term impact: fully reimbursing all SVB and Signature Bank depositors — even if their deposits are worth tens or hundreds of millions of dollars. And whenever that impact becomes fully clear, possibly in many years, it may not appear to have been the wisest way to protect Silicon Valley.
The key thing here is that even though the measure is ostensibly only about two failed banks, its message that all deposits are protected no matter how large is very likely to become entrenched and perceived by American corporate treasurers, savers and the banks themselves as permanently applying to all banks. Neither SVB nor Signature Bank were particularly large or systemically important banks. Until Friday morning, US and international financial conditions were orderly, unlike in 2008 when a similar measure temporarily guaranteeing certain uninsured deposits was applied to a US financial system that was facing existential disorder. If the stance is that deposits of SVB had to be protected — with no limit — even though it failed in calm times, then the same has to apply to any other bank.
Once that perception has become widely shared, as is the case now, it cannot be reversed without creating a new episode of financial panic. So even though the unchanged letter of the law still states that deposits are only protected up to $250,000 per account, in the real world, Americans will justifiably act under the hypothesis that their deposit protection is unlimited, because that’s the new stance that the SVB-Signature Bank episode has established.
Why does it matter? The US financial system functions as a network of professional participants that constantly assess risks and act accordingly. Banks, investors and corporate treasurers must all manage financial risks in a way that generally brings stability to the system. In other words, they must embrace what experts call “market discipline.”
Because ordinary Americans cannot be expected to permanently monitor the safety and soundness of their own banks, they are exempted from that effort and benefit from the FDIC’s formal guarantee, a system that the Roosevelt administration created in the early 1930s and has been widely admired and emulated abroad. By contrast, wealthy individuals or corporate treasurers who manage bank accounts in excess of the $250,000 threshold are expected to do so prudently and professionally, or else to face the risk of losing the money. To borrow from President Joe Biden’s public address on Monday, “That’s how capitalism works.”
Guaranteeing all deposits without limit, even in unsound banks like SVB and Signature Bank, removes an element of that elaborate system of market discipline. There have been many debates among finance experts about the design and impact of deposit insurance, with some seeing perverse incentives, what insurers call moral hazard, as inherent to any deposit insurance scheme, while others argue that unlimited deposit insurance is a reality that should be explicitly acknowledged.
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For better or worse, the unlimited guarantee that results from Sunday’s announcement makes the system different from what it was before, since uninsured depositors have incurred losses multiple times in the past. The new system is less based on market discipline and risk assessment than the previous one was. While the structural consequences are not immediately clear, it is easy to envision the detrimental effects of this shift — for example if poorly managed banks find it easier to attract large depositors in the future.
Limited deposit insurance has been a longstanding feature of US finance. Sunday’s action has altered it structurally, possibly forever. It is a regime change. Whether the new regime can be an improvement on the old one remains to be seen.