Sir John R. Hicks, Nobel laureate and high priest of economic theory, once said: "There is nothing more important than a balance sheet." After the collapse of the Silicon Valley Bank (SVB), the words ring very true again.
Neither SVB management nor government regulators kept tabs on the bank's balance sheet, and when they did, they didn't understand.
What is the US government's solution to the collapse of SVB? The Treasury Department, the Federal Reserve and the FDIC will fully protect deposits with the SVB and apparently every dog and cat with a bank account as well. And when it comes to the word "bail-out," Treasury Secretary Janet Yellen affirms, "We won't do it."
While Yellen is stretching the definition of "bailout" by doing so, she may end up with a point. This government bailout is not a bailout. He is a gift.
The Federal Reserve has just released a "Bank Term Funding Program" outlining how it intends to provide liquidity to American banks in the current turmoil. The Fed offers one-year advances to eligible borrowers in exchange for collateral such as US Treasuries and mortgage-backed securities.
The big trick, however, is that the Fed will value the collateral at face value. For example, if a bank holds $100 million in relevant securities trading 10 percent below face value, then the securities in the market will be $90 million. Under the Fed's new program, the bank can then get a $100 million advance on $90 million worth of securities.
The Silicon Valley Bank was closed due to impending payment difficulties. Worried about losses, many customers withdrew their money from their accounts. US President Joe Biden has now commented on this in a statement.
Essentially, the Fed has decided that hedging interest rate risk is no longer commercial banks' job. Why hedge interest rate risk when the Fed will cover your losses? The Fed has become Santa Claus for banks, and securities traded below par are the milk and the cookies.
With the blessing of Janet Yellen, FDIC chief Martin Gruenberg and Fed Chair Jerome Powell, banking is now a government-backed business. Andrew Ross Sorkin of The New York Times is right when he writes: "Once the government guarantees all deposits, the business of banks is hardly a business anymore."
Indeed, if the FDIC insures all deposits - even those over $250,000 - and the Fed bears the balance sheet losses of the banks, what work is there left for bankers? Very little.
But that's not the end of the story. Under such a government-backed regime, a massive amount of moral hazard is injected into the commercial banking system. Because banks get an incentive to take more risks because someone else, in this case the American taxpayer, foots the bill when something goes wrong.
And that's still not all. As night follows day, excessive interventionism always goes hand in hand with more regulation. And tougher rules for commercial banks will allow the shadow banking system to flourish.
That's exactly what happened after the 2007-08 financial crisis, when, following the passage of the Dodd-Frank legislation, the size of the shadow banking system grew by 75 percent in just seven years between 2010 and 2017. This is a threat to the stability of the financial system. And while stability isn't everything, everything is nothing without stability.
Having failed to anticipate the SVB collapse, the Treasury, Fed and FDIC put a bandaid on the wound. And only tear open new wounds.
Steve Hanke is an economics professor at Johns Hopkins University in Baltimore. Caleb Hofmann is Chief of Staff at the Institute for Applied Economics at Johns Hopkins University.
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