Deposit Insurance: Who Gets Bailed Out?

Deposit Insurance: Who Gets Bailed Out?

Let’s start with the reassuring message of President Biden that all depositors at Silicon Valley Bank will get to keep all of their money—not only the prudent and/or less prosperous depositors who managed to keep less than $250,000 in their accounts at the Silicon Valley Bank (SVB), but also?every person or corporation that kept more (even much more) than the FDIC insured limit. Let’s take the president at his word that the ?bank’s investors—not depositors—won’t be bailed out by the federal government. (And let’s assume that they won’t use their formidable lobbying forces to find a back door to reverse their losses.) Most of us can agree that it is a good thing for the government to prevent panic-driven runs on our local banks.

I’m neither a banker nor an economist. But you don’t need to be a rocket scientist to understand the causes of the collapse of the Silicon Valley Bank. I learned a few basics in a two-week seminar on banking and then, as CEO of a nonprofit.

In that seminar back in the 1980s, before the collapse of the savings and loan industry, I learned that bankers must be careful about matching assets and liabilities. Interest rates change. Over the last year, they’ve increased a lot. If, like SVB, you are locked into low-yielding fixed-rate assets, what happens when your depositors (a) demand a higher interest rate on their funds; and/or (b) move their money out of your bank in search of higher rates with other banks? Of course, when depositors line up around the block (or go on Twitter) to demand their money, you can raise cash to pay them off—but those darned rising Federal Reserve interest rates have made your investments worth less than you paid for them. Losing money on your investments is no way to run a bank—as your stockholders will quickly inform you.

It’s pretty basic, right? You probably know all this, or else learned it from the news over the last week. ?You would think that a bank CEO managing more than $200 billion in depositors’ money would know it, too. Well, yes, the CEO of Silicon Valley Bank knew it, but….

Here’s what I learned from managing a small nonprofit (now known as Inclusiv) that grew to be a mid-sized nonprofit, managing millions of dollars we raised as loans from socially responsible investors. We got audited every year by a CPA. For years, no problems, no questioned costs, clean balance sheet, no pesky footnotes. But as we grew, a paragraph appeared in every annual audit, cautioning us (and any interested investor) that we bore financial risk because we had balances in our accounts at the local bank that exceeded the federal deposit insurance limit. I was the CEO; it was my job to know that. But as our auditor noted, we believed that the risk was minimal, and after all, who wanted to make our work harder by spreading our money into multiple banks? So we kept in one convenient, fairly small bank even though it exceeded the insurance limit. Our CPA didn’t bust us; our social investors never complained; our board didn’t fire me. There were other things for me to lose sleep over.

In short, even as a nonprofit CEO, I was warned about and knew about the risk. As for the high-flying venture capitalists and technology executives of Silicon Valley, didn’t they know? Shouldn’t they have known? When SVB’s troubles became known, and when a stampede out of the bank began, ?they doubtless experienced a few anxious days when their deposits seemed at risk. But now, it turns out that they can sleep soundly. The free market did not save them. The federal government—that odious regulator that inhibits creative disruption and American entrepreneurship--saved them. (And perhaps it will next time, too.)

But what happens when the government does not step in? In my book, Democratizing Finance: Origins of the Community Development Financial Institutions Movement, I share two stories, separated by a century, one a tragic tale, the other a story of tragedy averted.

Freedman’s Savings and Trust Company was chartered by the U.S. Congress in 1865 for Black soldiers, who had no place to safely deposit their pay and bonuses. It grew explosively, with more than 30 branches in 17 states and the District of Columbia, serving more than 70,000 depositors with more than $57 million in savings. Fraud and speculation by its white managers and borrowers, as well as the financial Panic of 1873, drove the bank to the verge of collapse. In a last-ditch effort to save it, Frederick Douglas was recruited to become its president.?He soon recognized that the task was hopeless, that he had been tasked with reviving a corpse. Freedman’s Bank closed in 1874.

There was no deposit insurance. Although President Lincoln, General Grant, and other government figures were pictured on many Freedman’s passbooks, the bank was, in fact, privately owned. “It is certain,” Douglas wrote, “that the depositors in this institution were led to believe that as Congress had chartered it and established its headquarters at the capital, the government in some way was responsible for the safe keeping of their money.”

They were mistaken. Many depositors lacked the account documentation or had nowhere to turn for assistance. About half of the depositors eventually received about 60% of the value of their accounts, but many depositors—overwhelmingly Black and poor—got nothing. It was not only individuals who lost money: The Black churches, private businesses, and benevolent societies which had made deposits and encouraged their members and customers to do the same suffered losses. Many had to suspend or drastically curtail their services, compounding the racial wealth gap.

Fast forward a century to 1964, when baseball legend Jackie Robinson cofounded Freedom National Bank in Harlem. In 1990, the bank failed, putting at risk not only the deposits of Harlem residents, but also of many churches, social service organizations, and local businesses. Some organizations held substantial deposits spread out over multiple accounts, because they managed various programs and contracts. They mistakenly believed that each account would qualify separately for full FDIC insurance. But FDIC went by its rules, adding together all a single depositor’s various account balances. When those totaled over the insured limit (at the time, $100,000), the overage was uninsured. In an unfortunate echo of the Freedman’s bank collapse, churches, community organizations, ?local businesses, and prosperous individuals faced losses. Finally, after months of intense public outcry, Senator Alfonse D’Amato of New York (a conservative Republic) sponsored special legislation to make whole the depositors who had put so much hope in Freedom National Bank.??

Sometimes government “policies” are simply policies, revocable by ?force majeure. In the case of Silicon Valley Bank, it was not an act of God, nor an unforeseen natural disaster, but the fear of a tsunami of banking failures. The federal government overrode the FDIC’s insurance policies to save the economy. Are you reassured? Are you confident that it will do the same for you someday? Or is your cynicism compounded when the government rescues sophisticated, moneyed businesses and individuals who should have known better???

?????????????In an opinion piece, financial journalist Roger Lowenstein declared that “The Bank Rescues Just Changed Capitalism” (The New York Times, March 15, 2023), because the government rescued large depositors at Silicon Valley Bank who by the rules, ought to have suffered losses on uninsured funds. He rightly noticed that “risk taking on deposits has effectively become socialized”—that is, risk of loss was transferred from those who own substantial assets to the rest of us.

But that shouldn’t be a surprise. It’s not a fundamental change in capitalism or some kind of extraordinary one-off. Protecting private gain while socializing risk is the essence of capitalism, whether it is permitting coal mines to destroy Appalachia or pharmaceutical companies to profit from death-producing opioids. How many lives were ruined by the abusive, highly profitable mortgage lending that fueled the Great Recession? How many CEOs went to jail??

?????????????This time, the societal damage from bank failure is not as blatant or widespread as the Great Recession. Yes, we can thank Washington for averting disaster. The sound you hear is one hand clapping.??

? 2023 Clifford N. Rosenthal