Emergency Authority Can Create Emergencies

There's been a lot of ink spilled on the recent, spectacular failure of Silicon Valley Bank (SVB), the decision of the Federal Deposit Insurance Corporation (FDIC) to intervene, and what this means for the future of banking in the US. No, I'm not going to suddenly claim to be an expert on bank regulation, but we are going to talk a little bit about emergency authority, and its effects in the workplace. In order to get there, we're going to do a little history on the FDIC.

If you missed it, when SVB failed, the FDIC was obligated to come in and insure depositors up to the limit of FDIC insurance. The FDIC was formed in 1933, to create confidence in the banking system. After the Black Friday stock market crash in 1929, people started losing confidence in banks, and went to pull their money--a so-called bank run. But banks don't simply pile your cash in a safe and wait for you to pull it out. Banks lend and invest your money (so that they can make money). If everyone comes to withdraw their money at once, the bank will not have enough cash on hand to satisfy every depositor. Prior to the FDIC, if a bank run occurred (or if a bank had bad investments) and the bank failed, depositors would lose their deposited money (or some significant portion of it).

The FDIC was created to give every depositor an insurance policy guaranteeing their bank deposits. For FDIC insured accounts, if the bank fails, the FDIC guarantees that you will get your money back--that is, at least up to the limits of FDIC insurance. The FDIC guarantees up to $250,000 per depositor, per bank (with some more technical rules applying for joint accounts, different types of accounts, etc). The "insurance" from the FDIC is paid for by fees paid from each bank participating in the program. So while the FDIC insurance is not directly paid for by federal tax dollars, all of their costs are paid for by the people who are depositing money in FDIC-insured banks. The FDIC charges the banks an insurance fee, and the banks pass that along to their customers.

The problem with the SVB failure was that roughly 93.8% of its deposits were uninsured. This is because the deposits exceeded $250,000 in value (per depositor). In other words, only roughly 6% of the deposits held by SVB were actually guaranteed by the FDIC--and the holders of the other 94% of deposits stood to lose their money.

The FDIC prevented this from occurring, by administrative action. There was no law passed to increase the amount of insurance to something more than $250,000. Candidly, there didn't need to be. The law enabling the FDIC to operate includes something known as the "systemic risk exception" (SRE). The SRE basically says that the FDIC can ignore insurance limits and can cover greater losses if it determines that a given bank failure poses a systemic risk to the banking system. As it relates to SVB, the FDIC determined that if some huge chunk of depositor money was lost, it would undermine confidence in banks across the country...causing more people to pull money out of banks...potentially causing more bank runs...potentially causing more bank failures. The SRE gives the FDIC emergency authority to go above and beyond the normal limits of the law.

Whether or not the FDIC was right to invoke the SRE isn't the point of today's discussion. The point of today's discussion is to recognize the risk in building any system that has emergency authority in it. We build systems with emergency authority to...well, to deal with emergencies. With the SVB failure, the bank run started on a Wednesday, the bank failed by Friday, and the FDIC acted by Sunday. If the FDIC had to go to Congress and request emergency authority to insure a greater amount of deposits, it would have taken weeks, or months, or possibly would not have happened. The emergency authority was necessary to enable immediate responses to prevent the banking system from collapsing (if you believe that SVB posed such a threat).

There are many times we build systems with emergency authority. When I worked in government, there were many times that ordinances were drawn up that gave a manager a limited spending authority with an emergency override. A Public Works Director might have $20,000 in 'normal' spending authority, but might have $250,000 in 'emergency' spending authority. The idea is simple: for planned expenses, the Director should go to their City Council and get preapproval, rather than relying on their spending authority. But if a well fails and requires immediate repair, that's an emergency that can't wait for Council approval--so emergency spending authority is available.

I can give similar examples in the business world as well--but you get the gist.

The thought behind emergency spending authority is sound: we need to enable people to respond to true emergencies quickly. The problem with emergency authority is that it can cause people to create emergencies. I've seen public officials consider deferring taking action on what should be planned expenses--knowing that doing so will cause a much larger failure that can then be addressed with "emergency" spending authority.

Conversely, I've also seen people who don't have the emergency authority create situations that rely on it. I've seen contractors start large projects without fully fleshing out the potential cost/scope, because they know that if something goes awry, they can ask for emergency funding.

In some instances, this is the intended outcome. We want people to rest assured that in an emergency, someone will have authority to take action. The FDIC stepping in and rescuing all SVB depositors was done to reassure people who use banks across the country. There's an implicit message here: don't worry. Even if you have more than $250,000 deposited at a bank, we'll protect you. Interestingly, the FDIC sends this implicit message but makes it very clear that it is implicit only. The FDIC has repeated that they are not increasing deposit insurance limits. However, they are clearly relying on the public assuming that the limits are no longer relevant.

There are some perils to emergency authority then, right? It can cause abuses by those who have it and can cause abuses by those who benefit from it. But in some instances, the benefit outweighs the risk. If we've got to keep the wells working, that Public Works Director has to be able to act quickly. If we want the banking system to function, the FDIC has to be able to step in without additional congressional authority.

So how do we mitigate the risks of emergency authority? Audit.

Every time emergency authority is invoked, we do an after-action audit. We review the timeline and decisions carefully, and we analyze if a true emergency existed. We determine if an alternate approach was possible, without using emergency authority. We determine if the emergency was real or fabricated. Yes, we Monday morning quarterback the person (or organization) that exercised emergency authority.

We do so knowing that we have the benefit of hindsight, so we base our audit on what the decisionmaker knew or should have known at their time of taking action. Our goal is to ensure that they wielded their exceptional power wisely and properly. If they did, then it's an acceptable outcome. If they didn't, then we need to consider adding more guardrails/restrictions on emergency authority, and/or taking action against the person/agency who used it improperly.

Emergency authority relies heavily on the good judgment of whomever is granted it. Part of accepting a role with such authority is the mandate of exercising that good judgment, and being accountable when we fail to do so.