What should the government do about Silicon Valley Bank?
The answers fall into two general categories: "rescue" and "let the market work."
The "rescue" argument was laid out by Bill Ackman in a Saturday morning tweet. Basically, he says, the government stepping in to fully protect depositors over and above the $250,000 FDIC limit would prevent contagion. Failure to act along those lines will result in additional bank failures as depositors at other mid-sized banks move their money out of those banks and into money market funds, Treasuries, or presumably too-big-too-fail institutions like Citi or JPMorgan Chase. Ackman argues that asking depositors to assess bank safety is unrealistic: "I am a pretty sophisticated financial analyst and I find most banks to be a black box."
The "let the market work" argument was laid out in part by George Kaufman in a 1987 working paper for the Federal Reserve Bank of Chicago (hat tip: George Selgin). He writes: "On net, it appears that bank runs do not deserve the bad reputation they have received. They did a dirty job in maintaining market discipline. But someone had to do it!" Kaufman explained, "deposit insurance makes depositors less careful about evaluating and monitoring the financial integrity of their banks....as a result, insured banks are less restrained in increasing their risk exposure." The theory, at least, is that making an example out of a failed bank might encourage innovations in banking robustness. Perhaps it would spawn "narrow banking" along the lines suggested by John Cochrane, in which demand deposits must be backed entirely by short-term Treasuries. Perhaps it might generate a bank with gold-backed deposits, or encourage businesses to store their extra money in gold bars. Maybe depositors would purchase private insurance for the portion of deposits above the federally insured amounts, with premiums varying depending on the strength of the deposit-holding institution. Maybe a competition would emerge among the states to provide deposit insurance above the federal level, with a race-to-the-top among states that provide the safest environment for depositors. Maybe people would pay to subscribe to private services that rate bank safety similar to how Consumer Reports rates automobiles or Zagat's rates restaurants or U.S. News ranks medical schools.
Wherever one comes down on the "rescue" versus "let the market work" debate, one thing seems pretty clear: relying on regulators to monitor and prevent failures is an inadequate solution. The regulators are not perfect. The bankers are not perfect, either, and if they can make money short term by taking more risk, they will. The whole Silicon Valley ecosystem was built on a certain amount of wishful thinking—your money-losing startup was somehow worth a billion dollars?—and a willing suspension of disbelief. Sometimes it worked out surprisingly well—Amazon, Netflix, Tesla, Uber, Airbnb, Paypal—sometimes it didn't: FTX, Theranos. Next week, Silicon Valley VC's will probably be looking at pitch decks from founders with ideas on how to help depositors solve the problem of bank fragility. There are plenty of phonies running around California with startup ideas, and plenty more collecting large management fees from public pension fund investors by allocating money to the startup ideas. But if you had to place bets on who is better situated for success at fixing the uninsured large depositor problem—Congress and quasi-independent regulators, or the Silicon Valley tech bros, with all their problems—maybe you'd bet on the tech bros?
