Monday, March 13, 2023

 Call it what it is

It is understandable that the Federal Reserve and FDIC are reluctant to use the “b-word” to describe the operations announced at the weekend to respond to the crises at Silicon Valley Bank and Signature Bank of New York.  As bailouts go, they don’t look particularly expensive.  The FDIC has extended its guarantee to cover uninsured deposits at these two banks (which won’t cost anything if the assets are good).  And the Fed will use the Treasury’s Exchange Stabilisation Fund to backstop a funding program to allow any other banks with similar problems to trade out of their unrealised securities losses in a reasonably graceful way.

Neither of these programs will cost taxpayers’ money, as the press releases identify.  As long as we pretend that FDIC premiums aren’t taxes, that the ESF is costless unless it takes a loss and that credit from the Fed doesn’t count, then the economy is getting all the benefit of stabilising the system, for free.  It’s good policy.

But a bailout is what it is, and what it ought to be called.  The credit lines represent a subsidy to bad treasury management on the part of banks who should never have allowed themselves to get so badly overextended in terms borrowing short and lending long.  (They also, perhaps conveniently, avoid anyone having to ask impertinent questions about why the bank supervisors allowed these positions to develop in the first place).

The extension of the FDIC guarantee, though, is not just a bailout – it’s specifically a bailout for billionaires.  It undermines the whole point of limiting deposit insurance, and exposes the fund to risk.  And the benefit of this risk assumption mainly goes to the venture capital investment industry.

That industry has, frankly, done the exact opposite of having covered itself in glory over the last week.  We have discovered that major VCs put pressure on their portfolio companies to deposit at Silicon Valley Bank.  Then they encouraged those same companies to run on the bank.  And then some of them spent the weekend attempting to raise panic about the rest of the financial system, in order to put pressure on the government for a bailout.  All after having spent the previous decade talking about “moral hazard” with respect to student loan forgiveness, and praising themselves for “disrupting” the old fashioned financial system with cryptocurrency.

If there had been no bailout – if the FDIC had operated normally and not extended insurance to people who hadn’t paid the premium – then the bill would have arrived at the VCs’ door.  They are the owners of the tech startup companies, and they would have been the ones responsible for ensuring that those companies could make payroll if they had lost money in a bank failure through no fault of their own.  It might not have been pleasant for the VCs to put up more funding, or to admit that their contribution of management expertise and financial acumen had been so spectacularly negative, but they would still have done it. To let a good investment go bad in this way would, as Professor John Cochrane points out, a clear example of the sunk cost fallacy.  The venture funds were the source of the cash that was at risk in the SVB failure; it’s their loss that has been socialised.

And the fact that the VCs were able to use their portfolio companies as human shields in this way – a natural extension of the pretence that venture capitalists are in the tech industry rather than the financial industry – shows us what the real long-term cost of our current system of bailouts is, in terms of policy.  Because the Fed and FDIC will always find a way to stabilise the system, populist yahoos and libertarians can rail against “bailouts” and pass legislation to “protect the taxpayers”, all on the understanding that it is purely playtime; that when things get serious, someone will find a way to bail them out.

This is no way to run a financial system, particularly since there is the constant risk that one day the anti-bailout loudmouths will accidentally succeed. The Fed needs to say, loud and clear, that “Yes, this is a bailout, and that is good.  A bailout is often the best and cheapest way to prevent a catastrophe.  The people benefiting from it may be quite comically unattractive and undeserving, but finance is not a morality play.  Take your bailout and try to be less silly next time”.


  1. Given that a full three paragraphs here are dedicated to (correctly) complaining about VCs getting a bailout, I think it's only fair that you count yourself among the "anti-bailout loudmouths."

    Positing a future in which the public does not find the word "bailout" disagreeable seems a bit of a dubious defense of the word-- I can't imagine how that might come to be.

    What I'm hearing is that you want to use the word because you want to highlight the cynicism, avarice, arrogance, and hypocrisy of the Silicon Valley venture capitalist GPs who both shoveled out the LP cash that ended up in uninsured deposits, and then sparked the run on them to boot, and came away unscathed.

    Believe me, I'm with you there. But maybe you should just leave it at that? I know you're deft enough with the pen to dodge a semantic tar pit when it suits you!

  2. "They are the owners of the tech startup companies, and they would have been the ones responsible for ensuring that those companies could make payroll if they had lost money in a bank failure through no fault of their own."

    VCs often (generally? usually?) are not the owners of the companies in the sense in which you are suggesting it. Most are minority investors. For example, for one startup with which I am quite familiar, there are no external investors who own more than a third of the company, and only one with more than a tenth of it. Of course, minority investors are not responsible for ensuring that a company can make payroll. It's the board of the company who is responsible for that. If some VCs are asking for a subsidy, you in turn are asking them as a category to take on obligations no one ever thought they bear.

    Also, as a purely practical matter, VCs are not banks, and were never going to be able to provide infusions of cash this week to help companies make payroll. ADP's deadline for funds for this Friday's payroll is tomorrow. Even if you assume that the VCs had ready capital to deploy, which strikes me as quite unlikely, there was bound to be a liquidity crunch for process reasons.

    Agree completely that many VCs are bad people who acted poorly here.

  3. No one understands how horrible bank panics are. The US suffered too many under the gold standard (and there are still idiots who think that system worked, because "shiny metal is intrinsically valuable"). That said, I think the Fed avoided using the term bailout because the very psychotic people you mention would run with it and get Trump to say it on twitter and then when Trump gets re-elected and declares himself King of the Galaxy and Savior of the Confederacy, he will eliminate the Federal Reserve and start issuing coins out of an alloy of radium and gold (the masses will enjoy glow-in-the-dark money).

    Personally, I think we should outsource the Federal Government to Switzerland or Singapore, or perhaps a consortium of both. They could not be worse than what we have, and the absence of elections would be good for our souls.

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