Promises, promises

In 2020, the Fed promised to maintain an average inflation rate of 2%. They abandoned that promise as soon as it was convenient to do so.

After the 2008 banking crisis, the government promised to refrain from bailing out small and mid-sized banks and instead allow FDIC to handle the situation. According to Bloomberg, that promise is also being reneged on:

US authorities raced on Sunday to stem jitters about the health of the nation’s financial system, pledging to fully protect all depositors’ money following the collapse of Silicon Valley Bank while also giving any banks squeezed for cash easier terms on short-term loans. . . .

The Fed in a separate statement said it’s creating a new “Bank Term Funding Program” that offers loans to banks under easier terms than are typically provided by the central bank.

Fed officials said on a briefing call that the facility will be big enough to protect uninsured deposits in the wider US banking system.

This is even worse than only bailing out SVB.  It means that other banks will get similar protection.  It is tempting to think that bailouts solve the problem, but in fact they just make it worse.  The underlying problem is moral hazard, and each bailout makes people behave even more recklessly going forward.

One common misconception is that moral hazard is not a problem because bank shareholders at SVB will lose a lot of money.  That misses the point.  Moral hazard doesn’t cause banks to want to fail, but it does tilt the optimal bank strategy toward a socially excessive amount of risk taking. 

Obviously most banks don’t fail even under our dysfunctional system, but the problem is getting steadily worse despite an endless series of regulatory fixes that don’t address the root cause of the problem.  When regulators plug one gap, banks find an alternative method of loading up on risk.

Another misconception is that we cannot reduce moral hazard because big depositors don’t pay attention to bank risk.  Of course they don’t.  Why should they?  But what if they feared losing their money?

The only solution is to reduce moral hazard.  Instead, we are moving in exactly the opposite direction—adding to moral hazard.  Financial crises will get ever more frequent in the decades ahead.

PS. This made me roll my eyes:

SVB depositors “will have access to all of their money starting Monday, March 13,” the government said in a statement, adding that taxpayers won’t be responsible for any losses associated with SVB’s resolution. 

No cost to taxpayers?  Let me guess—the Treasury has a magic wand.