Every financial crisis begins with the untimely death of a canary in a relatively small metaphorical coal mine. The death was sudden and tragic, and the authorities were “shocked, shocked to discover that gambling was being practiced here”.
Nevertheless, government support is quickly provided to the financial victims and to prevent collateral damage to the banking system, for example by protecting elderly savers from bank runs in the UK. Northern Rock in 2007 and this month by technology companies in the case of Silicon Valley Bank. And then it gets serious.
On March 10, Silicon Valley Bank was ambushed by uninsured depositors who withdrew their money fearing the bank’s potential insolvency. The bank’s vulnerability resulted from poor risk management and regulatory oversight. Until last weekend, the federal government struggled with the prospect of a spreading bank run moved to complete all uninsured depositors at SVB and at Signature Bank, which New York authorities closed on Sunday.
On Thursday, 11 of the largest US banks moved coordinated by the Biden administrationannounced that they will inject $30 billion into First Republic Bank to strengthen their finances and increase confidence in the banking system.
This week’s canary in a larger mine was Credit Suisse, which received emergency financial assistance on Wednesday from the Swiss National Bank in the form of loans totaling $54 billion.
But the European Central Bank doesn’t seem to believe in canaries, so it raised rates another half a point on Thursday, even as the eurozone faces potential instability and presumably weak finances from its banks. At the same time, reports from European banking supervisors were published Criticism of the SVB’s care for uninsured savers. A European official said US authorities have shown “complete incompetence” by ignoring global standards and setting a dangerous precedent for further bailouts.
This is another kind of red flag that suggests we’ve reached Stage 2 of the current crisis: the debate over whether bailouts and bailouts create a “moral hazard” that rewards the reckless — bank executives in this case — for taking big risks without forcing them, they bear the cost of their actions.
A sharp rate hike and such rhetoric at this moment of crisis suggests a real potential for a policy blunder in the Eurozone. What will the authorities do if shaky stability becomes a problem for euro area banks? We can probably assume that the discussion in the European capitals will be very similar to that in Washington last weekend.
This idea of ​​moral hazard is carried through the debate over a financial bailout. It may be an intriguing question, but it’s kind of a political monster.
We regulate and supervise banks to control moral hazard. Whenever there is a bank run, the question always arises: Should we support banks in bad taste, even though of course it increases their incentive for poor performance and misconduct in the future? Or should we just let them fail?
There is a certain anti-modern, punitive aspect to these discussions. First, moral hazard is indeed bad among bankers, as they take more bad risks when they are less afraid of the consequences. Second, impending bank failures show that excessive moral hazard already exists among us. It is already well documented that Silicon Valley Bank failed because management was not careful; Credit Suisse observers are also concerned about this. But do we really want to let the pain go where it wants, despite the suffering inflicted on innocent bystanders?
U.S. Treasury Secretary Andrew Mellon reportedly advised President Herbert Hoover to “liquidate labor, liquidate supplies, liquidate farmers, liquidate real estate”. That was in the early 1930s, and that mindset—”people will work harder, live more moral lives” after a financial collapse—was a big part of what brought us the Great Depression.
Of course we must do everything we can to prevent bank runs by improving regulation, tightening capital requirements and making supervision more effective. However, the banking industry always pushes back, calling for deregulation and stating (unfoundedly) that the rules should apply to US companies and innovation. This counter-argument already starts with ridiculous claims to confuse the story, such as that the SVB’s problem is that it is too left-wing.
In fact, the core problem is always that the people who run banks are compensated on a return on equity basis, with no risk adjustment. As a result, they want as much leverage as possible — higher debt versus equity. These managers also want to take as much risk as possible. With that combination, they make millions in good times and run away in bad times, and we as a society have to bear the cost.
The tax reforms mandated by Dodd-Frank lasted eight years before being significantly reversed under the Trump administration. Now, after seven years of lighter official scrutiny, the financial sector is again poised for reckoning.
We should be wary of policies that create moral hazard, but context is everything. If the uninsured depositors of the SVB suffered significant losses, this would have resulted in a massive deluge of deposits from smaller and regional banks in safe havens (major banks and government bonds). This money flight would have ruined many, perhaps thousands, of otherwise healthy banks.
The immediate banking crisis may have eased, but it is not over yet. Will European regulators succumb to the temptation to set an example to any bank if moral hazard concerns resurface in Europe? One thing is certain: what they do will have global consequences, including for the United States, and we need to adapt to that.
Simon Johnson is co-chair of the CFA Institute Systemic Risk Council, former chief economist at the International Monetary Fund and professor at MIT Sloan.
Source: LA Times
Roger Stone is an author and opinion journalist who writes for 24 News Globe. He is known for his controversial and thought-provoking views on a variety of topics, and has a talent for engaging readers with his writing.
