Moneybeat: Mislabelling the bailout

MARY REICHARD, HOST: Next up on The World and Everything in It, the Monday Moneybeat.

NICK EICHER, HOST: It’s time to talk business, markets, and the economy with financial analyst and adviser David Bahnsen. He’s head of the wealth management firm The Bahnsen Group and he’s here now.

David, good morning!

DAVID BAHNSEN, GUEST: Well, good morning, Nick, good to be with you.

EICHER: It’s been quite the week and probably some consequential days still to come with the banking crisis we face. But here we are a week into it. How do you assess?

BAHNSEN: Well, it's a very complicated deal, because I think that the crisis was very limited. But by nature of what fractional reserve banking is, financial contagion can become very, very hard to limit. It will be easy for it to not stay limited, which was sort of the point of what the government was doing. So there is a lot I think, of mislabeling of what happened. And yet that's not to say that there aren't policy mistakes. To call what happened a bailout is a little deceiving in the sense that the people who own Silicon Valley Bank were very rich, and they're not now. They were blown out, all the equity is worth the zero, and none of the value of that bank was bailed out, the owners have an asset currently worth $0. And even the debt holders, the people who lent money to the bank, what we would call unsecured bondholders, they are getting back zero cents on the dollar. And that's very different than past situations that we would have called bailouts where there was some form of recovery for the either creditors or owners of the entity. But what we're referring to here are the customers of the entity, the depositors who had money on deposit with the bank, over $250,000, the insurance limit, and it is certainly true that they probably would have taken some hair cut, meaning they would have got back something less, I think it's about 2% less than the amount they had on deposit. But there are some estimates that it could have been as much as 5%. So they could have got back somewhere between 95 and 98 cents on the dollar. And it would have taken a while. They wouldn't have gotten it back right away. And so certain companies wouldn't have met payroll, and even the very few Mom and Pop type customers they had may not have been able to get access to all their cash. So in that sense, it can look like there's a bailout. And it's definitely a very dangerous precedent of suggesting that an understood and congressionally passed mandate can be discarded this way, it creates a moral hazard. And it obviously creates a whole lot of political optics. But why did they really do it? Because ultimately, a whole lot of people were withdrawing money from other banks that did not have the same level of problems that Silicon Valley and Signature Bank did. And then if they withdraw a lot of money, it creates those problems at other banks. No bank has on hand all the money that its depositors have given it. And we all know that, and people can agree with it or disagree with it. But we've had a fractional reserve banking system for 100ish years. And the fact of the matter is that contagion is a very hard thing to contain once it starts. And I have no doubt that's what policymakers were really afraid of. But Nick, it gets very complicated, because this bank was so poorly managed. There's a lot of questions as to why the regulators missed it. I believe that the Fed is incredibly culpable here, both in the bubble they helped create that funded these crypto and venture capital and other type things. But then also in the way that they helped burst the bubble by, I think, excessively tightening monetary policy the other way, which is really what hurt the value of this bank's bond portfolio, in other words, their own capital. So you have the Fed, you have regulators, you have a poorly managed bank. And then questions about why we have FDIC coverage at all, if they're going to just get rid of it whenever they deem it systemic risk.

EICHER: We better hold off on listener questions again this week … and if you’re one who’s sent something … not to worry, we’ll get to it. We’ve fallen behind a bit in the past, but we do read and consider everything and we do always catch up. But the reason I say that is I think it’s important … you covered the waterfront, David, maybe we zoom in on one key question … so how about tackling the question, where are we now with federal deposit insurance … the effective end to F-D-I-C limits … but only if you’re in the category of “too big to fail”? So talk about that.

BAHNSEN: Yeah, I would say that the issue of FDIC limits is probably the most widely practical. With Silicon Valley Bank and Signature Bank, if people were to say right now the assumption is that there's unlimited FDIC insurance at every bank, because how could they have bailed out the depositors there and not elsewhere? I wouldn't disagree. I think that optically and politically, it would be absolute bloodbath if there was a bank that were to fail now in Iowa, or in Texas that they didn't do the same thing for. And yet, my problem from a policy standpoint is that there is still a $250,000 limit. And so they can either make explicit that nope, there's unlimited depositor protection in our country, we will not let a bank depositor lose money just because a bank fails. And if they want to do that, which by the way, I'd be fine with, but they got to pay for it. And how do you pay for that kind of protection? You have to raise the premiums on the insurance that the banks pay for. And of course, banks don't really pay for it, bank customers pay for it. So it'd be a lower interest rate paid on deposits, it'd be a higher mortgage rate charged on mortgages. There's a number of things like that, that would really be the source of paying for it. To those who say, Oh, come on, how can they protect every dollar unlimiteddepositor protection? Well, again, we're talking about very rare bank failures. And there are incredibly tight constraints that even when a bank does fail, people have to remember that these banks have to have certain capital that they keep on hand. And so that's why I say Silicon Valley Bank was as poorly run as things could be. But they're still we're talking about 2% to 3% haircuts depositors would take, so we wouldn't be putting the entire banking system at risk, we would be putting the spread of bad banks at risk, and they would pay for it through higher banking cost. Now, I'm not suggesting they do that. But what I am suggesting is that if we're going to have FDIC limits go away, let's say so. Let's not do an implicit guarantee, like we did with Fannie Mae and Freddie Mac, and then end up having it become an explicit guarantee when there's a crisis, which is what happened this week. It was legal, they have the right under exigent circumstances where they believe there to be systemic risks, but politically, in a country that is already so susceptible to divisive things, if some tiny community bank in Mississippi went under, and they didn't deem it systemic, which it probably wouldn't be, then what is the message? That they cared about Silicon Valley venture capital depositors who donated to the Hillary campaign, and they don't care about a small depositer in Mississippi? Even though that isn't true, which it very well may be. But even if it weren't, the objects are so bad, it's an unhealthy way to run and protect our country's banking system. So there needs to be either an elimination of moral hazard where people do feel pain, or there needs to be an explicit policy. But people have to understand when they say, I wish those depositors had gotten what was coming to them, That they had over $250,000 coverage, that it was a bad bank, the law is the law, people have to understand that all of that is true, and sounds very good, but then your bank was next, or maybe not, but someone else's bank was next. You know what I mean? That's really the problem is a banking contagion is very hard to stop the spread on. And so as we sit here three years ago, for you know, the anniversary of when we were talking about stop the spread. Here we are again, worrying about stopping a spread. This time it was a banking contagion.

EICHER: Three years, hard to believe!

Well, as I say, we are going to get to listener questions, I promise. The email address is feedback@worldandeverything.com.

Thanks to David Bahnsen is founder, managing partner, and chief investment officer of The Bahnsen Group. bahnsen.com is a good place to go to read deeper.

David, imagine we have big days ahead.

BAHNSEN: Well, it's going to be an adventurous week this week. So we'll look forward to talking again next week. Thanks so much, Nick.

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