SVB , moral hazard, and risk, part 2

Greg Mankiw on the failure of SVB:

I am not particularly concerned about the moral hazard associated with insuring all bank deposits (though the expansion of deposit insurance should be done explicitly, rather than through the implicit and ad hoc process now occurring). It is not realistic to expect bank depositors to monitor the health of their banks.

I agree. It’s impractical to expect depositors to adequately assess and monitor risk, as I discussed earlier.

Arnold Kling weighs in again on SVB Deposit Insurance and Moral Hazard:

The rating services would have expertise in penetrating bank balance sheets, and they would tell civilians where it is ok to put money . But would that rating industry reliably do its job, or would it screw up royally, as when rating agencies of mortgage securities played a pivotal role in the financial crisis of 2008?

He just answered his own point. Rating agencies evidently cannot do their jobs well, like we saw in 2008. As said before, banks keep finding ways to fail no matter what anyone does. Every decade, it’s a different trigger or cause. This time it’s treasury bonds; in 2008 it was housing. We cannot prevent crisis because we cannot anticipate all the things that can possibly go wrong. No one expected that VCs would also coordinate such a rapid withdrawal of assets. How does needing to raise $1.8 billion mean total insolvency and a $100 billion losses 48 hours later? Maybe this proves that transparency is the problem, not the solution. Had SVB coordinated a bailout privately, a run could have been prevented.

Unless shareholders and managers are satisfied with just a modest level of returns, they will look for ways to grow their deposit base and take on a risky asset mix. Heads, they win. Tails, the taxpayers lose. That is moral hazard

Hmm…shareholders and managers lost everything in SVB. The stock is worthless and what remains will be distributed to creditors. Not to mention, possible legal and civil penalties from an investigation. So it’s more like they lose too, not just taxpayers. The closest thing I can think of a moral hazard argument is the depositors being incentivized to take on risk for a small increased return on deposits, knowing that they will be bailed out.

The difference between a 0% yield with 3-month bonds, like in early 2021, vs a 1-1.5% yield (like by buying 10-20 year bonds in 2021), entails taking on considerable tail risk, as was seen with SVB, just for that extra, tiny yield. But even CDs in 2021 were offering 1%. We’re not talking huge returns here, in which suspicions would be aroused. If a bank is promising a 1% real return on deposits, is that a reason for red flags to be raised or being greedy? I think not.