The bailouts of Signature Bank and Silicon Valley Bank have conjured up the phrase “moral hazard.” Moral hazard is defined as a lack of incentive to guard against risk where the consequences of risk-taking is insured by some backstop. In this case the backstop to Signature Bank and Silicon Valley Bank’s mismanagement of their portfolios is the bailouts provided by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the United States Department of the Treasury.
Shareholders and certain unsecured debt holders will not be protected by the bailouts, according to the Board, Treasury, and the FDIC.
No surprise that purchasers of bank stock or creditors of the bank will not be assisted. For centuries, shareholders and creditors have assumed the risks of putting their monies into a going concern. That is what a bank is, a going concern, an enterprise. In this case, an enterprise in search of returns. The greater the risks, the higher the returns the adage goes. In the case of these banks, they encountered risks that they were likely too inept to manage.
The government should bear the brunt of the ineptness. Proponents of the moral hazard argument would put me in the minority when I conclude that the government should be expected to bailout bank depositors. The mission of commercial banks is to wholesale the United States currency. They receive their charters from federal and state governments to carry out this act. They carry out this charter by engaging primarily in two actions.
One, the banks create and lend money to individuals and businesses whose activities generate returns that exceed the banks’ costs for maintaining deposits and conducting other operations.
Second, commercial banks buy and sell reserves in the interbank market. The reserves purchased in this market allow the banks to have sufficient funds necessary for settling payments and meeting Federal Reserve System requirements for keeping a level of capital available for staving off runs on a bank.
Depositors are clueless to these activities. In theory, their deposits are sold in the loanable funds (credit) markets to other consumers or businesses. In actuality, their deposits are used as leverage for the banks to borrow from other banks, individuals, and businesses. The government i.e., the Treasury, and the Federal Reserve System encourage these hypothecated activities seeing them as necessary for a working financial system and to increasing the value of the U.S. dollar.
A dollar that cannot move toward activity that generates highest returns is of no value and an erosion of value sends the wrong message to the globe.
What the “moral hazard” critics overlook is the economic impact on those of us who rely primarily on wages to get by. Hiccups in the current monetary and financial system in the immediate term that change the wage earners standard of living have a greater detrimental impact versus those individuals buttressed by the ownership of claims on income. While it behooves the wage earner to reduce his or her exposure to the current monetary and financial system, the short-term bandage on this injury should be applied. The wage earner should bear in mind that this fix is short-term and that it is up to us to seek out a longer-term solution.
In the short-run, replace “moral hazard” with “necessary political fix.”
17 March 2023
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