The Federal Reserve’s bailout of Silicon Valley Bank on Sunday was a simple and universal announcement made to the whole world: Oops. It offered yet another reminder that a predictable and unchangeable monetary policy like Bitcoin’s might help avoid the schizophrenic, ad-hoc policies coming out of the Federal Reserve.
What happened to the U.S. economy? Buckling to public pressure to address the economic effects of the coronavirus pandemic, the Fed slashed its federal fund’s target in 2020, causing interest rates to collapse. When inflation inevitably followed, it rocketed rates upward in the most rapid ascent of interest rates since 1988.
What is a bank to do? SVB, like almost any bank today, follows the standard playbook of funding long-term assets (like loans and securities) with short-term liabilities (like deposits). So, it bought U.S. treasuries with the large influx of deposits that ensued during the pandemic. Since bond prices and interest rates move in opposite directions, the values of these bonds cratered when the Fed hiked up interest rates. So, the book value of SVB’s assets slowly and steadily deteriorated until it faced a bank run late last week.
What SVB Did Wrong
For sure, SVB management made their share of mistakes. Banks are in the business of risk management, and SVB leadership should have better hedged their asset portfolio. But there’s no evidence that SVB engaged in the kind of risky financial innovation that characterized the great financial crisis. Rather, SVB was naive in buying securities without adequately addressing interest rate risk. But the swift and unprecedented increase in interest rates will inevitably cause some banks in the economy to suffer, and this bank was SVB. And so, the devaluation of SVB’s assets reveals as much the erratic nature of Fed policy as it does the risk mismanagement of SVB.
There are voices in various quarters, including government officials up to and including the president, who claim that this wasn’t a bailout and that taxpayers won’t pay. Both are false. The intervention took two forms: an expansion of deposit insurance to include uninsured depositors above the $250,000 FDIC limit, and an emergency lending facility that the Fed established for all banks. Both are bailouts, though their details and consequences differ.
Making both insuredanduninsured depositors of SVB whole is an after-the-fact renegotiation of the deposit insurance terms set by the FDIC. A depositor bailout is still a bank bailout. Insuring all depositors weakens incentives for customers to search for banks with good risk management, eviscerating the market discipline required for banks to manage risk well and earn their customers. Similarly, emergency lending allows banks to borrow from the Fed, using the bank’s devalued securities as collateral, which the Fed will value at par. That’s like pretending your crusty old Chevy is a shiny new Cadillac. This also will lead banks to mismanage risk, knowing that any bad decisions that deteriorate their asset values will be covered by Papa Fed. All these will lead to future financial crises. In this twist of irony, bailouts create the very problems that they were intended to solve.
Second, taxpayers will bear the cost of these bailouts in the long term. The Deposit Insurance Fund (DIF) of the FDIC will pay for the expanded deposit insurance. As of the end of last year, the DIF had a balance of $128.2 billion, which includes a 27% surplus of $27.2 billion over the amount of insured deposits in the banking system. By the end of last year, SVB’s held-to-maturity securities alone fell in value of $21 billion, which will eat up a big chunk of this surplus, leaving little for other banks (like Signature Bank). The FDIC funds the DIF through fees, called assessments, that banks pay. Once these fees tomorrow rise in order to pay for today’s bailouts, banks will surely pass these higher fees on to consumers, by either raising rates on loans or lowering rates on deposits. Either way, all bank customers, i.e. taxpayers, will pay the price from the ad hoc expansion of deposit insurance forced on them by the government.
How The Fed Made Mistakes Too
As for the Fed’s lending facility, someone must bear the cost of the devalued assets that the Fed acquires as it lends out to those banks at well-below market rates. Where do such losses go? As with all actions of the Fed, those losses will accrue to American citizens through inflation. The Fed will absorb the losses from those devalued securities the only way it can, by increasing the money supply. There is no free lunch, not now and not ever, and as always happens with inflation, those costs are borne by the poor, and those on fixed incomes with little access to the capital markets.
It is tempting to discount the moral hazard that bailouts inevitably create in a time of crisis. I witnessed this firsthand during the 2007-2009 financial crisis, when I served on the Council of Economic Advisers of the Bush White House and advocated for limiting the TARP bailout. And many of those same arguments then are reappearing now: “group X deserves special treatment” or “doing nothing will lead to broad economic collapse.” Such statements are rarely backed with data or even reasoning. Like free speech, a commitment against bailouts matters precisely when it is difficult to do. Now is that time.
In the long term, we need is a monetary system where central bankers cannot simply tinker with the money supply as they wish. This would prevent the Fed from slashing rates to zero during a pandemic and then catapulting them upwards afterwards. Such a system would essentially bind the hands of central bankers, like Ulysses on his mast, so that the money supply expands in a predictable and unchangeable fashion. It may seem strange to want to restrict our choices, but as the history of the Federal Reserve has shown, granting a central bank the power to manage the money supply leads to an endless cycle of booms and busts. How many more times do we need to watch the same movie of easy money, poor bank management, and ad hoc bailouts that transfer wealth from the poor to the rich?
Asking Congress to restrict the operations of the Fed is unlikely to work, and asking the Fed to commit to a predetermined rule or formula for the interest rate is even less likely. The Fed will never admit that they cannot fulfill their mission of price and financial stability, even in the face of the worst inflation in decades and their direct responsibility for overseeing banks like SVB. No one wants to admit that they can’t do their job.
Bitcoin Can Be A Key Part Of The Solution
Technology offers a solution, and it comes in the form of bitcoin. No individual or group controls Bitcoin. Instead, a network of thousands of nodes across the world executes the rules of the Bitcoin protocol, which stipulates a predictable and unchangeable issuance of new money that no one can alter alone. All protocol changes require an open source development process, which takes years to coordinate a variety of independent stakeholders. There is no central bank in Bitcoin, and therefore no group of people able to execute arbitrary bailouts.
Maybe the Fed shouldn’t have raised rates so quickly this year. Or maybe the Fed should not have lowered them for so long during the pandemic. Hindsight is, after all, always 20/20. Or maybe it’s time to admit that monetary policy is just too important to leave in the hands of a committee of unelected officials deciding on their whim every six weeks. The political pressure to move interest rates in one direction or another is simply too strong for anyone to resist, no matter their best intentions. Bitcoin offers an alternative to discretionary central bank management, with its predictable and unchangeable issuance of new money, removing humans from the money supply decision. Although under a vastly different circumstance, El Salvador has managed to recognize bitcoin as legal tender, integrating bitcoin into the nation’s monetary system, without losing the benefits of traditional banking. As Americans, perhaps it’s time to ask whether our entire monetary system also needs not a small patch, but a major upgrade.