Taxpayers at Risk: The Cost of Bailouts in the Banking Industry
The recent collapse of Silicon Valley Bank (SVB) and Signature Bank has raised concerns about the impact of bank failures on taxpayers. When banks fail, there is a risk that the government will step in and provide a bailout to prevent a wider financial crisis. These bailouts are funded by taxpayers. That means that taxpayers are always at risk when the government seeks to prevent or modulate bank failures. In this article, we will explore the cost of bailouts in the banking industry and the risks that taxpayers face.
The Moral Hazard of Deposit Insurance
Deposit insurance is a government-sponsored, albeit institution (customer) paid insurance that protects depositors if a bank fails. This insurance creates a moral hazard, where depositors do not make active investment/banking decisions, knowing (at least to the stated insurance amount) that the government will step in to protect them. Thus people chase interest rates, free services, or convenience, and ignore what the bank does with their money believing it is always just there. This can lead to banks taking on more risks than they should as they also chase returns and growth. Banks operate on thin margins and the volume provides their cushion.
Liquidity is both required and a death sentence. Too much and they fail to earn a profit. Too little and a run on the bank destroys them. All of this is under an impression that the government won’t let them “fail” to the point where depositors actually risk their uninsured deposits.
That is the moral hazard. When there is no true risk, behaviors are modulated to accommodate. Finally, hindsight is always 20/20. Bad decisions weren’t necessarily wrong decisions at the time.
Taxpayers are Always at Risk with any Form of Bailout
When a bank fails, the government may choose to step in and provide a bailout to prevent a wider financial crisis. That is what happened over the weekend of SVB’s failure. Fear that the global system would crash. This type of bailout is funded by taxpayers, which means that taxpayers are always at risk when banks fail. Ignore what President Biden said. Taxpayers funded it. Directly or indirectly. Period. This is especially true when the government is using other people’s money to bail out a failing bank. This frequently creates resentment among taxpayers who feel that their tax dollars are being used to bail out wealthy investors.
Taxpayers are Not Protecting the “Investors” of the Bank
It is important to note that taxpayers are not protecting the “investors” of the bank, at least in the SVB matter. Rather, they are protecting the bailout of depositors who were not thinking about the risks involved with banking. Depositors should be aware that banking involves risks and that deposit insurance should not be seen as a guarantee that their deposits are completely safe. The failure of SVB highlights the importance of maintaining sufficient liquidity in banks to prevent these types of collapses.
SVB is an Old-Fashioned Bank Run on Liquidity
The collapse of SVB has highlighted the importance of maintaining sufficient liquidity in banks to prevent these types of collapses. When banks do not have enough liquid assets to meet their obligations, they may fail, leading to a wider financial crisis. This underscores the importance of prudent risk management and the need for professional management (first), investors (second), customers (third), and (finally) regulators to monitor banks’ liquidity positions. This isn’t the first run on a bank or bank failure. Back in the 80s, there was FSLIC (Federal Savings and Loan Insurance Company) challenge.
Savings and Loans were in the mortgage business. Lending long on fixed rates and using short-term deposits for liquidity. When the inflation and deposit interest paid was greater than the fixed mortgage rates, this is called an inversion curve, and banks fail.
History may not repeat, but it sure rhymes (I think Mark Twain said that).
We’re Surprised that Other Banks are Not Going Down
The fact that other banks have not collapsed in the wake of the SVB and Signature Bank failures is surprising. This may be because people are moving their funds to larger, more established banks that are perceived as “too big to fail.” However, this also highlights the need for a stable banking system that is not reliant on the success of a few key players.
The cost of bailouts in the banking industry is a significant concern for taxpayers. Deposit insurance can help to mitigate some of the risks associated with bank failures, but it also creates a moral hazard that can lead to instability in the banking system. Policymakers and regulators must balance the need for stability in the banking system with the need to prevent moral hazard and protect taxpayers from the cost of bailouts.
Takeaways
- Deposit insurance creates a moral hazard where depositors may not make active investment/banking decisions and banks may take on more risks than they should.
- Taxpayers are always at risk when banks fail, and any form of a bailout is funded by taxpayers.
- Taxpayers are not protecting the “investors” of the bank, but rather the bailout of depositors who were not thinking about the risks involved with banking.
- The collapse of SVB highlights the importance of maintaining sufficient liquidity in banks to prevent these types of collapses, and regulators should monitor banks’ liquidity positions.
- The fact that other banks have not collapsed in the wake of the SVB and Signature Bank failures is surprising and highlights the need for a stable banking system that is not reliant on the success of a few key players.
If you’ve been away or occupied, you may have missed recent news about the collapse of a few banks that could have a domino effect impacting not only the banking sector but also you, our Customers.
In the US, when banks fail, the government may feel obliged to provide financial aid to avoid a broader economic crisis, that is ultimately funded by US taxpayers. This raises crucial concerns about the expense of bank bailouts and the dangers that citizens would be exposed to. This article examines these topics by discussing the moral hazard of deposit insurance, the significance of bank liquidity, the risks to investors and taxpayers, and the importance of sound risk management and regulation in maintaining a secure banking system.
If you are interested in learning more about the difficulties and intricacies of balancing financial stability while safeguarding citizens in the banking industry or if you have any queries, require clarification, or need assistance comprehending how and why these current events could affect you and how to protect yourself, please reach out to us at Morris + D’Angelo. This is our area of expertise!
Daniel Morris
Daniel frequently provides Media Content via Workshops, Podcasts, and Printed Articles on topics like Bitcoin and Cryptocurrency, Wealth Preservation and Planning, Global Banking, and many other high-level financial topics that serve and demonstrate the Value of our Global Network that should be of interest to those who need Private High-Wealth Services.
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