What Warren Buffett Can Teach Billionaire Bankers And Depositors
(Bloomberg Opinion) -- A little jeopardy goes a long way in getting people to be responsible. As the Federal Deposit Insurance Corp. cleans up after the collapses of Silicon Valley Bank and Signature Bank, it’s worth asking why bank deposits should ever bear any risk.
If all deposits were insured, no one would fear losing their cash and perhaps there would never be bank runs. Certainly, the FDIC wouldn’t now be sending America’s banks a $15.8 billion bill to cover its costs from rescuing uninsured depositors at the two lenders. There likely would have been no systemic spillover threat to the economy forcing the FDIC to act.
Fear is dangerous: It is contagious and can become self-fulfilling. But up to a point, it is useful. Anyone with large amounts of cash to manage — corporate treasurers, fund managers, very wealthy people — to be thinking about where to put it based on risk and return. That is how price signals are meant to be created and bring discipline to markets.
But maybe this view is misplaced idealism in a practical world. There is an idea that fear doesn’t enforce enough market discipline on banks because, ultimately, the state always has to step in to stop panics. In bank runs past, deposits have mostly been covered. Depositors don’t think enough about risk, the argument goes, because they know they’ll likely be rescued.
However, Warren Buffett argued at Berkshire Hathaway’s annual meeting this month that runs still happen because people don’t get this.
“I mean, you shouldn't have so many people misunderstand the fact that ... although there is a $250,000 limit on the FDIC, the FDIC and the US government and the American public have no interest in having a bank fail and have deposits actually lost by people,” he said.
So what’s going on, do depositors sense jeopardy or not? Trouble is it’s probably both: Uninsured depositors don’t think enough about risk in normal times, and then all depositors are most likely to panic at exactly the times when panicking will cause the most chaos.
If depositors do mostly get bailed out, why not prevent panics by making that outcome explicit? Why not, as billionaire investor Bill Ackman demanded in a tweet this month, create a system-wide deposit guarantee now?
That would be bad in my view. If deposits are always guaranteed, bank executives and shareholders need not worry about the risks they take with our money. In fact, they’d probably be more incentivized to take bigger risks because they’d get to keep the rewards if they won, but only lose a fraction of the money wagered if they lost, as Matt Levine described excellently back in March.
Regulators and central bankers think about this sort of thing, of course. After the 2008 crisis, they increased the amount of liquid assets that banks must hold to repay depositors and tightened up rules on the amount and type of risks that banks can take. Yet runs are still happening! We could increase deposit insurance even more, demand more liquid assets be held and further tighten control over risk-taking — essentially making banks solely payment utilities that don’t offer loans (aka narrow banks). But this would be a very inflexible system, slow to respond to demand and with less credit available generally.
The FDIC seems to be trying something different. In divvying up the bill for SVB and Signature, it will charge banks based on the amount of uninsured deposits on their balance sheet. That could incentivize them against relying too much on this kind of funding in future. The biggest banks have the greatest proportion of uninsured deposits, which is probably partly unavoidable because they will have large corporate clients with the most cash to manage. However, it does mean that banks most able to afford it will pay the greatest share of the bill.
The FDIC charges show that jeopardy attached to uninsured deposits cuts both ways. It should help keep both depositors and their bankers honest. However, there must be a quid pro quo for the practical reality that the state has to stand behind the system and protect the economy when very bad things threaten it. There should be financial justice. Buffett thinks the world has lost that.
Bankers and their leaders are too focused on getting rich and suffer too few consequences when things go wrong. “If you run a bank and you screw it up, you're still a rich guy and the clubs don't drop you and the charity groups don’t stop asking you to benefits and the world goes on,” he said. “That is not a good lesson to teach people who are holding the behavior of the economy in their hands.”
I basically agree. It would be far more effective to try and create greater penalties for bad management or negligence than to ask the state to flat out guarantee all our cash.
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Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.
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