The Bank Reform That Will Harm Our Economy and Our Politics

In the wake of the failures of Silicon Valley Bank and Signature Bank — the second- and third-largest bank failures in American history — members of Congress are debating what should be done to prevent future failures. Some have zeroed in on a new proposal to provide a governmental guarantee to bank deposits of any size.

This is a mistake. The current limit, $250,000 per person, is more than adequate for any banking needs an individual might have. An unlimited guarantee to banks that their debts to depositors will always be 100 percent backed by the government is an invitation for the banks to print money with Uncle Sam’s credibility but for their private profit. It is a government benefit that would aid the wealthiest among us, at a price to be borne by the rest of us.

Some have linked any such expansion to a corresponding increase in the rigor of bank supervision and regulation. The failures of Silicon Valley Bank certainly illustrate how much more rigorous bank supervision should become. But a quick look at banking history shows that linking expansions of public guarantees to tighter supervision is doomed to fail.

When Congress increases insurance guarantees, as it has done many times in the past, it is often with a commitment to greater regulatory scrutiny. And then banks, better organized and able to navigate the halls of politics with more acumen and dexterity than perhaps any other interest group, work to erode the rigor of those policies. Bank supervision and regulation — largely discretionary functions that are highly dependent on the presidential appointments that set the tone on how that discretion is used — inevitably fall victim to these pressures.

Bank guarantees, on the other hand, are forever. From the first days of federal deposit insurance in 1933 to the present, the government has never, not once, lowered its official guarantees to banks. The guarantees move in only one direction, always up, even as supervision and regulation regularly fall by the wayside.

We don’t need to look far to see this dynamic play out. After extensive guarantees of not only the entire banking system — all depositors, rich or poor, plus money market funds, insurance companies and all the rest that made the 2008 financial crisis so extraordinary and so politically toxic — Congress extended deposit insurance per depositor to $250,000 from $100,000. In 1934, the limit was $2,500; correcting for inflation, the limit in 2008 would have been roughly $40,000.

According to the Federal Reserve, the average American bank balance held in transaction accounts is around $42,000, as of 2019. The current deposit limit is so much higher that we cannot say it is intended to protect anyone like the average saver.

After raising the limit, Congress deliberated at length before passing Dodd-Frank to ensure, in the words of Barack Obama upon signing the law, that “there will be no more taxpayer-funded bailouts — period.” To help make good on that commitment, Dodd-Frank instituted a number of different regulatory and supervisory tools that were meant to keep banks safe, sound and fair to their customers. But within just a few years, Congress pulled back on supervisory discretion for some of the very banks that are now at the center of the current crisis.

A system of public guarantees for bank debts as far as the eye can see will mean only pain for our economy, our financial system and, perhaps most important, our politics.

If banks really paid the full value of insurance for the $18 trillion of deposits in the country, as some who promote this idea propose, in good times that would represent a gigantic pile of cash that bankers and their lobbyists would almost certainly insist should be given back to them for their own purposes. They would most likely succeed in this effort; they always have. What would emerge from that success is an unfunded mandate to offer protections to the wealthiest citizens, paid for by all of us together. Economically, that’s a deeply regressive policy. Politically, it is toxic too. Headlines that remind us all that multimillionaires receive taxpayer bailouts while the average citizen struggles to scrape by will only increase in frequency.

The critics of the current regime have one important point: It has never made sense to treat wealthy individuals and small businesses identically. Multimillionaires and billionaires don’t need the same federal guarantees as a small company trying to make a monthly payroll.

Some have sensibly suggested that we therefore focus exclusively on those kinds of accounts, which would receive full government support. For those small businesses that are struggling to meet payroll and do not want or know how to develop the cash-management expertise of large corporations, we should extend protection.

But that same umbrella should not extend to the wealthy. In fact, Congress should drop the level of protection for wealthy individuals to $200,000 per depositor per bank and expand it to $2 million for small businesses, an easy-to-remember order of magnitude of difference between the two groups. These amounts are more than enough to cover any needful banking relationships and put depositors in the driver’s seat to practice good risk management, practices that the depositors of Silicon Valley Bank failed spectacularly to do. Lowering the protection for individual depositors would also send the strong signal that our historic practice of moving the public goal posts for bank guarantees can be reversed.

These changes are not meant to solve the problem of bailouts, a problem that is only as good as the regulators and supervisors who carry out our laws. They are meant instead to sound an alarm. Our present deposit insurance system isn’t working. Rather than admit defeat on the entire enterprise and provide underpriced insurance for underregulated banks without limit, let us instead reinforce a system that worked well, within limits, through most of its history.

Peter Conti-Brown is a professor of financial regulation at The Wharton School of the University of Pennsylvania. He is working on a book on the history of bank supervision in America.

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