What Counts As a Bailout?

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Things moved very fast early Sunday evening. As you likely now know, the troika of the Fed, the FDIC and the Treasury axed a second bank — Signature Bank of New York — and decided to guarantee all deposits at Signature and Silicon Valley Bank because of “systemic risk” to the whole banking system. As noted yesterday, the issue at least with Silicon Valley Bank (SVB) seemed to a significant degree to be one of liquidity. It appears to have assets to cover the great majority of its deposits. So the costs to the FDIC should be limited, and perhaps there’s no cost at all. I’m less clear on the exact situation at Signature Bank, which had more exposure to the imploding crypto sector. But I assume it’s broadly similar.

To me the most interesting and noteworthy issue to emerge over the last 48 hours is the debate or really the unclarity about what counts as a “bailout.” The dictionary definition is simple enough. There is no specific or technical meaning. It just means action to relieve someone or some entity in financial distress. But what became clear this weekend is that quite a few people have decided post-Global Financial Crisis that a bailout is relief for shareholders. Making depositors whole is not. That’s just making depositors whole. As long as the bank’s owners get wiped out or take a severe hit, it’s not a bailout.

But there’s little basis for that distinction.

Obviously, words can mean anything we want them to mean. At some level the point is just a semantic one. But it’s more than that. This is one of those cases where a set of important policy and political questions are hidden inside a made-up word or in this case a word to which people have ascribed a specific meaning it really doesn’t have.

The tech bros in Silicon Valley don’t want to call it a bailout because that clashes with their general libertarian worldview and because of their haughty reaction to the crisis of 2008. The Biden administration also doesn’t want to call it one because of how politically toxic the “bailouts” of 2008 and 2009 ended up being. Those and others have a good reason to avoid the B word. But what about everyone else?

As a policy matter, in this case, there was a strong logic for having owners of these banks get wiped out while making the depositors whole. The former makes to punish those who made the bad decisions and avoid the moral hazard of actors paying no price for risky behavior. The latter makes sense both because there seems to be sufficient assets to cover the great majority of deposits if not all of them and also to prevent runs on other banks. But it is a bailout. It is a bailout of the depositors who had substantial uninsured deposits and saw their bank fail. That’s a bailout.

The argument for not calling it a bailout is that depositors had no way of knowing or no obligation to know the health of their bank. There are some strong assumptions embedded in that logic. But it’s worth bringing them to the surface.

The issue I think is this. We have essentially two definitions of a “bailout.” One is something close to the dictionary definition: any radical departure from existing contractual or legal rules and obligations to minimize risk to the broader economy. But floating in the background there’s another definition, which is more like a rescue that saves people from the impact of their own decisions — being let off the hook, as it were. Put another way, if you’re undeserving, it’s a bailout. If you’re deserving, it’s not.

At the heart of the policy and political questions is under what circumstances and with what justifications the guarantors of the national financial system (Fed, FDIC, Treasury) will step in and change the rules. That question goes back to the issue of regulation and whether the guarantors of the financial system have sufficient regulatory oversight to do the job they’re charged with, to make extraordinary actions such as these as rare as possible.

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