These are from a former student and I’ll probably have more of my own.
A former student of mine at the University of Rochester’s Graduate School of Management, whom I hadn’t heard from in over 40 years, emailed me on the weekend and gave me permission to quote him. He had read my Hoover Defining Ideas article in which I argued against the bailout of Silicon Valley Bank.
Here’s his first email:
David,
I am a former PhD student of yours at Rochester in the late 1970s. I eventually graduated with a dissertation concerning political risk and multinational firms. After teaching for a while, I moved on to the SEC, then Treasury, and finally ended up at the FDIC, in the TOO BIG TO FAIL group, and retired soon after, frustrated that our group was not making any serious progress in regulating such institutions. I just wanted to confirm that your analysis of the multiple failures concerning the SVB failure is spot on. Additionally, the $250K limit on deposit insurance should promote closer scrutiny of the bank by larger depositors. Eliminating or weakening that protection limit, as was done in this case, would likely result in less private sector scrutiny of bank behavior, not what is needed.
Anyway, keep up the good work,
Frederick J. Patrick, Ph.D.
I taught at the U. of R. from August 1975 to July 1979. I replied to thank him and then he replied with more details:
David,
Thanks so much for your response. I’m fully retired now and have been for a while, but I still maintain a few contacts at the agencies where I worked.
Oddly enough, I was working at the Office of Thrift Supervision as the Director of Credit Policy when Washington Mutual failed in 2008. About a year earlier, I gave a speech at the annual meeting of the federal banking agencies that was titled “There’s a tunnel at the end of this light” that characterized the mortgage market as being fueled by rising house prices, low unemployment, and low interest rates, a rare combination that was unlikely to last. Given the environment, Washington Mutual was engaged in making many NINJA mortgages that required virtually no underwriting (No Income, No Jobs, No Assets), a practice that was tolerated because rising house prices were thought to likely cover any defaulted mortgages. When pushed on this, WaMu said that if it didn’t make these types of loans, it would be out of the mortgage business. A year later it was, indeed, out of the mortgage business, with the largest bank failure in our history.
The structure of OTS was such that it unintentionally abetted such practices. There were five regional heads of supervision, the idea being that there was substantial regional variation in lending practices and standards. For example, mortgage default rates were much lower in Minnesota than in New York, perhaps driven by cultural standards. So having regional directors with substantial autonomy made sense. However, it was my understanding that the budget for the regional supervision was based only on the size and vitality of the institutions under its supervision. The regions did better when their institutions did better. WaMu was huge and growing quickly …
Anyway, the lesson learned at Rochester that the incentives that individuals face matter in making business decisions has proved remarkably resilient, be it accounting practices (Paul Healy’s dissertation) or political risk, among others.
Please feel free to quote my earlier missive. And, to address equality issues of my own, my wife and I took the same last name when we married in 1979 – it’s Phillips-Patrick, so I’m legally Frederick Phillips-Patrick. (And on an entirely different note, after we married, we spent the ’79-’80 school year in London, where I attended the London School of Economics. It turned out that my faculty advisor was Janet Yellen, who was visiting the LSE that year. How ironic!)
Again, great to hear from you,
Fred
READER COMMENTS
Vivian Darkbloom
Mar 21 2023 at 10:24am
“Additionally, the $250K limit on deposit insurance should promote closer scrutiny of the bank by larger depositors”.
In thinking recently about the issue of “moral hazard” and the incentives that would “promote closer scrutiny of the bank”, I asked myself, “what would be the result if FDIC insurance were to cover, say, only 90 percent of a loss up to $250,000”. Wouldn’t this encourage *everyone* to have “closer scrutiny”? Deductibles seem to have beneficial behavioral effects in other areas of insurance, so why not in this case? I’m not saying insurance is desirable, but this might be an appropriate middle ground for some who think it is.
Vivian Darkbloom
Mar 21 2023 at 10:42am
Another thought about those “larger depositors”: The FDIC is funded by premiums paid by “insured banks” ( I would say, rather, “banks with insured depositors”). Until 2010, the assessment base for those premiums was based on total average deposits. After, Dodd-Frank in 2010 that was essentially changed to all liabilities. (I ignore here the risk assessment factor in calculating the premium rate).
Thus, effectively, depositors with more than $250K of deposits end up (indirectly) paying premiums for depositors with less than $250K in the bank. Does this make sense? It is yet another example of the progressive nature of government and quasi-government regulation ( along with university tuition, medical insurance, etc., etc.)
vince
Mar 21 2023 at 1:14pm
Neither total average deposits nor total liabilities make sense as a measure of covered deposits. I hope there’s more to their rate-making system. Then again, it does make sense if they’re nonsensibly covering uninsured deposits anyway.
vince
Mar 21 2023 at 1:19pm
Of course, that works both ways.
Alan Goldhammer
Mar 21 2023 at 4:00pm
Not all depositors are alike. I serve on the Board of a moderately sized non-profit with assets of $55M. A significant amount is in a financially stable regional bank and the CFO reached out to them Monday morning after SVB was taken over. I understand the stuff about moral hazard and perhaps everyone should move deposits to the Chase subsidiary of JP Morgan. That way we end up with one bank that is truly too big to fail. Of course that’s just funny talk but what is the obligation an organization that might have significant operating funds on deposit? In theory, it one believes what Anat Admati has written, virtually all banks are technically insolvent. What’s a medium size non-profit to do?
robc
Mar 22 2023 at 4:41pm
One…diversify? You may not want 220 bank accounts, but that isn’t my problem.
Two…don’t diversify and buy private insurance on the the 54.75MM currently uninsured.
[And yes, I realize all 55MM isn’t in cash, but just using that number as an example]
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