Reviews | FDR would hate the solution to the current banking crisis

Second, he knew what it took to deal with a banking crisis and, more specifically, how to restore public confidence in the banking system. At the height of the Great Depression, he faced a challenge far more daunting than the problems of the present – ​​and he managed to turn things around almost immediately. In contrast, policymakers and regulators are hesitant today, hoping that empty words and weak measures can restore confidence. FDR’s mirror is very revealing of the shortcomings of the current political response.

Many people are surprised when I tell them that FDR explicitly opposed federal deposit insurance during the 1932 presidential campaign. 1932, his 1932 letter to the New York Sun stated that federal deposit insurance “would result in lax bank management and negligence on the part of banker and depositor. I believe that would be an impossible drain on the federal treasury.”

FDR makes an important and empirically correct point here: good bank risk management depends on the discipline of depositors, which depends on their skin in the game.

Later, Roosevelt reluctantly agreed to create FDIC insurance, at the insistence of Representative Henry Steagall, as part of a larger political deal, but he limited the agency’s coverage to small deposit balances. . Moreover, he had closed all the banks in March 1933, and they were only allowed to reopen and have access to insurance coverage after undergoing a thorough examination to establish that they were in good financial health. .

FDR did not deal with the bank run by throwing deposit insurance at the problem, or waiting for other banks to be closed by worried depositors. He first ended the runs by closing the banks and established a credible process for them to reopen after demonstrating their strength. Because regulators’ reviews were demonstrably credible to independent observers, and often accompanied by a capital increase, confidence in the system was restored and many banks were able to reopen quickly. The runs did not return, not because of the poor coverage of the new deposit insurance system, but because FDR had actually solved the problem of weak banks that had caused the runs.

What would such an effective policy response to the current crisis look like? The problem today is much less serious, which facilitates the solution.

There are only about 200 U.S. banks that are clearly vulnerable due to stock losses similar to Silicon Valley Bank. Regulators should have met with these banks individually last weekend, asked them either to offer credible recapitalization commitments immediately or to place them in conservatorship (from Monday morning). In conservatorship, their activities would have been limited until it was determined whether they could offer adequate recapitalization or, if not, be placed in receivership. In the meantime, they could have been allowed to pay out all insured deposits, but only to pay out a fraction of uninsured deposits (based on the potential losses of uninsured depositors at each bank). This would have pushed these banks to solve the problem quickly and would have limited the illiquidity problem to a portion of uninsured deposits with a small number of banks.

If this had been done, industry and academic experts would have been able to immediately reassure relatively uninformed filers that the government’s policy response had been effective and that there was no cause for further alarm. . I think some uninsured depositors would have wanted to move their funds anyway, as a long-term precaution, but the short-term urgency of these disruptions would have been greatly reduced.

Instead, the Biden administration did nothing about the 200 vulnerable banks, encouraging continued panic. The two measures they took last Sunday clearly failed to calm the market. First, the bailout of uninsured depositors at Signature and SVB has no clear implications on the risk of loss for uninsured depositors at other banks, particularly given the amount of criticism these bailouts have received for being politically motivated and unfair. No uninsured depositor worried about their own potential losses will think their money is necessarily safe now.

The second political announcement was also ineffective. The Federal Reserve has created a special new lending facility for banks, allowing them to borrow for up to one year against eligible Treasury and agency securities. Banks can borrow an amount equal to the face value of these securities, which exceeds their market value. This implies a partially unsecured loan (the opposite of the typical “haircut” applied to collateral in central bank lending).

These loans give worried uninsured depositors no reason to rest easy. The decline in the value of vulnerable banks’ securities is not temporary but is fundamentally the result of the Fed’s interest rate hikes, which will not only persist but will intensify in the future. Securities used as collateral are not going to increase in value as a result of Fed intervention here. Second, the loan is only for one year, so after the end of this year, a bank that is insolvent today because its securities have lost value will still be insolvent. For these reasons, the Fed’s lending program will not cause uninsured depositors of an insolvent or deeply weakened bank to decide not to withdraw their funds immediately, if they were already predisposed to do so.

It’s time to take FDR’s example to heart, tackle the banking problem immediately and directly, and give American depositors a real reason to believe that “there is nothing to fear but fear itself.” even “.


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