Deposit insurance and the run on the bank
In the 2023 episode on the collapse of Silicon Valley Bank, Bob Zadek lays out the nature of bank deposits and the role of federal deposit insurance. He argues that the public misunderstands the depositor relationship: when a person deposits money, the depositor is making an unsecured loan to the bank and is the lowest form of creditor. Because depositors are creditors, the concern is that all of them might demand their money back at the same time, which creates a run on the bank. Zadek says that starting in the time of the Great Depression the federal government decided that to avoid a panic it would guarantee that debt so that depositors would not rush to withdraw. That, he says, is deposit insurance. He notes that the insurance was not unlimited and is now limited after Dodd-Frank to $250,000, so that money on deposit at or below that amount is protected Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Kling explains that over 95 percent of Silicon Valley Bank’s deposit money was not insured because the typical customer was a business with sums like $3 million or $4 million, well above the insurance limit of $250,000. When those depositors saw the bank was underwater, they started a run Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Silicon Valley Bank and the FDIC’s response
Zadek describes Silicon Valley Bank as a relatively newly formed bank going back about 40 or 50 years, the 16th largest bank in the country, with robust funds on deposit, public shareholders, and a leading role in startups in Silicon Valley. It failed, and he asks Kling how a bank could go from alive and well to a corpse in one sunrise and sunset Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Kling traces the collapse to a huge portfolio of long-term mortgage-backed securities and Treasury securities bought before interest rates went up; the value fell, and because most deposits were uninsured, a run began. He then turns to the failure of regulators and rating agencies. He lists the California Home Loan Bank Board, the FDIC, the auditor, and the rating agencies, and says none of them did anything until the crisis was over, even though short sellers could see it happening. He says the Home Loan Bank Board sent examiners about a year earlier and they said this was a problem, and that bank regulators know banks are not supposed to organically triple in size: SVB had $60 billion in deposits in early 2020 and closer to three times that by the end of 2022. Kling says the regulators saw the interest rate risk but did nothing, and adds that he jokingly wishes a Freedom of Information request could get all the memoranda written about Silicon Valley Bank within the FDIC, because he suspects some old cranky person there was writing memos urging that the bank be shut down or told to hedge its interest rate risk, and somebody higher up said no Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Nationalization and moral hazard
Kling argues that what happened over the weekend was that the banking system of the United States was nationalized, and that the system is now like the Chinese banking system, with the government controlling it. He says it was not so much a bailout of SVB as a bailout of every other bank, because roughly a quarter of banks are in bad condition relative to long-term bonds, holding too many long-term bonds and borderline insolvent, and that if SVB had been allowed to fail, First Republic and other banks would have suffered runs and there would have been a general atmosphere of fear. He says the authorities did not just make uninsured depositors whole at SVB; they said that at every bank from now on uninsured depositors would be made whole, and they made a lending facility available so any other bank could borrow to meet liquidity needs. From that, he says, follows tighter regulation, because the government has become the ultimate backstop for every bank and can legitimately say that since banks are playing with house money, it should control what risks they take and what lending they do. He says this gets back to something like the system in China Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Zadek counters that he would modify the tense: he says we already have a highly regulated banking system, and now we have not seen anything yet, based on his professional contact with banks and bankers who explain decisions apologetically as doing what the regulators require. Kling agrees, saying SVB bought long-term bonds and mortgage-backed securities because the government says that is how to minimize capital requirements and grow without continually going to the capital market. He adds that up until 2008 government likes to channel credit to its preferred uses, mostly its own spending, and keep it away from things like gun shops, and that since 2008 credit requirements have become too tight, with no year in the last 15 in which housing starts kept up with population Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
De-banking and the FDIC’s denial
In the 2022 episode on the weaponization of consumer finance, Bob Zadek and Todd Zywicki discuss Operation Choke Point and the use of bank accounts against lawful businesses. Zadek says it got outed and then the FDIC or the OCC denied doing it, comparing it to a Dear Colleague letter from the Department of Education: the government says it did not tell banks what to do but merely casually expressed an opinion that it was not crazy about bank accounts for gun dealers, even though that is a lawful activity, and bankers got the hint The Weaponization of Consumer Finance (2022).
Zywicki calls the no-fly list a great analogy and says this is cancel culture coming to banking, with banks depriving private citizens, churches and non-profit organizations of bank accounts. He cites the Alliance Defending Freedom, saying a number of religious liberty organizations had clients lose their bank accounts over time, and Mike Lindell, the MyPillow guy, who lost his bank account for being too controversial on various issues. He says this is increasingly a weapon used by authoritarian governments to prevent dissent, giving the example of Canada, where Justin Trudeau froze the bank accounts of Canadian truckers protesting vaccine mandates to the extent that people could not even use their own bank accounts to post bail, and a judge let one person have bail but she could not access her bank account to pay for it. He says the Chinese have done this, and that Iran announced women who protest the mandatory hijab rules will get two warnings and then have their bank accounts frozen. He says they understand why it was called Operation Choke Point, because they said they can choke off the air you need to breathe, and they are leveraging bank accounts to force compliance by dissenters The Weaponization of Consumer Finance (2022).
Zadek closes by thanking Zywicki for sharing thoughts set forth in his new book, Consumer Credit and the American Economy, and says it is scary how the government has weaponized something as benign and ordinary as consumer credit and access to banking, because it is insidious and nobody knows about it The Weaponization of Consumer Finance (2022).
Across episodes
The two episodes touch the FDIC from different directions and show no development of a single argument: the 2022 episode treats the FDIC as one of the agencies that denied directing banks to drop customers in the de-banking discussion, while the 2023 episode treats the FDIC as a regulator that saw problems at Silicon Valley Bank and did nothing, and as part of the backstop that Kling says nationalized the banking system. Bob Zadek appears in both, but the guests differ, with Todd Zywicki advancing the de-banking account and Arnold Kling advancing the nationalization and moral-hazard account.
What the sources do not cover
The excerpts do not describe the FDIC’s creation, its statutory authority, its governance, or the mechanics by which it resolves a failed bank, and they do not state the date or terms of any deposit-insurance legislation beyond Zadek’s reference to Dodd-Frank and the $250,000 limit. They do not give the name of any bill or case, nor any holding. They do not state what ultimately happened to Silicon Valley Bank’s depositors, creditors, or shareholders beyond the intervention Kling describes, and they do not cover the outcome of the de-banking incidents Zywicki mentions.