Opinion: Government bank rescues never went away. Just don’t call them bailouts – The Globe and Mail

The term bank “bailout” has disappeared from the financial lexicon. It implied taxpayer-funded rescues equivalent to the GDP of a small country, rescuing the rich from the fallout of hopeless investments and protecting inept executives from lynchings at the hands of wronged depositors, clients and shareholders.

The Swiss government and central bank were careful not to label UBS’s takeover two weeks ago of hellbound Credit Suisse a bailout, calling it a “merger.” Only days earlier, the U.S. Federal Deposit Insurance Corp. (FDIC) seized Silicon Valley Bank as fleeing clients and depositors handed it a death sentence. Nor was SVB technically a bailout.

But both bank crises had the elements of one, suggesting bailout culture never fully disappeared. No bank of any size is allowed to implode overnight, lest it wipe out depositors, even rich ones, and infect the enormous and eternally fragile interconnected banking network worldwide. The value of the financial services sector is conservatively estimated at a quarter of the global economy, and some estimates put it far higher.

UBS’s merger with Credit Suisse was pushed through by the Swiss government and the Swiss National Bank (SNB). UBS paid the equivalent of US$3.2-billion for Credit Suisse, but the deal came with sweeteners that wiped out a class of bond holders and put Swiss taxpayers on the hook for a potential fortune, giving the touted “private-sector” solution the air of a public-sector bailout.

The SNB agreed to give UBS about US$109-billion in liquidity assistance to facilitate the deal, and the Swiss government will absorb up to US$9.8-billion in potential losses in winding down Credit Suisse’s investment and trading portfolios and selling unwanted businesses. Swiss taxpayers are unlikely to take much of a hit unless the banking crisis deepens, pushing the enlarged UBS to the precipice (it was bailed out in the financial crisis 15 years ago). Still, were it not for the government loans and guarantees, Credit Suisse’s rescue probably would not have happened.

The White House was adamant that SVB’s seizure by the FDIC during a run on the bank was not a bailout. “No losses will be borne by the taxpayers,” President Joe Biden said.

But consumers – that is, taxpayers – over time may ultimately bear the cost of SVB’s downfall. That’s because the FDIC guaranteed all deposits at the bank, going beyond its mandate to cover depositors for a maximum of US$250,000 per account. Since most accounts at SVB were above that limit, the guarantees will protect wealthy and corporate clients. The FDIC estimated that the cost of SVB’s failure to the insurance fund would be US$20-billion.

The FDIC’s deposit insurance is funded by quarterly premiums levied on banks. If more banks go bust – they could, since they are clogged with long-term bonds whose values shrank when interest rates climbed – the FDIC will need a lot more money to guarantee deposits. If it does, it will undoubtedly jack up the levies, and the banks will pass on the extra costs to customers, as they always do. Tom McClintock, a Republican member of the House of Representatives, said “consumers are bailing out the banks when FDIC insurance coverage is extended to large deposits. Ultimately that is spread directly to all bank depositors through higher fees. That is a bailout.”

There was a time when banks were allowed to collapse. Investors, customers and depositors took the pain and were careful to choose sound banks the next time around. The Federal Reserve did not exist until 1913, and the FDIC was born 20 years later. Franklin Delano Roosevelt, who became president in 1933, initially opposed deposit insurance, arguing: “We do not wish to make the United States government liable for the mistakes and errors of individual banks, and put a premium on unsound banking in the future.”

But haunted by sporadic bank runs, the public demanded insurance, and in it came – even if it smelled of un-American socialism. Still, the resistance to bank bailouts continued through the 1970s. The culture changed in the following decades.

The 1932 Glass-Steagall Act, which separated commercial and investment banking, was pretty much dead by the 1990s. Banks gobbled up Wall Street players, exposing them to “casino” risks and a culture they did not fully understand (Credit Suisse’s purchase of First Boston played a big role in the bank’s downfall). At the same time, many banks became so big – through mergers, diversifying into new businesses and the growth of the economy – that they could not be allowed to fail. The term “too big to fail” emerged in 1984, when Continental Illinois collapsed, then the largest bank failure in U.S. history. It was bailed out by the FDIC, which insured all deposits.

Between the deposit insurance payouts and the bailouts, which went from sporadic to commonplace during the global financial crisis of 2007-2008, banks lived and died on the good graces of the government. The whole system came at a huge cost and encouraged reckless behaviour that was propelled by massive stock option awards to management.

What was the point of sober, cautious behaviour if you knew the government had your back? At the same time, rescuing rotten banks came at an economic cost. In the past, bank failures helped trigger sharp, quick downturns followed by strong recoveries. Productivity and business dynamism improved, and a purer form of capitalism emerged.

The rescue culture was supposed to end after the financial crisis, when bank capital ratios were beefed up and other financial safety measures were put in place. The failures of Credit Suisse and SVB show that the rescue era is still with us, even if neither bank was technically bailed out. There will be more, and the economy and capitalism will suffer for them.