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Bank Collapses are Common; Investor Fear is the Real Danger

March 28, 2023

Article courtesy MIRS News for SBAM’s Lansing Watchdog e-newsletter

The Silicon Valley Bank and Signature Bank collapses themselves didn’t present a threat to the economy, but investors’ fear of losing money is a real threat.

University of Michigan-Flint Economics Professor Chris Douglas said 30 banks have failed since 2015, but because the investors in Silicon Valley Bank had such a high-profile clientele and were able to use an effective follower base on social media, they were able to whip the business world into a frenzy with their collapse. This presented a problem when clients began removing funds from regional banks across the nation.

“The typical American probably had no idea eight banks failed in 2015,” Douglas said.

Douglas said people putting money in banks are pretty confident about doing so, but if they see other people pulling their money out of the bank, it can create more people running to the bank asking for cash.

“It’s just a couple of people that get spooked,” he said. “Other people see those people get spooked, so they get spooked, too, and everyone runs for the exit at the same time.”

He said the practical result was regional banks, like Comerica Bank, founded in Detroit, end up losing investor confidence.  He said the stock dropped from $59 to $33 on March 10, when Silicon Valley Bank ended up in trouble.

Because the investors in the banks were riling up the community, the federal government stepped in and said the Federal Deposit Insurance Corporation, or FDIC, would make sure everyone got their money back.

Douglas said that leads to something referred to as a “moral hazard.”

Western Michigan University Assistant Professor of Finance Matthew Ross defined a moral hazard in economics as incentivizing bad behavior.

“When somebody gets bailed out, that makes future bailouts more likely because if you don’t have bad consequences for bad decisions, probably you’re going to get more bad decisions,” Ross said.

Ross said instead of the bank owners and investors taking a loss and going down with the ship because they overextended themselves, the FDIC bailed out everyone. As a result, the rest of the banking community ends up absorbing the damage and passing it on to customers.

“In some sense, it is a bailout of these primarily tech startups out in California,” he said.

He said the reason for the overextension was that Silicon Valley Bank and Signature Bank were victims of their own success after they both had lobbied to have the investment cap raised from $50 billion to $250 billion 10 years after the housing market crash in 2008, the largest in history.

The FDIC makes sure that people who have deposits are insured for at least up to $250,000. Anything above that would have to be gained during liquidation of the bank, which is why the Michigan State Housing Development Authority said they checked their portfolio to make sure the deposits were secure.

Douglas said the problem is that bailouts can encourage banks to act more like Gordon Gekko, the fictional character from the Wall Street movie, than a financial institution.

“Banking should be boring, You should just take deposits, use those deposits to issue loans, buy safe treasury securities and this shouldn’t be glamorous,” Douglas said.

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