How The Government Is Making The Silicon Valley Bank Crisis Worse

The recent bank run and then failure of Silicon Valley Bank kicked off a mini crisis that’s already being made worse by the government.And it could even morph into a far worse downward spiral if Federal regulators don’t back off, according to a recent report.

“More penetrating government control of the banking industry will not change human nature,” states the research note from financial analytics company HCWE & Co. “What it will do is to degrade the economy by increasing the cost of banking.”

The report highlights the problems of baking bailouts & unlimited protection of depositors, plus the dangers of increasing the already-overbearing regulations of financial institutions.

All SVBs customers rescued

Already, we’ve seen all SVB depositors protected and the U.S. and UK governments brokering private “bailouts” of what remains of the institution. The fact that all depositors were saved, alone is cause for worry as it doesn’t give well-heeled customers an incentive to bank with financially robust institutions.

Bailouts and excessive depositor protections inevitably lead to falling government bond prices and a flight to buying cash as investors look skeptically at America’s financial system. As investors begin to increasingly favor cash over higher yielding bonds the flight to cash speeds up and the feedback loop continues. The righthand side of the chart below shows that part of the story.

Bet on more regulatory talk soon

However, that’s not the whole of it. Inevitably our elected officials in Congress will want to reassure voters that there banks are safe. To do that more regulations will get piled onto the banking companies. Inevitably the bank’s customers will pay more and probably find it harder to get necessary business loans. The new regulations will ultimately hit the economy with slower growth and result in a falling stock market at which point investors will shift from stocks to cash. The righthand side of the chart above illustrates this problem.

In both cases the problem with the feedback loops is the government involvement. In simple terms if the government would stop interfering. The annotated chart below shows that dropping the predictable regulations overhaul (that could come arrive any day soon) would short circuit the left hand side of the feedback loop. Likewise stopping bailouts and protecting all depositors all the time would do the same for the right hand side.

One of the problems in all this mess (and yes its already a mess) is the banking industry has sold congress a bill of goods that without banks the economy is toast. In 2007-2008 the message was the financial system was at risk. This time it was a single bank, SVB. There has been at least one more since them.

Let them fail

However, when I spoke with David Ranson, director of research at HCWE & Co, and author of the report, he said banks should be allowed to fail. Indeed they should. Its part of the natural economic cycle. Companies inevitably run out their usefulness to the economy.

I’ve long said that if banks get bailouts why shouldn’t pizzerias, or newspapers, or websites?

Its hard to imagine New York without pizza available on most corners. They are an important part of the economic ecosystem.

Likewise newspapers and websites have a vital role. Yet few people want the government to dip its toes into those sectors anymore than they already do. I’m not alone in this view.

“I think banks should be treated more like Pizzeria’s,” Ranson says.

If only Congress would listen. In fact, your can almost count on the government to do the opposite.