SVB Debacle Brings The Fed One Step Closer To Becoming Provider Of First Resort

In what should go down as one of the all-time greatest propaganda campaigns in U.S. history, members of Congress convinced millions of Americans that deregulation caused the 2008 financial crisis. Following the collapse of Silicon Valley Bank, they’re at it again.

Predictably, populists such as Senator Elizabeth Warren (D-MA) are blaming the SVB failure on “rolling back” the 2010 Dodd-Frank Act’s stricter oversight. Aside from whether Dodd-Frank regulations were effective at all or amounted to anything more than additional paperwork and higher capital requirements, Congress has never repealed a single Title of Dodd-Frank.

Warren’s argument amounts to whether additional stress testing, capital, or liquidity would have saved SVB. But Dodd-Frank stress tests are designed to ensure sufficient capital to cover losses resulting from “adverse economic conditions,” not from individual mistakes or bad strategies. Separately, it’s very hard to make her case using capital and liquidity requirements because SVB was well above the requirements–in some cases twice as high and even higher than the ratios reported by JP Morgan Chase.

Of course, politics can be unpredictable, but not when it comes to financial market turmoil. Populist politicians from both political parties use every opportunity they can to score points. They clamor for more regulation on the “big” banks, decry government guarantees, and romanticize community banks.

But very few Democrats or Republicans ever forgo increased government backing or try to fix the long-term failure of the American regulatory approach. As a result, the U.S. government has consistently increased federal backing, regulation, and micro-management of the financial sector for more than a century. And it hasn’t worked.

The main culprit for the 2008 crash was, supposedly, the 1999 Gramm–Leach–Bliley Act (GLBA). Never mind that all the GLBA did was allow some financial firms to conduct new activities, all of which were highly regulated. And it did not reduce those regulations.

By 2008, nothing had abated the long-term expansion of both implicit and explicit government backing in the financial sector, or the increasingly proscriptive rules and regulations that came with it. Rather than finally admit the approach was flawed, Congress doubled down and passed Dodd-Frank. But more federal backing and more regulation only provides people with a false sense of security, something that should be painfully obvious now.

The finer details of the SVB collapse, including the difference between a bank holding company and a commercial bank, are even more problematic for Warren’s argument. But they’re a distraction from what really matters: the broader implications of what Congress does next.

As with most financial disturbances, it seems likely the U.S. is headed for an expansion of the status quo. But the stakes are much higher this time because there isn’t much left to the private side of the existing public-private relationship in financial markets.

The primary assets of most banks are now agency mortgage-backed securities and U.S. Treasuries. Money markets aren’t much different, and the Fed now provides them with the ultra-safe option of parking cash at its reverse repurchase agreement facility. It’s indisputable that the same safety-first mindset is bleeding into capital markets. Financial companies have more regulatory boxes to check than ever, but they have little room to make their own investment decisions.

If the intelligentsia gets its way, there will be virtually none.

For starters, they want all money – not just deposits – explicitly insured. Naturally, they want even more regulation so bureaucrats can prevent people from choosing how to move their own money. It’s all in the name of stability, of course.

Further, they want to “clarify banks’ place in U.S. society and their relation to the government,” such that all money becomes “a governmental product.” They actively hail a “new monetary era” with central bank digital currencies, a digital version of the dollar that ties citizens directly to the government. They want to transform the Fed into a provider of first resort instead of a lender of last resort.

That world would be profoundly different than the highly flawed public-private arrangement we have now, but not in a way that is amenable to a free society. It would give a select few untold economic and political power over everyone else. Give it whatever name you like but it is the kind of system the U.S. was founded – with all its flaws – to reject.

But just like any good populist autocrat, they’re teasing us with a false sense of security.

It may not be obvious, but this prospective era is merely a small step from the current one. Tragically, the current mess is a direct consequence of constantly shifting toward this new era with slightly more government backing and regulation.

Just as it is unrealistic to expect regulators to foresee every possible scenario and plan for all negative outcomes, it is idealistic to think a system based on full government provision of money and finance will produce more economic opportunity and prosperity for the masses. Nobody should have the power to exert so much of their own will on financial matters because it gives them power over people’s lives.

The way out is to reverse course, not to double down again.