Moral hazard rears its head again, only to be shouted down by an angry mob with pitchforks (or the modern equivalent, tweets).
By now you’ve probably heard about the collapse of Silicon Valley Bank (and shortly thereafter Signature bank). If you’re not familiar with what happened and why check out Matt Levine’s column. Unlike most banks, the people using SVB tend to be more sophisticated (or should be). They’re not widows and orphans but people who have convinced professional investors to give them millions of dollars. But there are some moral issues getting very little attention.
We begin with moral hazard itself. This is where one party can take on excess risk knowing they won’t be liable. A common example is in insurance. The reason healthcare companies didn’t cover pre-existing conditions is because it created a moral hazard. If pre-existing conditions were covered then when I’m healthy I could choose to keep my money instead of spending it on insurance I wasn’t using. The day I got diagnosed with cancer, I could then buy insurance and be fully covered exactly the same as someone who had been buying insurance for years. Why buy insurance? (Other than for when I get hit by a car and can’t wait a week for the insurance to kick in, but that seems unlikely so not worth the cost.)
Moral hazard is part and parcel to insurance. My retirement savings is covered by SPIC, which is the FDIC for brokerage accounts, and covers up to $500,000 per investor. After Madoff, I talked to the firm where I kept my retirement investments and asked what happens if they run off with my money. They have additional insurance up to $10M per account. (Technically, they could be lying when they send me such documentation, so I’m assuming some risk there.) They have to pay for that additional insurance which increases their costs which are passed on to me. In other words, I’m the one paying for that additional protection. If I knew the government would bail me out, I wouldn’t bother paying for it.
The second issue is the other side of that same coin. You’re paying for that insurance whether you know it or not. The FDIC insures bank accounts up to $250,000 per depositor. When a bank goes under that’s the minimum someone gets. If the bank has assets that can be sold, depositors can get more, if not, the FDIC steps in with their money (here’s a great outline of how the FDIC works: Anatomy Of A Bank Takeover on NPR). The government has said it will bail out all depositors. According to CNBC, “The money to fully reimburse depositors of the collapsed Silicon Valley Bank and the shuttered Signature Bank will be furnished by other banks, not taxpayers, Treasury officials said” (source).
The government will not take money from taxpayers directly [but people who pay taxes will likely still wind up paying for this].
What they are technically saying is, “the government will not take money from taxpayers directly [but people who pay taxes will likely still wind up paying for this].” The money needed to make account holders whole (if any, it remains to be seen what the shortfall is) will come from the Deposit Insurance Fund. The DIF is funded by banks, hence the comment “will be furnished by other banks.” Banks get their money from account holders (more specifically paying account holder interest in exchange for use of their money). While it is possible to be a taxpayer who doesn’t have a bank account, or someone with a bank account who doesn’t pay federal taxes, that Venn diagram has a very high degree of overlap. In other words, you and I, fellow tax paying bank account holders, are bailing them out; it’s simply being done through the banking regulatory system and not IRS tax collection.
Before you think at least the moral issue is either or between those two, it’s not. I’m both paying for insurance I may not actually need and I’m paying higher fees or getting lower yield (de minimis perhaps, but non-zero) because my bank must bear the cost and it will be passed on to you and me.
In short, every time we bail out people, we encourage risky behavior. That’s what we’re doing by bailing out the depositors, even if we don’t bail out creditors and equity holders of SVB itself.
The next issue is more subtle. (Disclaimer: I am not a lawyer or accountant and none of this is legal or financial advice.) Peter Thiel led the call to leave SVB. Under rule 10b-5 of the Securities Exchange Act, it’s illegal to issue material misleading statements. If I told you tomorrow that a stock was going to fall because they would go bankrupt and I had no basis for that, I’d be breaking the law. This prevents people from spreading rumors to manipulate security. That said, you can use true information to make a judgment call. This is most likely what Thiel did, recognizing there was an issue with SVB’s balance sheet. I very much doubt he was violating 10b-5.
Coincidentally, Brex, a company in which he invested, got billions of dollars of the money moved out of SVB. Did Thiel have any moral obligation to disclose this interest? When investors go on TV to discuss assets, they need to disclose if they own any funds about which they’re speaking. You could argue Thiel just said jump from, not jump to, so shouldn’t have any such obligation. Funds certainly moved from SVB to other banks as well. You could also argue it was Thiel and a few others who caused the panic and have a moral, even if not legal, obligation to their words and actions and should have disclosed their potential benefit.
Banks face risks every day, interest rate changes, FX fluctuations, sector movements, macroeconomic conditions, etc. can all impact a bank’s balance sheet. There’s certainly enough cover that anyone can say at most any time, “I’m worried about bank X because Y happened in the market.” If you’re an owner or significant shareholder in another bank, is it ok for you to do that? I’m not saying that Thiel did anything wrong, only that there’s a line somewhere and society has not had a discussion about where it is. One day that line will be crossed; it will be better for all if the line is clearly drawn before it is.
“I never thought I’d see the day when twitter libertarians would be imploring for the Fed and the Treasury to ‘Do something!’”
Finally, we have the hypocrisy of the VCs and founders. Disclaimer: I did briefly run a small VC fund and I am a founder. The community has generally held the attitude of “break the laws until we get caught and then hope we’re big enough to defend ourselves.” Consider that PayPal ran afoul of banking regulations (according to some lawyers with whom I spoke years ago), rideshare companies violated taxi regulations, and Airbnb violated hotel and housing regulations. This is to say nothing of the cryptocurrency community who opposed financial oversight and decades of other tech companies asking not to be regulated. But when their money's on the line we suddenly saw calls from them for the government to step in, including from many who should have the financial sophistication to understand the hypocrisy of their heads I win tails you lose approach to oversight. As one friend of mine put it, “I never thought I’d see the day when twitter libertarians would be imploring for the Fed and the Treasury to ‘Do something!’” Edward Ongweso Jr.’s Slate article goes into this in more detail with many specific examples. To be clear, not every founder and VC argued against government oversight and called for a bailout, but far too many did.
In the US we’ve seen a pattern of financial bailouts. Savings & Loan institutions in1989, LTCM in 1998, banks, AIG, Fannie Mae & Freddie Mac in 2008. Sometimes bailouts are needed. Covid was not something the travel or hospitality industry could have reasonably planned for and only the government could step in. Likewise, the automotive companies could not have prevented the Great Recession. However, the banks and other financial institutions could have seen it coming and certainly did contribute to it (and benefited from the causes of it). We have seen time and again that finance companies engage in risky behavior only to be bailed out, further encouraging the risky behavior. Until the consequences are enough to outweigh the benefits—which also requires that well connected whining works no better than the whining of the less well connected—such excessive risks will continue to be taken. While many people complain of regulations, we have them because without them we wind up in situations where we the people get stuck with the bill.
Sigh. Maybe this time will be different. (And if you believe that I have a highly levered, no-risk, better-than-market-returns alt-coin to sell you.)
It’s critical to learn about corporate culture before you accept a job offer but it can be awkward to raise such questions. Learn what to ask and how to ask it to avoid landing yourself in a bad situation.
Investing just a few hours per year will help you focus and advance in your career.
Groups with a high barrier to entry and high trust are often the most valuable groups to join.
