When the Biden administration announced on Sunday that customers of the collapsed Silicon Valley Bank and Signature Bank would receive full refunds of their lost deposits, it appealed to a single exception to banking law that otherwise caps deposit protections. in cash and cash equivalents at $250,000.
The exception, known as Systematic Risk Exemption (SRE), is a caveat in the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991, a law that requires the Federal Deposit Insurance Corporation (FDIC) imposes the “least cost” on taxpayers. when it uses its Deposit Insurance Fund (ADF) to liquidate failing banks.
The law — which limits the FDIC’s power to guarantee deposits — stresses that the agency must choose the least expensive method, even if it inflicts losses on uninsured depositors, creditors and shareholders of a failing bank. In theory, the law encourages government officials not to pay more than the law requires.
However, the exception, invoked four times in response to the 2008 financial crisis and scaled back under the Dodd-Frank Act, can extend reimbursement to uninsured deposits when the US Treasury Secretary decides that additional help from the FDIC would mitigate “serious adverse effects” to economic conditions or financial stability otherwise unavoidable under the “least cost” response. To use this authority, the Secretary must first obtain authorizing votes from two-thirds of the FDIC Board of Directors and two-thirds of the Federal Reserve Board of Governors, in addition to consulting with the President.
During a Monday press briefing, after a weekend filled with contagion risk concerns, President Biden said taxpayers would be spared the cost of guaranteeing uninsured deposits, while shareholders and some holders of unsecured debt would not see their losses repaid.
“No loss will be borne by the taxpayers,” the president told reporters. “Instead, the money will come from fees that banks pay to the Deposit Insurance Fund (DIF).”
“I would consider this a bailout”
Still, the move to fully reimburse uninsured depositors has sparked controversy from critics who see the measure as an unfair use of banking law and, ultimately, a government bailout.
Ken Griffin, founder of giant hedge fund Citadel, reportedly described the decision to the Financial Times as a bailout that speaks to the collapse of American capitalism.
Morgan Ricks, a professor at Vanderbilt University School of Law, said while “bailout” isn’t a legal term, reasonable minds may disagree about the administration’s interpretation of the gray area of the law.
“We have uninsured depositors who are cured. I would consider that a bailout,” Ricks said. “Also, people can reasonably say this is not a bailout.”
Morgan noted that this week’s measures differ significantly from the controversial safety nets that taxpayers were asked to assume during the 2008 financial crisis, when FDIC funds proved too minimal to cover SREs that the Bush administration authorized to bail out some of the largest banks in the country.
The bailout then provided hundreds of billions of dollars to the Treasury, the FDIC and the Federal Reserve Bank of New York to absolve Bank of America, Citigroup and Wachovia of financial responsibility for failed mortgages and other loans. Unlike current banking law’s stricter requirements that make FDIC funds inaccessible to operating businesses, Bank of America and Citigroup were allowed to remain in business, while the SRE paved the way for Citigroup’s acquisition of Wachovia. .
Nationwide deposit guarantees for regulated banks date back to 1933, when widespread bank closures and resulting deposit losses prompted Congress to create the FDIC. Its stated purpose then was much the same as it is now: to pay depositors up to the insurance limit in the event of bank failure, to sell the bank’s assets, and to settle its debts.
While the DIF – the fund that pays for depositors’ losses – is funded primarily by quarterly valuations on insured banks and, to a lesser extent, by interest earned on investments and assets recovered through liquidations, critics say that because the fund is ultimately backed by the in full confidence and credit to the federal government, taxpayers take risks when the government chooses to protect uninsured depositors. The FDIC is also authorized to operate a federal line of credit if DIF funds are insufficient.
According to Ricks, taxpayers would only be liable if the FDIC became insolvent, which happened in the wake of the savings and loans crisis of the 1980s that cost taxpayers about $125 billion and gave birth at the FDICIA.
A former FDIC director who asked not to be identified told Yahoo Finance that the risk to taxpayers of insuring Silicon Valley Bank and Signature Bank customers is low because the FDIC is far from having need to access the FDIC line of credit.
For the fourth quarter of 2022, DIF reported a $2.8 billion increase in its balance sheet to $128.2 billion. Contributions for the period totaled $2.1 billion and represented the fund’s largest source of income, followed by fund investments which totaled $498 million.
Still, Ricks points out that banks can be expected to impose higher assessments on their customers and shareholders, many of whom are U.S. taxpayers.
“We shouldn’t pretend that it doesn’t affect the American people one way or another. It does, indirectly,” Ricks said. “It’s impossible to say what the ultimate impact of these costs is, but the costs are real.”
“This is how capitalism works”
There is also debate over whether the administration’s use of the statutory exception further exposes taxpayers by setting a new standard for bank deposit insurance.
“It sets a precedent,” Ricks said. “And it becomes difficult to argue that depositors in the big banks actually bear the risk of bank failure that the law says they are.”
In 2010, a study by the nonpartisan Government Accountability Office concluded that the looser law in place during the 2008 financial crisis would weaken the incentive to manage risk. Several months after the study, Congress revised the SRE so that it could only be used if the bank in question closed.
In his Monday press briefing explaining that loss coverage would not extend to investors, President Biden said.
“They knowingly took a risk, and when the risk didn’t pay off, investors lose their money,” he said. “That’s how capitalism works.”
Alexis Keenan is a legal reporter for Yahoo Finance. Follow Alexis on Twitter @alexiskweed.
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