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Delusional Hubris Guarantees Failing Banks, Gov't Bailouts

failing banks and government bailouts nothing new

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Jefferson Weaver By Friday, 24 March 2023 11:31 AM EDT Current | Bio | Archive

The recent failure of Silicon Valley Bank (SVB) has led to widespread concerns that the entire banking industry would be at risk if depositors nationally decided to withdraw their funds from their own banks.

This fear of a country-wide bank run prompted the federal government to announce that all depositors funds would be guaranteed — even those accounts exceeding the FDIC-insured limit of $250,000.00.

This announcement must have gladdened the hearts of bank managers everywhere.

Such assurances seem to suggest that bank executives can run their respective banks with impunity because no customer would ever lose a dollar.

After all, the government (which does not typically seek the approval of the nation’s long-suffering taxpayers) now stands ready in the wings, waiting to pick up the pieces should one or more of America’s banks fail.

SVB is only the latest in a long line of banks to be bailed out by the federal government.

This fine, if not tarnished, tradition of crony capitalism arguably began with the 1984 bailout of the Continental Bank of Illinois.

At the time, Continental was one of the largest banks in America.

It ran into trouble after buying a portfolio of bad loans from a failed bank — Penn Square Bank of Oklahoma.

Unfortunately for Continental, the bad loans compounded the ill-effects of its own mismanagement and sparked a run on the bank in which of billions of dollars were withdrawn in the span of a few weeks.

Ultimately, the FDIC was forced to intervene with a massive infusion of some $13 billion in capital and loans — which was instrumental in protecting the account holders and the bondholders — even though the bank's shareholders were largely wiped out.

The government also became the bank’s sole shareholder for several years, until finally disposing of its shares in 1991; only a few years before the newly privatized and re-named Continental Bank was acquired by another Mom and Pop store called Bank of America in 1994.

It was in the aftermath of the Continental debacle that the phrase "too big to fail" began its emergence natonally and notoriously. 

This fear that the failure of a single major bank could bring about a total collapse of the entire financial system prompted the government to seize the banking operations of Washington Mutual in 2008 after nearly 10% of its deposits (totaling about $17 billion) were withdrawn over a chaotic 10-day period following a credit rating downgrade.

At that time, Washington Mutual was the largest savings and loan association in the country, boasting assets in excess of $325 billion.

However, the sudden depletion of its cash reserves left it in a precarious financial position which led it to being placed in FDIC receivership.

Soon thereafter, the FDIC negotiated a sale of Washington Mutual’s banking operations to JP Morgan Chase for the bargain-basement price of $1.9 billion.

This deal was an incredible bargain for Chase’s shareholders and the platoons of lawyers who undoubtedly appreciated the vast sums already spent by the government, on behalf of its citizens, to present Washington Mutual’s banking operations to its suitor on a silver platter.

It also recalled the complaint voiced by many commentators that the government’s continual backstopping of failing banks had effectively eliminated any sort of consequences from poor management practices.

Additionally, it also essentially guaranteed that profits for banks would be privatized whereas the losses in the event of a failure would be borne in large part by the public.

Of course the fall of Washington Mutual occurred while much of the global banking system was rapidly deteriorating during the 2008 financial crisis.

Indeed, Washington Mutual’s collapse was preceded by that of Bear Stearns and followed by that of Lehman Brothers.

These two global investment banking giants bet tens of billions of dollars on heavily-leveraged purchases of mortgaged-backed securities and other toxic assets that plummeted in value as the underlying assets (subprime mortgages) became unmarketable.

Bear Stearns and Lehman Brothers were worth some $20 billion and $46 billion, respectively, prior to their demise.

Only prospective purchasers of Bear Stearns were offered a government loan guarantee of $30 billion. As it turns out, that loan guarantee persuaded JP Morgan Chase to acquire it for a fraction of its value whereas no government loan guarantees were offered for Lehman Brothers, which ultimately was forced to file for bankruptcy. 

Each of these failures were caused by the investment decisions of the executives.

In other words, they were not simply random outcomes arising from external market forces beyond anyone’s control.

If each of these financial institutions had been prudently managed with an appropriate allocation of assets to cover the risks posed by their outstanding liabilities, then they would probably still be in business today.

However, their executives believed that they could increase the leverage on their assets and earn outsized profits without commensurately increasing the dangers of failure.

Their decisions to pursue profits and ignore the risks of having dangerously few dollars in the bank to cover potentially enormous liabilities ultimately turned out to have existential consequences for each of these institutions.

Their eventual fates once again reaffirmed that even the biggest banking institutions are not immune from the same delusional hubris that once caused a young man named Icarus wearing wax wings to fly too close to the sun.

(Related articles may be found here, and here.)

Jefferson Hane Weaver is a transactional lawyer residing in Florida. He received his undergraduate degree in Economics and Political Science from the University of North Carolina and his J.D. and Ph.D. in International Relations from Columbia University. Dr. Weaver is the author of numerous books on varied compelling subjects. Read more of his reports — Here.

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If each of these financial institutions had been prudently managed with an appropriate allocation of assets to cover the risks posed by their outstanding liabilities, then they would probably still be in business today.
fdic, svb
Friday, 24 March 2023 11:31 AM
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