When Silicon Valley Bank was on the verge of collapse earlier this year, powerful venture capitalists like David Sacks of Kraft Ventures lambasted the government, demanding it backstop all of the bank’s depositors — mostly VC firms and their portfolio companies. That would mean bailing out those whose deposits were above the statutory $250,000 limit. Otherwise, the VCs insisted, contagion would reign, and more banks would fail.
The Federal Deposit Insurance Corp. quickly acquiesced. It also ended up bailing out uninsured depositors of Signature Bank and First Republic Bank — by selling the latter to JPMorgan Chase.
But such insured depositor bailouts have been costly, according to New York University School of Law professor Michael Ohlrogge. In a new study, he estimated that “since the financial crisis, the rise of uninsured depositor rescues has coincided with a dramatic increase in FDIC costs of resolving failed banks.” The price tag? At least $45 billion in additional expenses over the past 15 years, he calculated.
“Resolution costs to the FDIC have nearly doubled” since the financial crisis, he wrote in the study.
Ohlrogge made a number of policy proposals, including that the FDIC disclose more information about its valuation practices “in the interests of transparency and accountability.” That would not only cut costs, he said, but also “lessen the moral hazard associated with uninsured depositor rescues.”
The failures of Signature Bank, Silicon Valley Bank, and First Republic Bank were three out of the four largest commercial bank failures in U.S. history, together holding about $300 billion in uninsured deposits at the time of their failures, Ohlrogge said. Their failures cost the deposit insurance fund of the FDIC an estimated $31.5 billion.
Since the financial crisis, uninsured depositors have experienced losses in only roughly 6 percent of total U.S. bank failures, according to Ohlrogge. While the FDIC has resolved 539 bank failures since 2008, at a cost $131 billion, total losses born by uninsured depositors over the same period have been a mere $190 million.
“Formally, the United States caps deposit insurance at $250,000 per account, but in reality the post-2008 financial system comes close to providing de facto total deposit insurance covering all amounts in all accounts,” Ohlrogge said.
He explained that the rise in uninsured depositor rescues has resulted from a shift by the FDIC to almost always resolving failed banks by selling them as a whole (including both insured and uninsured deposits) to an acquiror, generally with a generous subsidy provided by the FDIC. And “despite the FDIC’s statutory mandate to use the least-cost means of protecting insured depositors of a failed bank, these whole-bank sales are frequently not the most efficient means of resolving failed banks,” he said.
He argued that the FDIC may be experiencing “mission creep” in which the FDIC has taken it upon itself to protect uninsured depositors out of concerns for the consequences of failing to do so — and even though the law requires it to get authorization from the Secretary of the Treasury and the President.
One reason for the shift, Ohlrogge suggested, is that there is no system to independently verify whether the FDIC’s decisions are the least costly solution. “During the early 2000s, the FDIC’s Office of Inspector General reviewed failed bank resolutions with some frequency to ensure that they complied with the least-cost test requirement,” he said. But he said that has only happened once since the financial crisis.
Moreover, he said the FDIC is “strikingly secretive” about how it makes its decisions, even keeping secret its valuation methodologies from the banks that bid to acquire some or all of a failed bank’s assets and liabilities. “The FDIC tells bidders that it will select the least-cost bid, but it does not describe how it will estimate the costs it will accrue under different bids,” he said.
For policy reforms, Ohlrogge suggested that “as a first step Congress should mandate that the GAO conduct regular audits of the FDIC to assure its compliance with least-cost resolution.” He said Congress should also consider increasing transparency requirements for FDIC implementation of the least-cost test.
Additionally, he said the FDIC should also disclose information on the balance sheets of failed banks as of the time the banks failed, rather than as of the quarter before failure, as the FDIC currently does.
“These reforms have the potential to improve fidelity to the currently established law, save tens of billions of dollars of resolution costs, and contribute to financial stability,” he wrote.
