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The Fed smothers capitalism in an attempt to save it (economist.com)
74 points by 2OEH8eoCRo0 on March 18, 2023 | hide | past | favorite | 126 comments



Unmentioned are the regulatory implications of 100% deposit insurance.

A regulator liable for ALL the deposits becomes responsible for ALL the assets. Regulators are generally conservative, and loans to new companies with strange ideas and no track record don't look so good to them. SVB's underwriting of startups depended on regulatory freedom to take risks not entirely understood by regulators, with corresponding risk that those loans might fail. Some career bureaucrat will not look kindly on a bunch of loans to the likes of nextbigthing.com.

That underwriting didn't kill SVB. But restrictions on it are likely to follow -- the bureaucrats lack the judgment and knowledge to approve anything without a proven track record.

The SVB depositor bailout may have spared startups some anxiety and complication (the bulk of their cash was never at risk), but it may very well prevent the replacement of SVB. The startup community will likely regret its weekend of panic and special pleading.

(There is also the problem of politicization of credit allocation, which we saw in 2008 when mortgages to low-income and subprime borrowers contributed to (I don't say caused) the housing bubble that brought down the whole mortgage market. But this will be of less interest/concern to the tech startup community.)


Let's preface this by stating that I'm looking at things from outside the US, but nonetheless mildly affected by SVB's collapse.

There is already talk about rules being changed so that in case of an implosion like SVB, the executives' bonuses could be clawed back over a span of several years. That would be a damn good start, because it would put the C-suite personally on the hook for setting up these cock-ups. It won't be enough.

I hope, and would expect, that FDIC fee structure will also change. The best way to incentivise banks to spread their exposure risks across industry sectors will likely be to charge aggressively progressive fees for increased sector risk. Spread your risk across multiple, mostly uncorrelated sectors? Pay reasonable fees. Concentrate on just one or two? Get charged through the nose, to the point of stunting your profit margins.

Sticks and carrots are not always enough. Sometimes you do need modded, lethal cattle prods.


We've effectively had 100% deposit insurance at the "too big to fail" banks since 2008 and the lending restrictions you are predicting have not happened.

The fundamental problem is that we had effective 100% insurance at the "too big to fail" banks but not at the others. People just didn't think about that until quite recently, and when they figured it out, they panicked and were going to move all their money into the too big to fail banks unless the government stepped in.


Why weren't the likes of JP Morgan competing with SVB for this business?

And notice that in 2018 SVB was explicitly relieved of the increased regulation accompanying the "systematically important" label.


> A regulator liable for ALL the deposits becomes responsible for ALL the assets. Regulators are generally conservative, and loans to new companies with strange ideas and no track record don't look so good to them. SVB's underwriting of startups depended on regulatory freedom to take risks not entirely understood by regulators, with corresponding risk that those loans might fail. Some career bureaucrat will not look kindly on a bunch of loans to the likes of nextbigthing.com.

SVB wasn't making those kinds of loans to startups and it wasn't risky loans that blew it up.

The problem is that its model of deposits was startups which would get backed by $5M-$50M all at once and then need to draw that down over time.

The problem comes when VC funding dries up completely and then there's no new deposits to replace everyone burning through their cash.

They did take mortgage debt back in mid-2021, but it was not particularly controversial mortgage debt -- however due to rate increases in mid-2022 it went underwater on a mark-to-market basis. This wouldn't have been a problem if they could hold to maturity, which is what they stated they intended to do (and which they probably did intend to do) but the drawdown in deposits forced them to sell some of these to raise cash and forced them to book those losses.

The weird risk here was really the way the deposits all dried up and the cashflow out of the bank became strongly negative due to economic conditions of the depositors. The whole business model of the bank had a baked-in bank run that would happen. That isn't really a normal kind of risk, though, and not something that is typically regulated or anticipated by anyone. The actions to close down the bank and take it over and insure the depositors seems fine to me.

The moral of the lesson seems to be that bigger banks need to have startup-oriented divisions that will accept this business and absorb those cash flows inside the scope of a much larger bank. You can't have one bank that takes all the deposits of something volatile like VC funded startups. I don't know how you regulate that though other than the Fed explaining to the major banks like JPM that this kind of thing can't happen again so they need to start serving VC companies.


Was SVB actually lending money to companies with no revenue? Isn't that where VCs should be?


I'm sure they weren't lending to zero revenue companies but there are lots of new small companies with some revenue and capital that need some momentary liquidity: credit lines, bridge loans to next equity funding, etc. And loans/services to people with stakes in such companies. Need a loan to fund exercise of options in a private company that's doing well? SVB might do something like that, Citibank not so much.

A knowledgeable bank can safely make such loans but no regulator will.


Financing startups is not the roll of banking. Banks are low margin and high volume.


I fail to understand why they don't pick a number like 90%. Enough to prevent financial ruin of depositors, but also set to encourage some measure of risk evaluation by depositors.


Should depositors really be responsible for risk evaluation?

How much do you know about the balance sheet of your bank? For any banks that are not publicly traded, shouldn't they be forced to then share their financials and transactions with depositors?


> Should depositors really be responsible for risk evaluation?

A nudge. So OK, call it 95% coverage. People putting money willy-nilly into shady "banks" is how we got here.


Why don't banks charge to hold your assets? They're liabilities. You should have to pay the bank interest if you expect to be made whole. Rhetorically speaking, where is the restitution money coming from?

If you're making money in interest, dividends, capital appreciation, market value, etc., that's because your capital is being employed. That's risky and the profit (or loss) should be a function of that risk.

Banking as a pure store of assets feels decoupled from that objective.

I do think SVB depositors being made whole was good, but a hypothetical widespread failure event across dozens of big banks would be catastrophic. There should be easy liquid stores of value that are essentially zero risk for this type of failure, even if you have to pay for them.


Banks use deposits to fund loans and profit by the difference in the rates paid by the loan and the depositor.

It's a pretty good business model with a stable deposit base, but SVB got a huge influx of deposits and mismanaged it.


> Banks use deposits to fund loans and profit by the difference

Yes, but but that's risk.

It feels like there should be a class of bank that doesn't get involved in additional risk at all, that makes all of their expenses and margin on management fees.

You'd experience inflation and the fee itself, but it'd be better than stuffing it under a mattress.

I imagine you'd want to have this as a diversification method as one vehicle in your total protfolio of investments and value stores.


I think you're describing money market funds, they take your cash and put it into very short-term commercial paper and t-bills. Google says they're managing something like $3 trillion these days. Places like Vanguard, Fidelity and Schwab offer them and you can write checks against them.

And many banks make lots of money on fees and various services. It's problematic because no one likes ATM fees and minimum balance fees, and the politicians get involved.


No, I think he means something like the Narrow Bank or Oeconomia Augustana by Dieter Suhr.

Oeconomia Augustana works like this. Your bank borrows money at the Feds funds rate and when you borrow, instead of paying the interest on the loan, the feds funds rate is deducted from your balance. When you transfer your balance, the new recipient has to pay the interest fees as he is benefitting from the fact that the Fed issues this safe liquid and universally accepted money and the bank can survive a bank run. The interesting aspect of this is that if you lend your money via certificate of deposit you don't have to pay the fee, so there is no risk of depositor funds for loans drying up as opposed to the Narrow Bank system where there is very little incentive for people to lend their money via certificate of deposits, which is why they suggest doing away with lending and betting everything on mutual investment banking.


Exactly what I was interested in, and the other benefits and properties of this setup are great.

I want to put some portion of my portfolio in something exactly like this. It would make sense to me if more companies and individuals held some portion of their net worth in these safe depository vehicles. This feels bullet proof.

Thank you!


People expect free government subsidized insurance on their bank accounts though. The fact that this means wealthy people receive a higher subsidy does not bother them.

In fact, they will rally against it, even though say a -5% on their demand deposits is most likely going to be an insignificant amount of money, and if they want to earn money they should have gotten certificates of deposits so the bank doesn't have to take on the duration risk.


There are already banks that provide products to sweep your large valued accounts into as many banks as necessary to keep your entire balance insured.

Insuring 100% balances is fine, it’s up to them to set premiums and banking policy directly.

As long as failing banks fail (stockholders wiped out, assets seized and sold to cover deposits first) there’s no problem with insuring deposits.

I do have a bit of a problem with how broadly bad mortgage backed securities are being bought by the fed to prevent losses from bad investments from failing more banks.

Housing prices are killing our society and there needs to be pressure against the enormous loans nearly every homeowner has.


Insuring 100% balances is fine, it’s up to them to set premiums and banking policy directly.

I disagree. Why should everybody suffer higher fees, higher loan interest rates, and lower savings interest rates so that a small number of rich people can be stupid with where they put their money? If your business puts its money in the hands of reckless yahoos and can't pay its salaries it should have to get a loan to do so until it can get its deposits back from the failed bank.

Every time we remove a piece of accountability we inject permanent stupidity into the system.


What the fdic just did was insure 100% at a "systematically important" bank while charging a special assessment to all the banks, even if the same designation and thus extended insurance did not apply to them. It's the worst of both worlds.


Insuring balances is not 100% fine. Spitting money across banks decorrelates the risks. And presumably whomever is picking the actual banks involved is choosing them with some care. So the FDIC is surely fine with people opening multiple accounts.

But insuring 100% of the balances at a single bank creates moral hazard. It gives executives a bigger incentive to gamble knowing that their losses will be covered. They'll be less sensitive to long-tail risk. Their customers will be less worried about bank failure, and so more likely to place their money with banks that are taking more risk.


The executives will have no choice but to take risks. Depositors, knowing their funds are covered no matter what, will chase banks with the highest yield. Eventually, the only way to compete higher is to take greater and greater risks. He who takes the most risks gets the biggest interest rate, he who does not loses his depositors to someone who does. In the end the conservative actors implode from losing their depositors and paying special assessments for 'insurance' risk of competitors, and aggressive actors pump up from those chasing high yields and then explode with their depositors getting bailed out.


Very well put.


It's questionable how much splitting money across banks decorrelates risk. SVB's mistake was buying slightly too many treasuries at slightly too long a duration. Pretty much every bank is in this same boat if interest rates continue going up.

All the banks own debt (treasuries, mortgages, bonds, etc) at pitifully low interest rates.


It's not all that questionable. How many banks have failed out of the total number of banks?


Suppose the FDIC decides they are keeping the 250k limit. The logical outcome is for companies to leverage fintech services that help spread corporate deposits among multiple banks.

The problem is now you have high correlation across that pool of banks. If depositors get scared and a bankrun occurs, they are now pulling money from the entire pool. The 2008 bank failures provided a small glimpse into that correlated risk.

How many banks today are capitalized sufficiently to handle a bankrun of the scale that occurred at SVB? SVB's balance sheet is not unique, all banks have significant unrealized losses due to bonds, mortgages, and any other kind of debt that they own. During the pandemic, the Fed reduced the reserve requirement to zero so banks need to keep 0% of customer money 'in the vault'.


That sounds like a very specific hypothetical future risk. That's a logical outcome in a vacuum, but companies have managed large cash and near-cash positions for a long time without services like you describe. I think your "slippery slope" argument is a fantasy.

But if it weren't, and if it were a problem for the FDIC, which I don't think is established, then the FDIC can just change the definition of what's covered a bit. It's not a hard fix for them to say that they won't cover more than $x per beneficiary total.


nah, they will get another SVB through lobbying, regulatory capture, and deregulation in time.


Sort of amazing that someone could write an article referencing bank panics, the Great Depression, and the role the Federal Reserve without even mentioning what constraints that the pre 1999-Glass-Steagall would have placed on a bank like SVB.

Would those in the know classify SVB as primarily a commercial bank, handling the deposits primarily of businesses (they don't seem to have been in the car-loan and home-loan sector, but I have no idea), and loaning to other businesses, or as an investment bank, with a large portfolio of stocks and bonds? Did SVB have a trading division like Goldman or JPMorgan does, i.e. SVB Capital? What's the SVB Group structure all about?

Glass-Steagall seems to be getting a lot of attention as a possible contributing factor in this story in other venues:

https://www.newsweek.com/bring-back-glass-steagall-opinion-1...

https://www.nytimes.com/2023/03/15/opinion/silicon-valley-ba...

https://www.huffpost.com/entry/yellen-glass-steagall_n_64136...


The Economist covers the topic of banks pretty much every week. Individual articles are mostly written to be short and approachable; depth comes through multiple articles over time.



Thanks, just posted this, but deleting mine.


Banking has been a quasi-government-operated industry for over 100 years, since the creation of the Fed in 1913, the creation of the FDIC in 1933, and the increased regulation since 2008.

In 2008 the Fed created a two-layer banking system: banks that were "too big to fail" whose deposits are effectively insured for infinite amounts, and all other banks whose deposits are insured for $250k. Nobody realized this until a few weeks ago, and without the government's scramble to respond everyone would have moved their deposits to the big banks, killing all the others.

People finally realized this because of duration risk on long-term investments. Who caused that duration risk to actually manifest as a real problem? The Fed! The same people who are supposed to run the banking system in a stable way have contributed to the instability of the banking system by keeping rates low for so long, overreacting to Covid, assuming inflation was "transitory", and then raising rates very quickly trying to squash the inflation they caused.

That's not capitalism. We haven't had capitalism in banking for a century.

People have an impression that banking is a private industry and the government comes in to bail it out, when really the government was involved the entire time.

Aside from the crash in 2008, where the Fed really did help, a number of the major recessions in the past century have either been caused by or made worse by the Fed, including the Great Depression by Bernanke's own admission.

Banking regulations certainly need to be changed because of what happened last week, but the way the Fed is run should definitely also be changed.


> Nobody realized this until a few weeks ago, and without the government's scramble to respond everyone would have moved their deposits to the big banks, killing all the others.

Hopefully no one will take this as a political endorsement but this is the most exquisite exchange I've seen illustrating your point by Secretary Yellen and Senator Lankford.

https://youtu.be/CX6O--sk48A?t=5430

Based on her response I anticipate we will continue to see the effect you predicted. Yellen was pretty much speechless in the face of presentation that people will start moving their money to banks designated as ones worthy of "systemic risk" designation.


> Aside from the crash in 2008

There’s a strong argument to be made that the Fed caused the crash in 08 too. First by keeping rates too low for too long after the dot com crash, then aggressively raising them right up until things started breaking. Sound familiar?

The Fed did a great job after 08 convincing everyone it did a great job managing the crisis, which I think is fair. But there’s also an argument to be made that they played a role in causing the crisis too.


Let the Fed itself offer protected savings accounts to the public?


The introduction of the Fed didn't cause booms or busts. Those were already there and happened more frequently, roughly every four years.


When this happens to a bank, the FDIC should step in, make the bank liquid again (perhaps by trading the bonds and other investment products for cash), evenly pay out every customer with whatever there is, pay up to $250,000 per customer for the shortfall, if there is any. If there was no shortfall, pay out to investors/debtors. Then shut the bank down.

I think a lot of people perceive the bank as having zero assets and the FDIC is covering 100% of the deposits. Some $200B or whatnot. But most of what people deposited didn’t just vanish.


The challenge is what to pay to the people who pulled out all their assets hours before the bank failed. If the people who pulled out all their assets fast enough keep 100% and the people who didn't keep 50%, this is wildly unstable and we see constant bank runs, as was common in the early 20th century.

If the people who pulled out all their assets fast enough keep 100% and the people who didn't keep 95%, and normal people are banking, this is slightly unstable but most people aren't going to bring down the financial system to slightly reduce their risk of losing 5%. The system has been working like this for 70 years.

The current batch of Silicon valley/new york financial types would stab an orphan in the face with their mother's fine silverware, to avoid losing 5%.


What you described is what happens during a normal bank failure. That happens fairly regularly to small local banks and it's not normally even newsworthy.

That's not an adequate response to a systemic risk against the entire banking system.


Good to know.

And fair enough. I won’t pretend to understand just how much risk there was to the entire system. But obviously the officials felt it was immense.


It all happened so fast , I have been holding Bitcoin for far too long now and just last year I lost over 60 bitcoins to hackers who invaded my wallet . It was this faithful morning I was at work when I received an email from blockchain saying I needed to verify my account again for security purposes which I did thinking that it was the legit blockchain email address that was sending the mail to me , I ended up clicking a file that was attached to the email and that was how it all happened, my PC froze for like 2 minutes and the next thing was me receiving a notification that my Bitcoin has been sent out to another wallet , I was so furious and confused on what to do about this , tried emailing the blockchain support to see if I could by any chance get my bitcoins back but they said that nothing can be done about it , for a sec I almost gave up on it but then it struck me that I could actually use the help of a hacker to trace the Bitcoin back . I reached out to V I R T U A L H A C K N E T @ gmail . Com for their help .. all they needed was the details of my own very wallet and the wallet which the coin was sent out to . In less than a week the funds was traced back to the culprit who had invaded my wallet and it happened they used part of the money already and all I was able to recover was about 40bitcoins out of 60 that was stolen . I’m still happy and grateful regardless . All thanks and appreciation goes out to V I R T U A L H A C K N E T @ gmail dot com for the incredible job they did . They are active both on email and telegram @ VIRTUALHACKNET .


I always think of the Fed as the doctor who overprescribes antibiotics or the fire brigade whicb won’t let even a spark go bu in the forest without flooding the whole zone in order to prevent a fire.

Sometimes you have to take it in the chin like a man and spend 5 or 6 days with tonsillitis and congestion. The following week will be amazing because you are back to normal and appreciate all that you took for granted. Food, drinks, even mundane things such as breathing normally

Same thing with fires, sometimes the soil needs a violent fire to clean weeds and old trees and disseminate nutrients down the soil

We know these concepts at the micro-level, it’s about time we learn them at the societal level.

People are longing for the end of the boom-bust cycle. If anything we need them to be more violent and in line with what Nature does with the 4 seasons


The last president who initiated a controlled burn quickly got voted out of office and is widely remembered as a bad president, while his successor got to take credit for the regrowth. Any politician who hears your proposal would agree in principle, but in the back of their head they would be thinking "do I want to end up like Carter?"


Why even run for the highest office if you won’t do whatever you believe should be done?

The term limit is there to press people and to make them think that when it’s all over they look back and should be proud of something they have done, not a mere “the pollsters told me to do X and I did X”

Unless you do whatever you want being POTUS sounds like a hellhole job.

All day building coalitions and having meetings , being mostly sedentary, no privacy, constant assassination risk, constant attacks…and at the end of the day a bunch of pollsters are your boss. You get to ride in AF1 but that’s not unlike a Boeing Business Jet and there are some also available for private charter


> Why even run for the highest office if you won’t do whatever you believe should be done?

A president must choose their battles and use their political capital wisely, lest they burn it all and are unable to accomplish anything else for the remainder of their term.


That's not what Carter did. He inherited a bad economy from Ford and Nixon and failed to fix it. We expect our presidents to fix problems whether they caused them or not. At the end of 8+ years of a bad economy, oil embargoes, and leadership that conveyed a depressing message for the country's future prospects, the voters were rightly displeased with Carter.


Remind me, who installed Volker again? Who cranked the interest rates? Who got voted out of office because they finally cranked the interest rates high enough to tame inflation?


We, as a society, do not reward leaders who follow this. We are our own worst enemy, like petulant children we demand our candies even as our teeth rot out of our heads.

There is a quote: bad times make strong men, strong men make good times, good times make weak men, weak men make bad times.

We are firmly in the weak men period.


>There is a quote: bad times make strong men, strong men make good times, good times make weak men, weak men make bad times.

careful, that phrase and kind of talk will have you labeled a misogynist incel that hates women.

Anything that recognizes the need for (strong) men in society is inherently bad.

We will soon reap the reward of that cowardice.


I mean yeah, surely women play a role in the world too. Unless by "men" we mean "people", in which case why not just say that?


I take “strong men” in the quote to be men willing to take the harder but correct path - not kicking the can down the road the way our “leaders” all seem to do now.


I'm really tired of hearing that meme without any substantiation. It seems like you could just as easily say that bad times make bad men (make bad times...).

Look at places in the world (or your own hometown) that are "bad" (high crime, low social trust, etc.). Are those the places that are producing the best people?


The quote suggest a way the world works, but there is no evidence that it is close to accurate. I admit it is rhetorically pleasant.


Yeah, during the panic over SVB, I saw lots of argument that people with millions of dollars in cash shouldn't have to worry their pretty heads over managing that money. Lots. And I think that's true in the same sort of abstract way I shouldn't have to worry about how what I'm eating affects my health. All desserts, no vegetables, right?

But back here in the real world, arguing for eternal and unlimited taxpayer bailouts implies eternal and unlimited interference from the people paying for the bailouts. Capitalism is about risk and reward. It's about a cycle of gambles and consequences, good and bad, that helps society discover what works and what doesn't. If you take away the consequences, it's not capitalism anymore. Maybe you end up with socialism for the rich, maybe you end up with gray, bureaucrat-run playpens. But either way you lose the engine-for-progress part of capitalism, which I see as the heart of it.

I was talking with my retired aunt yesterday and she asked about the reaction here in tech-land to the SVB bank run. When I explained to her that there were people with millions or tens of millions in cash in one bank, she was gobsmacked. She is just getting by, and even she keeps accounts with two separate companies. In her words, "You never know!" The question she had that I couldn't answer: "How do people think history doesn't apply to them?"


It's not unusual. Only about 60% of deposits in US banks are insured.


It's not that unusual for a given dollar to be at risk. It's very usual for a particular bank account to have dollars at risk.


I think the article misses the real dilemma. Think about all the firms who do payroll through Rippling, should those employees and firms suffer because of something they essentially knew nothing about? We want to avoid moral hazard but we also want to avoid firms going bust for no reason. I think the issue is that big economic players (in this case some billionaires and VCs) point to all the small players that will by wiped out and it feels a bit like a hostage scenario. And in that hostage scenario we're basically always going to choose to socialize the risk. IMO the problem comes when we make decisions to socialize risk without socializing reward. When the two are tied together we eliminate the hostage feeling, now big players know there is a big cost to being saved by the government.


> those employees suffer because of something they essentially knew nothing about

Just like the tens of thousands of layoffs before and since? Employees at those companies were really at no more risk than employees at even the most profitable of companies (a’la Google).


You're entirely right about the hostage scenario.

Ultimately the VCs that guided their portfolio companies to use SVB and neglect obvious cash management are responsible for the anxiety. I suspect they would have stepped up to fill any gaps, which would have been less serious than claimed; making payroll was never seriously threatened.

But before then they were happy to let some useful idiots clamor for a depositor bailout that would absolve them of that responsibility.


The systemic risk to the entire banking system was real and still is, and VCs banding together to save a single bank would not have helped.

The systemic risk became real simply because a lot of people realized that SVB was not the only bank with problematic assets. The result would have been an outflow of deposits to the "too big to fail" banks because those banks effectively have infinite deposit insurance (because everyone already knew they would not be allowed to fail).


I think the VCs would have helped not SVB but their own portfolio companies. The amounts involved would have been small and the VCs would not want to admit to their own investors they were idiots.

Failure of a number of regional banks does not threaten the whole system but the handful with sketchy solvency / liquidity.


All banks that were not in the “too big to fail” category were at risk as panicked depositors would have flown to safety in the arms of Chase and the other big banks. They would have done that even if their own smaller banks were just fine, because of a fear that other people would do it first. Once the panic begins it becomes a self-fulfilling prophecy.

Also, many other small banks are not fine. SVB is not the only one with concerning duration risk in their assets.


The rewards are socialized, because the small players would not have existed in the first place if not for the big players. All these small companies that were impacted by SVB only existed in the first place because VCs invested in them. The same story plays out in many other industries.

The losses aren't really socialized either -- not this time, and not in 2008. In 2008 the government made money on the bailouts, effectively getting an investment return on taxpayer money. So far in the rescue of SVB no taxpayer money has been spent either.


Nope. QE is a fig leaf over a money printer. The Fed is the bagholder of last resort. They haven't made money in any real sense until they sell those assets (or roll them off) and they never will because every time they try the market throws a shitfit and they go back to printing.

https://fred.stlouisfed.org/series/WALCL


QE transforms treasuries into their liquid equivalent. You can call this money printing if you want to but then money printing is a meaningless term that means everything and nothing. My clock is printing time. My car is printing miles.


In theory, these are all just loans and they get paid back. In practice, the Fed's balance sheet just keeps increasing. A loan that always gets covered by a bigger loan is never really repaid, and a loan that is never repaid isn't a loan, it's a payment. These are payments disguised as loans. A fig leaf over a money printer.

Look, I understand that you don't want to base your opinion on speculation about the trajectory of the Fed's balance sheet, but do you see how this refusal would give the Fed license to print money in exactly the manner I describe, by perpetually growing the balance sheet?

Let's be concrete: would you be willing to bet me $10k that in 10 years the Fed's balance sheet is under $10T? If not, I rest my case: this is money printing, not liquidity provision, and the smart part of you not willing to take my bet understands this.


NASDAQ is up though. It seems it's up every time there is a problem. How does that work?


Money printer go brrr to the tune of $300 billion: https://www.federalreserve.gov/monetarypolicy/bst_recenttren...

They've undone half of the quantitative tightening that's been going on in the last year.


We live in a big cold warehouse, heated by an old furnace. This guy "JPow" controls it.

The lucky ones, they've staked out places for themselves next to the heat vent, surrounded by broken glass and fences made of twisted rebar. Other squatters shiver way over in the corner by the windows. They regularly lose toes to frostbite.

When the squatters really start dying -- mothers wake up to find their babies have turned into frozen meat in the middle of the night -- then "JPow" gives in a little and cranks up the thermostat. The temperature in that far corner of the warehouse might even get above freezing.

But for the heat-lords who've got the good turf, man, it's like a day in the tropics. Shorts, flip-flops, Hawaiian shirts, margaritas. Party on!

Which is why, of course, it's always good news that plebs are starting to die of hypothermia. Because it means "JPow" has to keep 'em warm, and party time continues.

This little parable is, of course, a description of the Cantillon Effect.

NASDAQ is particularly sensitive to interest rates. People say it's because Tech is more future-looking, and when rates are high you want profits now. Or maybe it's sensitive just because that's what everyone believes. Either way, when rates go down, NASDAQ goes up.

It's weird that people celebrate news that the car is slow, because that means the driver is going to hit the gas. But that's how it be.


>This little parable is, of course, a description of the Cantillon Effect.

Except all the proponents of the cantillon effect can't seem to point at where it happens because it happens everywhere in the economy and every single economic actor has their own cantillon effect as anyone who saves demand deposits temporarily destroys money and creates a reverse cantillon effect at every single point in the economy and everyone who spends off their demand deposits causes a forward cantillon effect even if the central bank does nothing, making the whole theory completely useless as a method of blaming the government or central bank. When you consider the fact that commercial banks create commercial bank money and that there's thousands of them competing with each other the cantillon effect becomes more like a conspiracy theory because if the cantillon effect exists, it would be caused by inequality, not the other way around.

I have never seen anyone who points out the "Cantillon Effect" complain about too high banking profitability, for example. The Austrian Economists, who love the Cantillon Effect, always appear to demand higher interest rates which increases banking profitability, which immediately exposes their hypocrisy.

https://www.aier.org/article/the-mythology-of-cantillon-effe...


1.

> [C]onsider the fact that commercial banks create commercial bank money and that there's thousands of them competing with each other [...]. [I]f the cantillon effect exists, it would be caused by inequality, not the other way around.

This seems like an interesting point. Let me try to think it through. It seems that, in an unequal society, richer people have more credit, so lending/money-creation gives money disproportionately to them. Thus lending magnifies inequality of access to money. Say everyone can borrow at 1:1, and you have $1. Then you can transform your situation into one in which you instead have $2 and $1 liability. Whereas the guy with $10 can transform his holdings into $20 plus $10 liability. Now if that "1:1" is actually a variable that goes up as interest rates go down, then lowering the rate disproportionately gives dollars (and liability, but that is inflated away) to those who already have them. In the extreme disproportion, one guy has all the money and can buy all the houses (or other real assets).

This then locks in increased consolidation or monopoly power, which can be used to extract rents that pay off the liability.

So I can see how a "distributed Cantillon effect" could both be caused by inequality, and exacerbate it.

This model does depend though on "the interest rate" being a consensus thing, maybe centrally-dictated.

I suppose collusion/rehypothication is another issue. Liability chains are supposed to be acyclic, but if we can somehow cause "forgetting" across one edge of a cycle between ourselves, then we can make "infinite money" and buy up assets before anyone catches on. And then maybe "remember" things later and make the mutual debts all cancel. Maybe this scam is sort of happening in a distributed way...

2.

> The Austrian Economists, who love the Cantillon Effect, always appear to demand higher interest rates which increases banking profitability, which immediately exposes their hypocrisy.

It's weird actually. There's a kind of cranky libertarian strain. On the one hand it blames ZIRP and presumably wants higher interest rates. And on the other there are lots of goldbugs in that school who like... gold... which has a zero interest rate. So that would seem to be a contradiction...

Maybe it's not though. They also don't like fractional reserve banking and want narrow banks. So if gold is a way to put a hard constraint on how much money there is in circulation, then high interest rates are a soft/elastic version of same, within a fractional reserve system.

(Islamic banking seems to have similar principles. More "tracking chains of exchange", less creation of money/banking-liability.)

3.

The one thing we can be sure of is that a regime of falling interest rates continually drives up the prices of earlier bonds, so the people who win are the ones who got in earliest. It has a pyramid flavor but somehow worse, because although ever-increasing exponentials are at least a mathematical object that exists (even if there are real limits), a monotonically-decreasing curve with a lower bound of zero can at most asymptote to zero -- and if you put any bound on the rate of decrease, then you find that you reach zero in finite time. After that, then what?

Just thinking aloud, really.


Because every time there is a problem the Fed gives them what they want.


Bad news is good news when the only trader that matters is the Fed and his money printer.


Because money and (stock) value is not strictly correlated. A business can lose money but their stock can be up because value depends largely on potential unrealised gain in the future. Then theres the fed making depositors whole again which means any negative sentiment against several banks before the feds involvement will recover. Maybe someone more knowledgeable could weigh in on that last part.


> because value depends largely on potential unrealised gain in the future

Exclusively actually. Past performance is only relevant to the price as a predictor of future success.


Well, if we’re being nitpicky, balance sheet items such as a large net cash position (a derivative of past success or failure) are also relevant factors in the value of a company.


Sure, as it relates to where the price of the stock price may go in the future.


Because bad news is good news.

The markets have been high on ZIRP and QE for a decade now, and so when interest rates/inflation increase, the Fed takes action, reducing the price of assets.

Good news (more jobs!) means that the Fed will increase rates more (bad news!).

Hilariously enough, the actions of the government(s) to bail out various banks are regarded as bad news by the markets which mean good news for asset prices.

Yes, it's entirely insane. Welcome to modern capitalism, I suppose.


Because interest rates are the overwhelming determinant of general asset prices and bad news for the economy usually leads the Fed to lower/slow the hike in interest rates.


I am encouraged by how many people are now becoming aware of the influence of central banks on our lives.. I think the central bankers also know this, that we know now.. I think that makes them nervous


Every bank is insolvent today and people are just starting to realize this. They all were loaded with tons of liquidity that they couldn’t loan (due to demand) so they had to do something and they all bought “safe” assets in the form of treasuries, etc. The Fed continued to guide on low interest until they suddenly decided to raise rates non-stop.

All those deposit accounts paid 0% interest. Not there’s 4%+ interest available and everyone is pulling their money to put into those, or other things. The banks can’t actually do this much longer.

If you mark to market the bonds these banks are carrying you can see they are insolvent. As more people realize and pull out this and/or move money to higher interest accounts, they are doomed.

How is this fixed? Hope everyone chills? No it will only get worse. I sure it all? That will cause trillions in inflation overnight. Let all the banks collapse? That will spell anarchy and depositors will lose a lot. Quickly lower interest rates? Inflation continues and accelerates.

We are in grave danger right now.


>If you mark to market the bonds these banks are carrying you can see they are insolvent.

Do you have any sources/data for this? I saw something for BofA that indicated a $110b mark to market unrealized loss, but they have roughly $200b in equity so that wouldn't make them insolvent. I don't know if that $110b included everything or just a subset of their hold-to-maturity assets and would love to see more complete data for all big the banks if you have a nicely consolidated source for it?



The Fed already announced their solution. They are making loans available to those banks based on the acquisition cost, not mark-to-market value, of those treasuries.


This will result in hyperinflation. Hence why Yellen did not commit to the vast majority of banks. Did you not see that?


I did not see that, but I've been busy and missed a lot this week. Do you have a link?



This seems to only talk about FDIC limits, not about the Fed loaning money to solvent banks.


Here: https://finance.yahoo.com/news/study-finds-186-banks-vulnera...

This talks about the FDIC being insolvent as well.

I don’t think you understand how much money would have to be loaned. They’d have to print many trillions overnight. This is a hyperinflation event.


Not every bank massively grew by taking in billions of dollars of deposits that they didn't know what to do with in just a couple years.

Banks were only technically solvent before all of this, it isn't a big deal if they are now only technically solvent.


https://finance.yahoo.com/news/study-finds-186-banks-vulnera...

The FDIC wound run out of money. It’s likely more than enough of these funds should be in higher interest accounts. Even if it’s loans these bangs wrote, those loans are under water right now.


If the shareholders were wiped out (as I understand they were), then the moral hazard seems limited, no?

The main remaining moral hazard would be that customers would be incentivized to choose banks that offered higher rates as a result of taking on unsustainable risk. But this moral hazard is checked by investors who are directly incentivized to remain solvent and liquid, because otherwise they will lose everything.

This leaves me with two questions:

1. Did investors of the bank literally lose everything? Or did they get bought out by the government at pennies on the dollar? If indeed this was a liquidity crisis, rather than a solvency crisis, it seems like the shares would still be worth something. Did the shareholders have to agree to give up their ownership, and were they compensated for that?

2. Why didn't the 2008 bailouts follow this model? The way this bank failure was handled makes much more sense to me than the 2008 model. It seems right to me that shareholders should lose everything if the institution fails. Why did shareholders get to keep their companies in 2008?


At the moment SVB stock is worthless and SVB does not legally even exist anymore. The government didn't buy the shares. Every shareholder got wiped out, unless something changes.


The assets are rolled into the new bank, to back the deposits. FDIC probably won't pay in very much in the end.

https://www.fdic.gov/news/press-releases/2023/pr23019.html

Several banks were wiped out in 2008. Other banks exchanged large amounts of equity for government funds. Establishing systemic stability by injecting large amounts of government money was seen as better than letting the entire mortgage system collapse (which is what likely would have happened if all the banks holding mortgage backed securities were left to unwind). The shareholders didn't get off scot free, the government ended up their major partner and sold the assets for more than they had injected into the system (which doesn't necessarily represent a profit).


Because other, national/international banks like JPM, WFC, & BAC have a much closer uh... relationship with congress.


They're not smothering capitalism. They are doubling down on the corporate welfare, cronyism and centralization that's been on full throttle since 2008. That bailout and the acceptance of "too big to fail" banks was when they smothered capitalism


The very structure of the Fed since it's inception has been as a organization that serves banks. To some extent, it used to at least try to keep the industry from eating its own seed, but the lack of attention to that outcome really traces back to the 1970's and rise of neoliberal economic philosophy.

https://mattstoller.substack.com/p/fire-the-fed


is there realy no way to get "bank run insurance" from somewhere other than a central bank?


Anyone interested in such a thing would just keep their money in T-bills via a money market fund. Fast access, zero credit risk, but there is the hassle of sweeping/topping up the bank account used for transactions.

I understand many banks offer "insured sweep" accounts that do just this but of course this costs them cheap deposits. Go ask the various VCs why they didn't press SVB to make this service available to their portfolio companies.


What company is big enough to insure a $230 billion payout if just one bank fails, let alone more than one?


But you don’t need to payout $230B, assets didn’t go to 0. You need to payout like $30B, or whatever the difference between assets and liabilities.


Even $30B (as a single claim) would be difficult to handle. Again, name a company you would trust to hand over that much money then and not topple over.


I could see the re-insurance market being able to float it but it would probably work under an excess balance fee >$250,000.


Buy a calendar of deeply out of the money puts on the bank stock. Puts with strike price at 1% of trading stock price should be cheap.

Uber rich don't need to do this, because they lever up until they are too big to fail.


I hear Lloyds of London will insure just about anything. If you have $10m and you want to insure it, they can make you a policy.


Are those with capital served by the governments propping up the banks? Then it is capitalism.


Which people?

The people with opportunity capital that are now frequently denied the ability to rationally utilize their capital to acquire discounted assets from other irresponsible actors? Those responsible actors with capital - biding their time forever - are being routinely punished in this corrupted system of constant government intervention and bailouts.

Bankrupt GM would not have vanished, its pieces would have been acquired at a steep discount. Pandemic mega airlines would not have all vanished without government bailouts, some of them would have been acquired for cheap (and essentially all of their assets would have been acquired one way or another).

Buffett's Berkshire Hathaway for example, is typically extraordinarily responsible with its capital and most often maintains enormous reserves, ready to strike when the opportunity presents. The post great recession era has been a nightmare for him in terms of deploying capital, because the Fed was performing a decade plus long handout program to investors, making their assets artificially more expensive to fake prosperity. Buffett, one of the ultimate capital actors, is very heavily handicapped in these scenarios, insofar as he's unwilling to act as recklessly as the rampant speculators that commonly blanket Fed bubble markets (whether housing bubbles, dotcom bubble, or the couple of more recent bubbles such as in crypto).

So no, not all with capital are served by this environment of Fed & US Government fraud. Many would do far better without it, picking up cheap assets for pennies on the dollar when other irresponsible parties take insane risks and implode.


I think past 100 years have been a pretty good lesson that capitalism works best when there is government to help with collective action. This is what is happening now and how we avoid tragedy of the commons. Laissez faire capitalism is stupid and every historic data point agrees.


Problem is how government allocates all the funds.

Right now all the winners are chosen by the government. Thus, it is not based on meritocracy but entirely on connections.

Also, government and corporations have merged to such an extend that competition with existing players are not even possible.

I think a good classification for the current system would be neofeudalism. You are either a noble with connections or a peasant.


> all the winners are chosen by the government

Not true

> government and corporations have merged to such an extend that competition with existing players are not even possible.

Look at s&p500 cos from 2000 and now, there is a huge amount of displacement (due to competition).


Yeah. I like the economist until they make statements like this. Capitalism isn’t a moral good, it isn’t noble. It’s just a system we’ve “created” and we can adjust/mess with it as we see fit. They make it sound like there’s some moral imperative to “stay out of the way of the invisible hand” or whatever when, as you said, historically this has proven pretty destructive.


Yeah it wasn’t until I heard that the banks weren’t allowed to hedge HTM bonds that I truly appreciated the “make it up as we go along” nature of our monetary system.

There could be a bank run on Chase tomorrow and they wouldn’t be able to hold. The only thing keeping everything together is folks not panicking.


I'd distinguish between monetary system and economic system. An amazing page is wtf happened in 1971. [1] The event it's alluding to is the end of the Bretton Woods System [2]. 1971 is effectively the day that the USD became completely unbacked by anything whatsoever, enabling unrestrained "printing" of money.

It's quite difficult for a free market of any sort to function when you have a government that becomes capable of arbitrarily distributing effectively unlimited funds at their discretion. This is even more true when that "discretion" is often whimsical and self destructive. So you look at the various graphs seeing things like skyrocketing wealth inequality, inflation, government debt, and more - and all one can think is, "Gee, who'd of thunk?"

In any case, it's important to appreciate that our current monetary system only began about 50 years ago.

[1] - https://wtfhappenedin1971.com/

[2] - https://en.wikipedia.org/wiki/Bretton_Woods_system


>The only thing keeping everything together is folks not panicking.

That applies to a great many things in modern society.


My engineer buddy always says “you’d be amazed how many things are dependent on someone having their morning cup of coffee.”


Which historic data points?


- Outcomes in unregulated banking (early 20th century US+Europe, crypto more recently)

- De-regulation of banks prior to 2008

- Austerity vs stimulus in EU vs US post 2008

- Austerity post COVID in UK

- Healthspan outcomes in places with lax environmental safety regulations (us early 20th century, China more recently)

- Fishery collapse throughout oceans due to lack of government intervention

- Hunted animal population collapses (prior to intervention) and rebounding (after intervention)

The list could go on much much more…

Tragedy of commons just occurs everywhere all the time


2008 is an interesting data point to include in there because wasn’t it government intervention that was forcing banks to take on riskier loans in the first place?

The rest are solid data points at a glance though.


In the past 100 years we've had conservatively 17 recessions (not including the current one) lasting 17 years 11 months total time (18% of the time), and with 1,691% inflation...

And that includes all the adjustments to how they calculate CPI they like to include almost every recession to make it look less bad.


What’s wrong with inflation? We want to encourage growth & investment rather than hoarding of money, inflation is good because it punishes hoarders.

Recessions and bubbles occur more often in unregulated economies.


Funny. The government seems to only want to help with collective action for certain participants in capitalism. The rest of us get whatever those chosen participants allow us to get.


You mean like extra unemployment checks during COVID? COVID stimulus checks? Public student debt forgiveness? Various forbearances during covid?


Dont forget the selective sharing of inside information and bailing out of only certain banks and investors, that just happen "by pure coincidence" to make large political contributions and extensive lobbying to government officials that make those choices.


I am all for more oversight of the government and stricter ethics guidelines!




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