In the case of SVB, however, the bank was not engaged in the sort of risky lending seen in the subprime crisis, and increased "stress testing" wouldn't have saved it. It had put its deposits largely in federal securities, purported to be the safest assets available - so safe that they carry a "zero risk weighting" requiring no extra capital buffer. What went wrong was that they were long-term bonds at low interest. When rates shot up, the market value of the bonds dropped, since buyers prefer newer bonds paying higher interest. Bonds that could be sold were sold at a loss, and some marked "hold to maturity" could not be sold at all. As a result, SVB lacked the liquidity to meet the sudden unexpected demand for withdrawals.
The flaw to which SVB and many other "troubled" banks have fallen victim is the age-old systemic problem of "borrowing short to lend long." For centuries, banks have borrowed the money of depositors who expect to have it available on demand, and have invested it in long-term assets that cannot be immediately liquidated. The system works well so long as the depositors don't panic and rush to pull their money out all at once. But when they do, if the problem is systemic, not just single banks but the whole banking system can collapse.
We used to see this flaw dramatized every December, when TV networks ran the 1946 Christmas classic "It's a Wonderful Life." When the Bailey Brothers Building and Loan suffered a bank run, George Bailey (Jimmy Stewart) had to explain to the panicked depositors that their money had been lent to their neighbors. He was on the verge of suicide, when a guardian angel showed him how critical he and his bank had been to the community; and the neighbors pitched in and rescued the bank.
Even closer to the situation today was the crisis of the savings and loan associations (S&Ls) of the 1980s, after the Federal Reserve raised interest rates dramatically to kill inflation. Most of the assets of the S&Ls were long-term fixed-rate mortgages. As rates rose, they had to pay more to attract deposits; but the amount they earned on their fixed-rate mortgages didn't change. Losses mounted, but the S&L insurance fund, the FSLIC, lacked sufficient money to reimburse all the depositors at failed S&Ls; so the regulators turned a blind eye and allowed them to keep operating as "zombies." The matter was finally resolved with legislation in 1989 that placed S&L insurance under the FDIC and established the Resolution Trust Corporation to resolve the remaining troubled S&Ls. The ultimate cost to the taxpayers was estimated to be as high as $124 billion.
As with George Bailey's savings and loan, the flaw was not "fractional reserve" lending. The S&Ls pooled the money of their customers and lent only what they had. The systemic flaw was and still is that to make long-term loans, banks must borrow "other people's money," which is expected to be available on demand. Today the banks' liquidity options include not just their own depositors but other banks' depositors in the fed funds market, and pension funds and other institutional creditors lending in the repo market. But they all expect their money to be available on demand; and if the bank has lent it out in long-term loans, the bank can be caught short shuffling reserves around trying to meet that demand.
The Failed Banks Were Not Nationalized, But Maybe They Should Have Been
One option that was debated in the 2008-09 crisis was actual nationalization. As Prof. Michael Hudson wrote in February 2009:
Real nationalization occurs when governments act in the public interest to take over private property. " Nationalizing the banks along these lines would mean that the government would supply the nation's credit needs. The Treasury would become the source of new money, replacing commercial bank credit. Presumably this credit would be lent out for economically and socially productive purposes, not merely to inflate asset prices while loading down households and business with debt as has occurred under today's commercial bank lending policies.
Gar Alperovitz, professor emeritus at the University of Maryland, also weighed in on the issue. In a 2012 New York Times article titled "Wall Street Is Too Big to Regulate," he noted that the five biggest banks""JPMorgan Chase, Bank of America, Citigroup, Wells Fargo and Goldman Sachs""had amassed assets amounting to more than half the nation's GDP. He wrote:
With high-paid lobbyists contesting every proposed regulation, it is increasingly clear that big banks can never be effectively controlled as private businesses. If an enterprise (or five of them) is so large and so concentrated that competition and regulation are impossible, the most market-friendly step is to nationalize its functions "
Nationalization isn't as difficult as it sounds. We tend to forget that we " essentially nationalized the American International Group, one of the largest insurance companies in the world, and the government still owns roughly 60 percent of its stock.
Another example was Continental Illinois, the largest bank bankruptcy and the seventh-largest bank in the country when it failed in 1984. The FDIC wiped out existing shareholders, infused capital, took over bad assets, replaced senior management, and owned the bank for about a decade, running it as a commercial enterprise, selling it in 1994.
What constituted a radical departure from capitalist principles in the last financial crisis was not "nationalization" but an unprecedented wave of bank bailouts, sometimes called "welfare for the rich." The taxpayers bore the losses while the culpable management not only escaped civil and criminal penalties but made off with record bonuses. Banks backed by an army of lobbyists succeeded in getting laws changed so that what was formerly criminal behavior became legal. Instead of nationalization, we got TARP, the Troubled Asset Relief Program, in which toxic assets were purchased from financial institutions by the Treasury. Faced with the inequity of that solution, many economists recommended nationalization instead. Willem Buiter, chief economist of Citigroup and formerly a member of the Bank of England's Monetary Policy Committee, wrote in The Financial Times in September 2009:
Is the reality of the modern, transactions-oriented model of financial capitalism indeed that large private firms make enormous private profits when the going is good and get bailed out and taken into temporary public ownership when the going gets bad, with the taxpayer taking the risk and the losses?
If so, then why not keep these activities in permanent public ownership? There is a long-standing argument that there is no real case for private ownership of deposit-taking banking institutions, because these cannot exist safely without a deposit guarantee and/or lender of last resort facilities that are ultimately underwritten by the taxpayer.
. . . Once the state underwrites the deposits or makes alternative funding available as lender of last resort, deposit-based banking is a license to print money. [Emphasis added.]
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