Michael Lewitt on handling of SVB failure: "the government avoided a fire sale and created the time for these and other assets to recover"

While there is a great deal of handwringing about moral hazard with regard to the extension of unlimited deposit insurance at SIVB and Signature Bank (SBNY), that ship sailed a long time ago.  I think there are other lessons to be gleaned from how failing financial institutions were handled in 2008 that were applied (either knowingly or not) in this case that produced a better result.  And I think the FDIC did a reasonably good job managing a relatively orderly resolution of SIVB while minimizing any immediate systemic damage. 

The extension of unlimited deposit insurance will be debated for years but based on how the government handled the 2008 crisis, I believe it did the prudent thing here.  Had it extended a blanket guarantee on AIG’s obligations back then instead of selectively backstopping certain obligations, and also had it done the same with Lehman Brothers’ obligations rather than let the firm collapse, the losses in both cases would have been much lower and short-term and long-term damage to the financial system would have been much less.  Such a guarantee would have created the time required for these firms’ temporarily distressed assets to recover in value.  When financial institutions become distressed, the primary enemy is time.  Panic creates illiquidity which forces down prices to artificially low levels that almost invariably recover (sometimes rather quickly) once the situation stabilizes.  Today, even more than 15 years ago, time moves dangerously fast as a result of social media which accelerated the panic surrounding SIVB.  By guaranteeing the deposits at SIVB and SBNY, the government avoided a fire sale and created the time for these and other assets to recover (or begin to recover) their value, thereby avoiding unnecessary losses... 

In choosing between moral hazard and a bank run that could have caused unrepairable systemic damage, the government made the correct choice. It can address moral hazard later with measures designed to improve how banks manage their assets (including improved bank regulation), but the goal should be to live to fight another day. I would also add that the fact that depositors with more than $250,000 are almost exclusively “wealthy” as defined by the terms of our current political debates is a red herring.

~ Michael Lewitt, "Chasing Our Tails," The Credit Strategist, March 27, 2023