DANIEL VAUGHAN: The Hidden Costs of Government Bailouts for Banks

March 17, 2023

Governments often rush to bail out banks during financial crises to prevent economic collapse. However, these bailouts harm the average person and make banking more expensive in the long run. We're getting all the above in the bailouts offered to Silicon Valley Bank and Signature Bank. Wall Street profits while Main Street foots the bill.

Janet Yellen's Treasury may have gotten private banks to put up $30 billion in cash for First Republic Bank, but that doesn't solve the problem in front of us. When the Treasury, Federal Reserve, and FDIC announced that they were backing every deposit in Silicon Valley and Signature banks, they signed the death warrant for small banks. If your money is in a large institution, you're fine. If you're in a mid-sized or small bank, the federal government doesn't care. That encourages people to leave their small banks.

Government bailouts of banks during a financial crisis hurt the average person. Bailouts may seem like a quick fix to stabilize the economy, but they have long-lasting negative consequences. When the government bails out banks, the taxpayers ultimately foot the bill. This means that people who had nothing to do with the banks' risky behavior or poor management end up paying for the mistakes of those in charge.

Risky banks, and risky business.

Let's consider a hypothetical scenario. A bank has been making risky investments, and its management has engaged in fraudulent activities. As a result, the bank runs into trouble and begins to fail. Instead of allowing the bank to fail and face the consequences of its actions, the government decides to bail it out. The taxpayers pay billions to save the bank and prevent a financial meltdown. This bailout hurts the average person struggling to make ends meet and now has to pay for the banks' mistakes. In this scenario, the government bailout of the bank was unfair and set a dangerous precedent that encouraged reckless behavior by banks.

We know that Silicon Valley Bank made the dumb bet that interest rates would stay near zero. They did this despite a barrage of warnings that interest rates were increasing. Taxpayers should not have to be the backstop for bad bank management.

Bailouts create more expenses.

Secondly, government bailouts of banks make banking more expensive. When banks know the government will bail them out if they get into trouble, they are more likely to engage in risky behavior. This risky behavior may lead to future financial crises, which will require more bailouts, further increasing the cost of banking for everyone.

As the old saying goes, "there is no such thing as a free lunch." When the government bails out banks, someone has to pay the price. The cost of these bailouts is ultimately passed down to consumers through higher fees, higher interest rates, and reduced access to credit. This reality makes it more expensive for people to borrow money, buy homes, and start businesses. It also means that the increased cost of banking hits people already struggling financially the most.

Whether the FDIC ultimately decides to back every deposited dollar in the United States bank system or not, the fact that they are even considering it encourages bad behavior. Suppose a bank doesn't have to worry about its depositors losing their money. In that case, they can engage in any risky money-making venture.

Bailouts encourage bad bank behavior.

Finally, government bailouts of banks create moral hazards. When banks know the government will bail them out if they get into trouble, they have little incentive to manage their risks carefully or act responsibly. This fact can lead to banks taking on too much risk, engaging in reckless behavior, and ultimately failing, which can trigger another financial crisis. This cycle of bailouts and reckless behavior creates a moral hazard. Banks are not held accountable for their actions, and taxpayers are left to pay the price.

As an example, let's look at the 2008 financial crisis. Banks engaged in risky behavior, including giving out subprime mortgages to people who couldn't afford them. When the housing market crashed, many of these mortgages defaulted, leaving the banks with huge losses and average Americans on the street. Instead of facing the consequences of their actions, the government bailed out the banks. This act created a moral hazard, where banks knew they could engage in risky behavior without real consequences. In this scenario, government bailouts of banks not only hurt the average person but also encouraged reckless behavior by banks.

Bailouts hurt us all.

In sum, government bailouts of banks during a financial crisis harm the average person and make banking more expensive in the long run. Bailouts create a moral hazard, where banks are not held accountable for their actions, ultimately leading to taxpayers footing the bill. Instead of bailing out banks, the government should focus on the oversight it has and promote responsible banking practices. By all our evidence, the federal government used none of its oversight on these banks.

We should never have bailed out the banks this week. Allowing banks to fail and other institutions to buy or break up the remaining parts is a natural part of capitalism. We cannot ban failure in finance; it is a critical component of a healthy economy.

" A free people [claim] their rights, as derived from the laws of nature."
Thomas Jefferson
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