This week’s topic is about bank regulations. Do you have any other topics that you’d like me to cover in future articles related to thinking morally right or wrong, not politically left or right? Let me know in the comments. Cheers!
Yet another article about SVB (Silicon Valley Bank)? No worries, I’ll mostly stay away from the acronym of the week (who remembers FTX and SBF?). Instead, I’ll share my thoughts on government banking regulation which hasn’t received enough coverage. (If you haven’t had enough of SVB, Jim Brown and Helen Raleigh do a good job of providing context.)
Banking is one of the most regulated industries in the United States (and around the world). Wikipedia gives you a fair idea of the regulatory maze here at home. The government regulates central banking, deposits, lending, bank affiliates and holding companies, privacy, money laundering, community reinvestment, and more. And with each financial crisis, more is piled on. From the 1913 Federal Reserve Act (largely in response to the 1907 banker’s panic) to the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (addressing shortcomings that supposedly contributed to the 2007-09 Great Recession), the banking and financial industry have been burdened with ever increasing government regulations. And we’re already hearing calls for more from the predictable players in the wake of the latest crisis. Not that the bankers are blameless. Often, they’re in bed with their regulatory captors for reasons we’ll get back to.
As frequent readers of this column know, one of the main tenets of thinking morally right or wrong, not politically left or right, is that most if not all government regulations are immoral as they violate individual rights. Read the book or peruse the archives to see what I mean. Government banking regulation is no exception. Let me illustrate with a couple of examples: federal deposit insurance and “too big to fail.”
Federal deposit insurance is regulated by the Federal Deposit Insurance Corporation (FDIC). FDIC started in 1933 insuring deposits up to $2,500. It has since increased 100-fold to $250,000. This means that the first ¼ million you have deposited at an FDIC insured financial institution are safe in case that institution would default. And if you’re flush in cash, you can deposit a ¼ million at as many FDIC insured institutions as you like.
How does this violate individual rights? First, when banks fail, taxpayers are on the hook for losses above and beyond the insurance dues the banks pay to the FDIC. Yes, you guessed it, those dues are too low. Secondly, institutions that are not eligible to be covered by the FDIC are at a competitive disadvantage as they have to factor in the risk of default in their product offering. Covered institutions do not. Thirdly, insurance companies are for all practical purposes shut out of the deposit insurance market as they cannot compete with the too low FDIC rates.
Absent government regulation, we’d see a thriving market for voluntary deposit insurance, where both consumers and banks contracted with insurance companies for protection, and where insurance companies would provide oversight in exchange for coverage. If the particular terms of one insurance company were not to a bank’s liking, it would either look elsewhere or self-insure by maintaining high enough reserves. In the process, individual rights would be respected as nobody was forced into a relationship. And in the event of violations, the judicial system—a proper role of government—would serve as arbiter, resulting in individual rights protecting case law evolving over time that guided deposit insurance.
“Too big to fail” is the idea that certain financial institutions are so large and so interconnected that their failure would be disastrous to economy, and that they therefore must be supported by the government if going belly up.
As in the case of federal deposit insurance, this violates individual rights by making tax-payers responsible for potential losses. Furthermore, being classified as “too big to fail” gives you a rights-violating advantage over smaller competitors who don’t enjoy government protection. This partly explains why many large bank execs are in bed with the regulators.
In general, bank regulations favor large players as they have the resources to comply. Smaller actors do not. And for potential new players, the cost of regulatory compliance often lowers the expected return on investment meaning that they can’t raise capital to get off the ground or expand. This of course reduces competition for the large banks, another reason “too big to fail” CEO’s are cozying up to the regulators.
You heard me say it before: our elected representatives who are responsible for bank and other financial regulatory legislation won’t lift a finger until we express sufficient moral outrage over the current state of affairs. On the contrary, they’re more likely to listen to calls for more regulation. So, make your voice heard if you’re a champion of individual rights—and of competition—and tell them to stop making an immoral mess of banking and finance.
Any links to a banking committee or the like? They are listening to feedback now.