President Trump is eyeing a rollback of Washington’s role in regulating banks — even asking “whether the president-elect could abolish the Federal Deposit Insurance Corp.,” the Wall Street Journal reports. The liberal outcry was prompt. “Trump Prepares to Wreck Economy,” the New Republic reckons. Yet the left ignores how reforming bank oversight could offer a path to restoring accountability in an industry liberals condemn for recklessness.
The key element to any deregulatory effort would be to rein in what’s known as “moral hazard.” That concept blossomed in the New Deal. It’s the idea that investors, and institutions, tend to act recklessly when there are no consequences for their actions. If a bank’s owners know that a government bailout is more or less guaranteed, what’s to prevent the institution from placing risky bets that a more conservative bank would eschew?
Peak moral hazard, one could say, came with the advent of banks designated “Too Big To Fail” — i.e., so critical to the economy that a collapse would bring down the whole system. That, though, put Mr. and Mrs. taxpayer on the hook. The difference, before and after too-big-to-fail, came down to this. Before: a banker would take risks and bear the consequences. After: a banker would take risks, and the taxpayer would bear the consequences.
Before the FDIC’s creation in 1935, depositors would choose a bank based on its soundness. That’s why banks built before then tended to look like Roman temples. Their solidity signaled security for depositors. Well-run banks were rewarded with more deposits. “Absent federal deposit guarantees and the doctrine that some banks are too big to fail, safety constituted an opportunity — an economic franchise,” monetary sage James Grant writes.
What’s more, before the FDIC, bank owners — meaning, stockholders — were personally responsible for a crackup. Talk about accountability. It was called “double liability,” Mr. Grant says: “If their bank failed, they were personally liable for the depositors’ losses up to the full, or par, value of their stock.” That’s a feature, one can imagine, that bank industry critics like Senator Warren would like to revive.
With deposit insurance in place and “double liability” abandoned came “the decline in the value of the strong-and-silent-type balance sheet” at banks, Mr. Grant notes. “To the extent that the American depositor had come to believe that his money was really in the government’s hands, to just that extent was an ultraconservative bank at a competitive disadvantage,” he adds. So began the road to the 2008 meltdown — and later failures, like Silicon Valley Bank.
The FDIC’s rise opened the door, to put it mildly, to more adventurous lending policies by banks — who could operate without any fear of depositors losing their savings. “Unnecessary conservatism had had its day. The time had come for unnecessary risk-taking,” is how Mr. Grant sums up the shift in mentality. Which brings us back to the opportunity, now available to President-elect Trump, to address moral hazard.
The reforms being weighed by President-elect Trump, the Journal says, would “ease a host of regulations on capital cushions and consumer protections,” along with “scrutiny of consolidation in the industry.” Talk of meddling with the FDIC and its guarantees of deposits — “considered near sacred,” the Journal reports — is already being met with alarmism on the left. “The next recession starts here,” frets a technology journalist, Jacob Silverman.
Folding the FDIC into the Treasury, one option being considered, wouldn’t imply any threat to the New Deal-era deposit insurance program. Yet “even the perception” of a change to the FDIC’s guarantee “could quickly ripple through banks and in a crisis might compound customer fears,” the Journal reports. A rethink of banking regulations, though, offers a chance to dial back the FDIC’s role in rewarding reckless banks.