Was The Silicon Valley Bank Bailed Out by the Government?

The current crisis at the Silicon Valley Bank is a stark reminder of the dark days of 2008. Just like now, the entire banking system was in complete disarray. However, during that time, the government created the Troubled Asset Relief Program (TARP) which was commonly known as the bailout.

After 2008, the government as well as the banks faced a huge blowback because of the bailout. This is because bailouts basically meant that the banks could enjoy their profits and distribute them to the executives when the going was good.

However, if things went downhill, the government and the taxpayer would step in to foot the bill.

The bailout was basically a privatization of profits and the socialization of losses. It had almost become a swear word in 2008.

Hence, now when the banking system seemed to be under duress because of the Silicon Valley Bank collapse, the same question was on everyone’s mind i.e. Will there be a bailout? Will the taxpayer be made to pay for the excesses done by greedy bank executives?

In this article, we will have a closer look at whether the Silicon Valley Bank was bailed out and what its impact is on the system as a whole.

The Fed Denies Bailout

The Fed seems to be completely aware of the negative connotation that the word bailout holds amongst the general population.

This is the reason why President Joe Biden and even the Fed have categorically denied that there will not be any bailout for Silicon Valley Bank.

However, it is important to note how the government defines a bailout. As per the implicit definition of the government, a bailout is when the government or the central bank intervenes to provide emergency financial assistance to shareholders of the bank in order to keep the bank afloat.

In the case of Silicon Valley Bank, both these points are not being met. Neither are the shareholders of Silicon Valley Bank being shielded from any loss nor will the bank stay in existence.

The shareholders of the Silicon Valley Bank have lost almost all their capital in the $15 billion write-down. Also, since the bank does not have any equity, it will be closed down and replaced by a new management that does have equity.

It is for this reason that the Fed and the United States government have been saying that there will not be a bailout. However, this statement is misleading to some extent. This is because the Fed and the United States government will use public money to ease the situation at the Silicon Valley Bank and this might result in some losses for the United States taxpayer.

The Controversial Fed Loans

The Silicon Valley Bank fallout has been managed by the Fed in a different manner. Instead of trying to save the Silicon Valley Bank, the Fed has let it go bankrupt. However, at the same time, the Fed has come up with a controversial program wherein they will lend money to the banks against securities that they hold.

Now, lending against government securities is a common practice that has been present in the banking system for decades. It has generally been viewed as a safe way to lend money. So, what is controversial about the Fed lending money against securities?

Well, it seems like the Fed is lending money against the original value of the securities. This is absurd since the market value of the securities has drastically changed as a result of markdowns. These markdowns have been caused by interest rate increases.

Let’s understand this with the help of an example.

Let’s say that the market value of government security was $100. Because of interest rate increases, the current market value of this security is $85. This means that ideally, the Fed should lend $85 if it is taking the security with a market value of $85 as collateral. However, this is not the case! The Fed is lending $100 against the security which is being valued at $85 in the market.

Hence, the Fed is virtually giving away money to the banks to temporarily cover their losses. The assumption is that these loans will build the confidence of the depositors and they will not try to withdraw money from the banks. However, what exactly happens if the current market value of the security falls even further, let’s say to $70 and the banks are not able to pay back their loans?

The Fed is using taxpayer money in order to temporarily prop up the banking system in the hope that the crisis will subside over a one-year period. However, in the course of doing that, the Fed has literally underwritten the interest rate risk of the entire market!

Lowering Emergency Threshold

It is important to note that the Fed and the government of the United States have unintendedly lowered the threshold limit of risks in the market.

The actions the Fed takes today end up creating expectations for the future. Hence, going forward the Fed will be expected to cover all the deposits in any bank. This defeats the entire purpose of the Federal Deposit Insurance Committee (FDIC) and makes it meaningless. If all the deposits are implicitly insured, the $250000 guarantee seems pointless.

Hence, it can be said that the actions of the Fed jeopardize public money in order to prop up private banks. If all goes well, it is likely that the taxpayer will not face a loss. However, at the present moment, their money is being lent out by overvaluing risky investments.