A Market Test to Avoid Another Government Bank Bailout with Amit Seru | Policy Stories

foreign Valley Bank's failure began several of the largest bank failures in American history leading the federal government to step in to prevent widespread Contagion thousands of banks are still in trouble but there is a more cost effective way to solve the banking crisis that doesn't require trillions of dollars from the government Silicon Valley Bank and others fail because they invested large number of Assets in long-term low interest bonds and loans and did not protect themselves from the risk of higher interest rates they were also financed in large part by uninsured flighty depositor as a result when interest rates Rose over the last year as the FED Titan monetary policy the value of their assets fell and their flighty depositors ran to withdraw their funds research that my colleagues and I did during the weekend of svb's failure suggests that when the assets that all U.S banks hold are measured on a mark to Market basis based on interest rates today that is not based on the valued maturity but at current prices if the assets were sold today balance sheets of American banks are two trillion dollars lower than their current book values this is a large number especially if you compare it with a two trillion dollar aggregate equity in the U.S banking system as of March 2023 a full accounting of these losses has been avoided by Banks ability to maintain Health to maturity assets at their Book value that is these losses are unrealized for now but there's no avoiding the economic reality that the true value of equity capital in the banking industry has fallen by at least this amount this is a problem these reductions in asset values are unequally distributed across the system which some banks mean particularly hard hit in a well-capitalized banking system the distribution of equity to asset ratio you would want to see across 400 banks in the U.S banking system would be above zero but our analysis suggests that the entire distribution shifts to the left when accounting for Mark to Market valuations in other words over 2000 Banks accounting for 11 trillion dollars of assets in aggregate fall below the zero percent line the important implication of this analysis is that the recent fragility and collapse of several high-profile Banks is not an isolated phenomenon nearly half of the U.S banks could face similar difficulties if forced to liquidate a significant fraction of their Assets in the wake of large deposit withdrawals now how can government avoid the calamitous path taken all too often of regulatory forbearance as in the U.S saving and Loans crisis the Japanese banking crisis and the European debt crisis economic solvency requires a market test the ability to raise new Equity or long-term unsecured debt from outside investors is one such test that draws a clean line between solvent but illiquid and insolvent solvent banks with franchise value would be able to attract such capital in addition New Capital inflows would reduce fragility and restore skin in the game for these institutions there are two options for making sure more solvent but illiquid Banks don't fail the traditional regulatory level is to raise Capital requirements that is to require Banks to have more cash on hand available for depositors to withdraw but that's not a good prescription for solvent banks that are currently stressed it would result in solvent Banks Contracting their lending the course of action we recommend is instead for the government to require raising Capital by equity the amount per bank would be assessed by Regulators on a bank-by-bank basis in other words Banks would Shore up their balance sheets by selling public shares or some other form of equity to increase their cash on hand to avoid the stigma of an equity raise it would have to be required across many banks in the immediate term Regulators could also help Banks increase their Equity buffer by restricting Equity payouts and tie continued access to government lending facilities to increase Equity raises something must be done banks are too fragile in today's interested environment and there's likely to be turbulence in the commercial real estate market soon as businesses continue to deal with permanent work from home phenomena Regulators have a really tough job ahead of them providing insolent Banks a Lifeline with so the seats of a crisis in the future that would have Banks gambling for Resurrection similar to Savings and Loan crisis of 1980s our proposal asks Regulators to rely on the market to determine which banks are truly in sold requiring Banks to raise Equity Capital now will be less disruptive to the economy than having a large number of small and medium-sized insolvent Banks drain taxpayer resources and eventually fail foreign [Music]

Channel: Hoover Institution

Views: 291,641

Keywords: Hoover Institution, Hoover Institute, Amit Seru, Economics, Banks, Bank failure, Silicon Valley Bank, Free market, Bank run, Equity, bank closures, loans, bonds, interest rates, high interest rates, inflation, SVB failure, failed banks, american banks

Id: 72SuYfr1kPg

Length: 5min 23sec (323 seconds)

Published: Thu Jul 06 2023