FWIW, this line of argument produced one of the few times I have made a relative stop and think in a stereotypical holiday dinner table political discussion. The framing that worked was: suppose on the one hand you have a very smart guy trying to make a set of ironclad rules that nobody will get around. And on the other you have another very smart guy who stands to make a billion-with-a-B dollars if he can figure out a way around the rules the first guy made. Who do you think is going to win?

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Mar 16Liked by Arnold Kling

Re: "Think of government protection as a subsidy, and regulation as a tax."

The regulation (tax) can constitute a barrier to entry and thereby protect insider firms. A move in "the chess game of financial regulation"?

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In a casino - the bank always wins. Politicians don’t gamble with their own money, they do it with ours. They never lose.

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"Unfortunately, just as there are incentives for banks to lean on government, there are incentives for government to lean on banks."

Aye, there's the rub.

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My hypothesis is that the regulatory questions are mostly theatre for sidestepping the more fundamental reality that it's government policies that are driving the underlying trends that are making finance more risky at any given level of regulation.

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This is a great sentence: Think of government protection as a subsidy, and regulation as a tax.

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Re: “Unfortunately, just as there are incentives for banks to lean on government, there are incentives for government to lean on banks.”

And public choice might suggest that the regulators too have their incentives. Throwing out the $250,000 cap indiscriminately certainly increases the power of the regulating agencies and the use of an exception to swallow the general rule appears to be something of a declaration of independence from any legislative constraints. Amusingly, the stalking horse authority for this play is apparently 12 U.S.C. 1823(c)(4)(G) – worth a quick read to get a sense of the abuse that appears to be going on – ends with a requirement for GAO to report to report on the likely effect of the exception on incentives::

“(iv) GAO review.—The Comptroller General of the United States shall review and report to the Congress on any determination under clause (i), including—

(I) the basis for the determination;

(II) the purpose for which any action was taken pursuant to such clause; and

(III) the likely effect of the determination and such action on the incentives and conduct of insured depository institutions and uninsured depositors.”

That review should be a hoot.

The law also requires the promulgation of regulations to implement the systemic risk exemption but I am still working on figuring out what regs those might be. I doubt that they say “we can randomly pick and choose which politically-connected bank depositors we want to make whole” but they might as well. John Cochrance is surely correct that “It strikes me that both accounting and regulation have become so complicated that they blind intelligent people to obvious elephants in the room.“

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Time for depositors, regulators, banks’ management, shareholders, rating agencies, external auditors to be accountable and take responsibilities. Regulations is a cover my back activity of the politicians but it doesn’t solve many issues: European banks, regulated like nothing else, have been trading at a fraction of BV for almost 2 decades. SVB management was simply incompetent in managing interest rate and liquidity risk.

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It’s not a chess game. It’s whack-a-mole.

It doesn’t matter how smart the regulators are. There are many more people being regulated, all motivated to find ways to game the system. Parallel processing.

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We do need to go back to a two, or multi-tiered system of banks - with lower-asset banks less regulated. The $50 billion maybe should be reduced to $10 billion -- with no other special "banking" regulations other than contracts, and the $250k FDIC deposit insurance.

The moral hazard in this case would be reduced if depositors got stuck with some semi-loss, like 10% of their deposit is repaid in the long-term assets "at par", which they can keep (to maturity? ha!), or sell (at a loss).

The reality is that "safety" is poorly defined, but less safe is often more profitable. The financiers want the profit - but want the gov't to pay for the risk-caused problems when they occur.

SVB did LOTS of cool support for its startups, but its rocket scientist (??) mgmt failed to be careful enough in its investment strategy both in excessive HTM (hold) and AFS (available for Sale) securities.

Arnold commented earlier that the rocket scientists know what they are doing - which I'm sure is partly wrong. Yes, their math, given the assumptions they make, is correct (precise to multiple digits, even!) -- but their assumptions are wrong, like the idea that inflation is temporary.

SVB sold a lot of AFS assets (X amount), at a loss (Y amount). My challenge to Arnold or others is to define what rate (Z %) does that sale need to be to demonstrate a failure of their management model?

1%? 2%, 5%, 10%? Even without knowing the amounts, it should be possible to grade their performance, and should even be done by rating agencies.

Forbes has answers - https://www.forbes.com/sites/frankvangansbeke/2023/03/12/the-silicon-valley-bank-collapse-and-the-polycrisis/

plus a link to a tech paper on duration & convexity - https://www.westernasset.com/us/en/pdfs/whitepapers/convexity-complexity-2016-11.pdf

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We de facto guarantee deposits already - in every major crisis in the last 40+ years, depositors were made whole. Yet we continue to pretend the FDIC $250k limit represents something real. It’s the worst of both worlds where we socialize the cost of bank collapses yet bank runs still happen because people think maybe this time the government will enforce the $250k limit.

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