Is This a Crypto Banking Bailout?

As the wreckage that started inside crypto banking threatens financial institutions beyond the sector’s border, the U.S. government is eager to make it clear that it’s not going to let the situation get out of hand.

But is it a bailout?

“I instructed my team to act quickly,” President Joe Biden said on Monday, saying the Treasury Department and banking regulators took immediate action to protect depositors. “We will not stop at this. We’ll do whatever is needed.”

The Federal Deposit Insurance Corp. (FDIC) took over Silicon Valley Bank (SVB) and Signature Bank and exerted special powers to declare all of the customer money in the busted banks is newly sheathed in government guarantees. The Federal Reserve triggered its emergency authority to extend help to banks by offering one-year loans to back up their deposits.

Just days after the collapse of crypto-focused Silvergate Bank, the government has aggressively backstopped the banking industry, though Treasury Secretary Janet Yellen was careful to push back on some of the bailout rhetoric raging in Twitter discussions. She said over the weekend the federal government can’t return to its pre-2008 playbook.

When a toxic soup of mortgage securities and derivatives choked the global financial system at that time, the government made hundreds of billions of dollars in direct infusions into the banking system, and took a number of other measures to prop up the lenders. That help was ultimately paid for by taxpayers.

That’s not what’s happening here, so far.

Under federal law, federal authorities can declare a “systemic risk exception” when they agree the implosion of an institution may endanger the financial system. The Treasury Department, Federal Reserve and FDIC invoked that exception for SVB and Signature, after consulting with Biden.

The FDIC is guaranteeing all deposits at both banks – beyond the $250,000 limit the agency’s insurance fund usually protects. If the lenders’ own assets end up being insufficient to cover that cost, anything extra will come out of the FDIC’s fund, which is paid for by assessments on the banking industry.

The FDIC has used its deposit insurance to help prop up banking more widely in the past, when it temporarily moved to increase its coverage from $100,000 in deposits to $250,000 during the 2008 crisis. It later made that new level permanent. But this current move is just for the two named banks.

Meanwhile, the Federal Reserve is giving out its one-year loans to banks, letting them pledge Treasurys and other high-quality assets at face value. So if a bank needs cash quickly to pay for customer withdrawals, it won’t have to race out and sell assets at a loss. The Fed isn’t funded by federal appropriations, so this program won’t directly come out of taxpayer pockets, either.

“No losses will be borne by the taxpayers,” Biden said

Moral hazard

The U.S. Government Accountability Office warned back in 2010 about “moral hazard” concerns after the regulators intervened with Wachovia and Citigroup.

“Regulators’ use of the systemic risk exception may weaken market participants’ incentives to properly manage risk if they come to expect similar emergency actions in the future,” the GAO concluded in a report months before the passage of the Dodd-Frank Act that overhauled U.S. financial regulation.

“The lessons and scars of the global financial crisis loom heavily on regulators' minds as they put together the rescue plan this weekend,” said Josh Lipsky, senior director of the Atlantic Council’s GeoEconomics Center. “The clear emphasis that this not a taxpayer bailout – and instead that the banks will pay for it – is a shift from the crises of the past decade.”

Dodd-Frank – co-authored by then-House Financial Services Committee Chairman Barney Frank, who joined the board of Signature Bank after he left Congress – insisted the Fed shouldn’t be allowed to rescue individual companies, so the post-crisis regulations only allow the central bank to weigh in with wide-ranging help. Hence, a lending facility for everybody.

“The fact that finance departments in companies all around the country had digested what it meant for SVB to fail and had already acted meant that there was imminent nationwide risk,” according to an assessment circulated by Beacon Policy Advisors, a research firm in Washington, D.C. At that point, as companies began moving money out of regional and community banks, the government needed to boost confidence in those institutions and “avoid the risk of a cascade of failures.”

Government takeover

This is not an injection of cash into crypto-tied institutions, allowing them to continue doing business as usual. It’s more like a government takeover that’s imposing new management on the banks.

And it’s not even cut-and-dry the banks that have so far collapsed were crypto banks. Silvergate was focused on digital assets, but Silicon Valley Bank was a crypto-friendly institution more famous as a backer of many tech startups. Signature Bank may have dipped heavily into the sector, but since last year it was quickly trying to shed many of those connections.

The term “bailout” has difficult connotations in finance, and especially in crypto. The 2009 origin story of Bitcoin is rooted in criticism of the bailout of banks.

The pushback against the description was echoed at the state level on Monday, when New York Department of Financial Services Superintendent Adrienne Harris addressed her state’s shutdown of Signature.

“This is not a bailout,” she said. “We moved quickly to make sure depositors were protected.”

UPDATE (March 13, 2023, 20:48 UTC): Adds comment from Josh Lipsky.