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Samizdata quote of the day – moral hazard edition

“Deposit insurance is a cancer at the heart of the capitalist system, destroying its ethical foundations. Rich depositors should not be able to secure returns, in the good times, for investing in fundamentally riskbearing activities (which fractional reserve deposits are, by their nature) but then be bailed out by the government when times are tougher. And banks are the largest allocators of capital in the economy – so this fundamental injustice gets spread across the entire economic system.”

Andrew Lilico, The Sunday Telegraph (£)

A problem in much of the West is that the large investors who have been bailed out, such as those who did so via Silicon Valley Bank, or Credit Suisse, etc, is that they tend to be politically quite powerful. A lot of the north Californian business class, for instance. And it tends to vote Democratic.

25 comments to Samizdata quote of the day – moral hazard edition

  • bobby b

    “Deposit insurance is a cancer at the heart of the capitalist system, destroying its ethical foundations.”

    This strikes my (non-banker, non-banking-knowledgable) heart as hyperbole. But, like I say, this might be because I don’t know banking well.

    But, anyway, to SVB . . . The shareholders of the banking corporation – the very people who ought to be safeguarding their investment – fell asleep, and now it sounds as if they are losing their entire investments because of it.

    The bank still holds the too-low-interest bonds, and will realize a good portion of their planned return – but not enough quickly enough to fight the run. The fedgov will take ownership of those bonds, and will eventually recoup much of whatever it pays out. Because of that, this will not be a hugely expensive bailout. The now-bereft shareholders will have financed a good bit of it.

    But I don’t think that the depositors should be charged with the same level of responsibility for oversight of the bank’s day-to-day investment decisions as should the bank’s shareholders. Letting them lose their entire book when SVB forgets to check interest rates seems excessive.

    And, at the time the decision was made to cover all losses, it did indeed look precarious for the larger banking community, the failure of which would have been rather costly for the country’s entire population. (In hindsight, I doubt it was going to spark a general run – perhaps a limited but significant one.)

    Creative destruction as a theory is great, but sometimes breaking that rule can avoid a lot of economic pain. I doubt that the increase in self-discipline and the cleansing of weak performers that such a huge hit to many depositors and anyone else downstream of them in payments would cause could make up for the economic pain to tens of millions (at least) that would follow from an uncovered spreading banking failure. And that was the consequence I think they were fearing at the time of the decision.

    The difference between “libertarianish” and “hardcore libertarian” lies in how much pain to real people you are willing to let happen in order to follow the hands-off path of creative destruction – to leave the market entirely to itself so that it may self-correct. Omelettes and breaking eggs. I just think that sometimes the eggs are cheap, and sometimes they are expensive. A bank-confidence failure right now would be an expensive egg.

    (Personally, I wouldn’t choose to cover all deposits, but I would seriously raise that $250k ceiling, while wiping out the shareholders. I don’t see how that’s a cancer on the system.)

  • I’d imagine that if this was a bank in Houston, TX and the customers mainly Democrats, it would have been allowed to go bust and phuq the “Contagion Risk”.

    Once again, bailouts happening, profits privatised and losses socialised because of politically connected depositors.

  • John


    As you are happy to see shareholders wiped out (and for clarity I am not disagreeing with you) what if anything would you do about the SVB board members who unless proven otherwise were acting on information unavailable to other shareholders when they traded out a couple of weeks before the shit hit the fan publicly.

    In all the multitude of reports, editorials and opinion pieces I have seen plenty of belated comments about their lack of appropriate qualifications and experience but very little about the morality and legality of their self-preserving actions.

  • @John – Insider trading surely? They knew the bank was bust and sold the shares to unknowing counterparties. The SEC needs to simply reverse the transactions so that those unknowing counterparties are made whole at the expense of the Banksters and then arrest the Banksters.

    To get that far they’ve clearly committed multiple crimes, so prosecute the bastards to the fullest extent of the law, otherwise there is no consequence to doing this sort of moronic shit all over again.

  • bobby b

    John: If they sold based on inside info not available to the public, they’ve breached fiduciary duties to the corp and violated insider trading laws. Disgorgement of profits, and a regulatory fine, and perhaps criminal prosecution are all in their possible future. (In a fair and law-based world, at least – not sure what will happen here.)

    Some – mostly those darned libertarians – will argue that insider trading isn’t improper or bad, but these people all took their board positions on the explicit basis that they wouldn’t do that. Change the law before you break it.

  • Terry Needham

    Bobby B
    Lilico’s argument is that, if depositors are receiving interest on their deposits, they are in reality lending money to a bank in the expectation of earning a profit on that loan. It is for them to take responsibility for insuring that the person, or persons, to whom they lend their money is/are sound – The risk should be theirs. It should not be ours. I find his argument convincing.

  • bobby b

    P.S. In a corp, when impending doom is suspected by insiders, or right before earnings are publicly announced, a blackout order goes out to insider shareholders that stock sales are forbidden for them until the restriction is lifted. I’m wondering if that instruction would normally be issued by a bank’s Risk Manager – a position that had been unfilled for some months. I could see trying to base a defense of insider trading charges on the lack of such instruction if it never went out.

    I doubt it would be successful, but it would be a decent plea-bargaining chip.

  • bobby b

    “The risk should be theirs. It should not be ours. I find his argument convincing.”

    I think that, as a moral point, this is valid. But the situation is more complex than that – leaving depositors completely, and existentially, vulnerable (over $250k, a trivial corporate sum) is going to cause great disruption and economic pain to a large portion of the country if things head south because of a general loss of confidence, and so I think there is a distinction between the proper sufferings of shareholders and depositors that is worth recognizing. It’s a balancing of many interests, not a simple binary decision.

    In point of fact, the risks and costs that might be encountered through a spreading banking failure of confidence will be OUR risks and costs, throughout general society. So, the underlying moral point fails here, in that there is no way to simply lay those costs off on that one bank’s specific depositors.

    Also, deposit insurance does presently exist and is paid when appropriate. We’re now just arguing about the level of that protection. Sort of like the old joke of, we’ve established that you’re a whore, now we’re just haggling over price. 😉

  • Lets not forget RICO (Racketeer Influenced and Corrupt Organizations Act), if they’ve been conspiring to hide the banks insolvency while they defraud it through share sales and bonuses.

    Why should Banksters get away scot free for crimes that others would spend decades in jail for?

  • Johnathan Pearce

    bobby b: This strikes my (non-banker, non-banking-knowledgable) heart as hyperbole. But, like I say, this might be because I don’t know banking well.

    It is nothing of the kind. State-backed protection of depositors creates moral hazard, because in the back of bankers’ minds is the idea that if things go arse over tit, they get taxpayer-backed protection for their clients. The lessons of recent decades is that lots of people, often risk-takers and wealthy, have been bailed out. Years of very low/negative interest rates have also created a “zombie” corporate world where making a large profit isn’t necessary if your business can stagger on in a world where borrowed money is cheap. But like a morphine addict denied his fix, the pain will be devastating in the end.

  • William O. B'Livion

    Also, deposit insurance does presently exist and is paid when appropriate. We’re now just arguing about the level of that protection. Sort of like the old joke of, we’ve established that you’re a whore, now we’re just haggling over price.

    We should also be arguing *who* we’re arranging to sleep with.

    I would argue that The State should not be the front line, or even second line insurer, especially for corporate accounts.

    The State should “simply” require that banks purchase deposit insurance as part of their
    certification process, and require that they “clearly and plainly” disclose their certification status.

    The State is often unable or unwilling to look too closely into malfeasance before it becomes public for various reasons, including that to the bureaucrats, it’s not their money, and it’s a (usually) uninteresting problem for the politicians.

    If the risk is transferred to private parties they have more incentive to watch what the bank is doing.

  • The Pedant-General


    “a position that had been unfilled for some months.”

    There’s some epic chutzpah there….

  • tim c

    An alternative way to look at this is to simply ask the question “if bank deposits were completely uninsured then how many people would have their money in a bank account?”
    The answer is that nowhere near as many people would, and that’s the idea. Deposit insurance props up an industry that isn’t safe, and masks the risks involved in holding money in banks.
    The fact that there is ANY insurance means that banks aren’t run under the rules of capitalism.

  • Paul Marks

    It is not just “deposit insurance” – it the basic principle of lending out “money” that-does-not-exit.

    There is nothing wrong with money lending – with lending out, for productive investment, Real Savings (the sacrifice of consumption) – whether your own Real Savings or the Real Savings of other people that they have voluntarily entrusted to you.

    However, modern banking is almost entirely nothing-to-do-with-this. Modern banking is, overwhelmingly, creating “money” from nothing – Credit Bubble blowing. The state is then called upon to bailout the banks and other financial institutions and allied Corporations, when the Credit Bubble inevitably runs into trouble.

    To some extent this was true even in the 19th century – for example Sir Robert Peel’s 1844 Banking Act was violated in a couple of yeas because the Bank of England “had to” create money from nothing in order to bail out the banks.

    However, the scale of the legalised fraud (and it is legalised fraud) in the modern economy is light years beyond what even Walter Bagehot (the vile third editor the Economist magazine) could have imagined – this is not corrupt cheating round the edges of a, basically, sound economy.

    No – this is not cheating at the margin of a, basically, sound economy – the modern situation is that the entire Capital Structure is twisted to Hell, there is no sound economic foundation. None.

  • Paul Marks

    What would happen if “deposit insurance” was abolished tomorrow? Well vast numbers of people would try and take their money out of the banks (I certainly would) as all (yes ALL) the banks are really insolvent – indeed they are insolvent by definition as the principles they run on are insane (treating loans as de facto deposits “crediting to the account” – and-so-on).

    However, people could not do this as only a few percent of the British money supply is notes and coins – the vast majority of “money” has no physical existence at all, and (therefore) can not be given to people in physical form.

    Please note that I am NOT saying that only a few percent of the British money supply is physical gold – no NONE of it is physical gold (or any commodity), only a few percent of the British money supply is even token notes and coins.

    The monetary and financial system (and the Corporate State economy that depends upon it) is utterly insane – not just in the United Kingdom, but also in the United States, and just about every other country.

  • Jim

    “Insider trading surely? They knew the bank was bust and sold the shares to unknowing counterparties. ”

    The information that showed SVB was bust was publicly available. It was disclosed in their most recent 10Q form that was released in January. This showed that unrealised losses on the bond portfolio had all but wiped out the banks capital. You can’t accuse a bank employee of acting on insider info if the information they acted on is out in public for all to see. They maybe had a greater understanding of the data’s significance, but that would be down to their knowledge of banking in general, not SVB specifically. Anyone could have seen that data and come to the same conclusions and either sold their stock, or shorted it.

  • Fred Z

    Many of the comments here seem to be using the term ‘deposit insurance’ in a fashion I do not understand.

    Big investors getting paid out in amounts over the ‘deposit insurance’ limit has nothing to do with ‘deposit insurance’. It’s a bailout, a gift from taxpayers to the politically powerful.

    I don’t see anything wrong with or evil about actual ‘deposit insurance’. In Canada this is run by the Canada Deposit Insurance Corp. which is funded by virtually all Canadian banks and near banks. It guarantees deposits and similar up to $CAD100K. In their FAQs the CDIC does say in response to “How is CDIC funded?”

    CDIC does not receive tax dollars or public funds to operate. CDIC is fully funded by premiums paid by our member institutions.

    And in response to “Can CDIC go bankrupt?”

    CDIC’s role is vital to the stability of the Canadian financial system and to the flow of financial services. The CDIC Act provides that CDIC cannot be placed into bankruptcy. CDIC is a Crown corporation and is backed by the Government of Canada.

    So it is government backed but supposedly has plenty of assets and is well managed. Is it? Justin Trudeau, Trudeldumb the younger, is running this joint, so who knows.

  • bobby b

    Fred Z – even if the insurance agent sells you your fire coverage during the fire, it’s still insurance coverage.

    Just not very smart insurance coverage.

  • Fraser Orr

    I’m not opposed to deposit insurance at all, in fact I think it is a good idea. I’d rather it was run privately by, for example Lloyds of London, or some other insurance product. But just because the NHS runs the British healthcare system doesn’t mean healthcare is bad per se.

    My objection to the SVB thing is not the deposit insurance, but that they broke all the rules to favor politically connected people. It is crystal clear what the deposit insurance cap is. It is on every web site, it is on a little sign at the teller station on every bank branch, it is impossible to not know what the limit is.

    They should have paid that out up to $250k, and that is it. I can’t get over the fact that Roku had half a billion dollars in cash in there. I mean FFS did the CFO lose his job for that? Irrespective of the deposit risk, how can you possibly leave that much cash sitting around without doing at least some work for you. Did the CFO get fired? No, of course not. In fact their share price went UP.

    So who got saved here? The regular man in the street was protected by the insurance. The rich fat cats who are connected, are the ones who got bailed out. Perhaps grandma doesn’t know about FDIC insurance and so we want to go softer on her and make sure she is made whole. But these big companies? It is inexcusable what they did, and even more inexcusable that they didn’t suffer any punishment at all.

    What about the collapse of the banking system? Well perhaps there needs to be a bit of panic that causes these guys to pull out their massively underinsured cash and be in a better position.

    I’ll say again: most people seem to think Obama rescued the economy in 2008 with his MASSIVE bailout or the rich and well connected. What hardly anyone seems to know is that as a consequence of this nearly the whole of the american retail mortgage industry was taken over by the government, like some 1970s Britain nationalization scheme. The high street banks and quite simply a veneer on the mortgage business where nearly all loans are held by the US Government and its departments. I find this utterly shocking, and I find it particularly ironic that the organization with the most outrageous debt position, the most under collateralized debt anywhere in the world, seems to think that they are best positioned to handle everyone else’s mortgage.

    Oh and BTW, regarding the directors profiting from insider trading — I think the insider trading rules are terrible, and completely wrong. The solution to this is pretty simple. It should be a rule on each stock exchange that requires officers of companies listed on that exchange to publish their intended stock trades in the company (and maybe all companies) publically seven days before the trade is made. When I worked at a Hedge Fund I was required to ask permission from the hedge fund managers before I traded anything in my 401k, which was ridiculous, but it doesn’t seem too much to ask of the officers.

  • Chester Draws

    the banks are really insolvent

    Half of the businesses in the Western world are insolvent. That is they could not pay their obligations if asked to tomorrow. Most of the rest would fold if required to, because running the business without that capital would make it stupid.

    Your absolute insistence that modern banking is the source of all ills is not only tiresome, it is plain wrong. The West was build on borrowed capital. Without it, everything crumbles away.

    The creation of debt, by abolishing usury laws, is a key factor in fueling the massive growth in the economy in the late Middle Ages. That gave enough capital for the Industrial Revolution. No capital, and the new inventions would have never been exploited. As they were not in places without capital, despite having access to the technology.

    If debt is to be outlawed, which is what you seem to want, then we will re-enter the Middle Ages. Companies will have to grow on internal capital only, which means they will grow very slowly, if at all. If they grew big they would be extremely difficult to sell, because who would have that sort of money? No mortgages — or a person would be insovlent — would destroy the ability of all but the richest to own property. It would spell economic distress to all but the very rich.

    It’s a fantasy solution.

  • Chester Draws

    It is nothing of the kind. State-backed protection of depositors creates moral hazard, because in the back of bankers’ minds is the idea that if things go arse over tit, they get taxpayer-backed protection for their clients.

    The bankers didn’t care about the shareholders, who they work for. Why would they care extra for their depositors? There is no moral hazard as a result of deposit insurance. If they are going to play silly buggers with their own employment prospects, the thought that some other incidentals might be hurt isn’t going to bother them.

    The hazard is two-fold 1) the directors have insufficient skin in the game financially, so don’t lose enough in a crash and 2) there are not enough prosecutions for recklessness.

    Or do you suggest that banks did not fold in the era before deposit insurance? Because that is plain wrong.

  • Johnathan Pearce

    Chester Draws: Your absolute insistence that modern banking is the source of all ills is not only tiresome, it is plain wrong. The West was build on borrowed capital. Without it, everything crumbles away.

    I will leave Paul Marks, whom I think you are addressing, to respond himself, but here are my thoughts. First, “modern banking” – a form of fractional reserve banking with central banks acting as lenders of last resort to prop up those that get into trouble – is the source of many, but not all, ills. This is not about being against borrowing, which is silly. This is about being against borrowing being enabled by the creation of capital out of nothing by nothing more than expanding a balance sheet and then getting surprised when this house of cards falls over. I am not against FRB, so long as depositors know what is at risk. (FRB would be far more cautiously run if we had a world of competing currencies, because there would be an inversion of Gresham’s Law, with good money driving out the bad.)

    The key is to match liabilities with assets. If I deposit $1,000 in a three-month savings account, that money can be be lent out for three months, and is the right way to build capital (responding to your earlier point). I get paid interest to compensate me for not having access for that money until the end of the three months, and so on all the way up the maturity scale.

    Where the issue falls apart is when people hold cash, and expect to get it immediately out, and they have that money lent out for, say, six months, or six years. This process is sometimes referred to as “maturity transformation”, but this is the hocus-pocus of FRB that some regard as dangerous. Clearly there is a maturity mismatch, and if the borrowers default in large numbers, depositors are at risk of getting wiped out. The “modern” feature was that with central banks becoming lenders of last resort – which began to happen over a century ago – more and more banks that got bailed out didn’t get as concerned about the risks of depositors being hit as before. The advent of deposit protection as backed by the State created the moral hazard issue, or certainly aggravated it.

    Yes, banks used to fail all the time. The history of early capitalism is full of these sagas. You seem to think that capital cannot be accumulated if we had to rely on savers putting money into deposits. Well, that is why interest should indeed be applied to time-deposits to compensate for the loss of access. Also, bear in mind that a lot of expansion capital is not in the form of debt, but equity.

    In the early days of a small business, owners will secure a loan against the value of a house, etc, if they have little in the way of business track record, etc. With debt, it is more useful for a, large firms that already generate a lot of cash and have lots of assets against a loan, and b, for firms with uneven flows of income but assets, and where they need a 365-day revolving credit facility to cover cashflow. But in many cases, when people are building a business, equity makes more sense as the driver.

    It may annoy you that some commenters here bang on about central banking, the Cantillon effect, and the rest of it, but the reason why it is so important is that for decades, the way we do banking in the West has acted to shield people from the true risks they run, the risks they impose on others, and the costs. Look, for example, at the current vogue for “ESG investing”, diversity, equity and inclusion, and so on. If we had interest rates that reflected actual supply and demand for real savings, rather than central bank fairy dust, firms would have to work harder on making a profit, and spend less on providing the products of our “woke” universities with pointless ways of spending their time. And I humbly submit that that is destroying capital.

  • Paul Marks

    As for non banking corporations.

    Up to 1965 the tax rate for companies in the United Kingdom was the same as for individuals – it was Harold Wilson (not known for a free market person) who started to tax companies (via the new “Corporation Tax”) at a lower rate than rich individuals – the Milton Friedman idea that corporations just represent individual share owners (“Aunt Agatha” with her share certificates behind the clock on the mantlepiece) being, sadly, utterly mistaken.

    By the way 1965 was also the last year when individuals owned the majority of shares in the United Kingdom – these days, both in the United Kingdom and the United States, corporations are mostly “owned” by other “Woke” institutions (such as Pension Funds) – hired managers supposedly in charge of other hired managers, and all supported by the endless funny money of the Central Bank (the Bank of England, the Federal Reserve, the ECB, the Bank of Japan, the Swiss National Bank – which just gave a massive bribe to UBS to “buy” Credit Swiss, and so on).

    There is no particular reason why individuals or companies should be taxed highly – in Hungary they are both taxed at 15% (but remember the high Social Security taxes – still we have them to), in Paraguay it is 10% – before 2012 (not so long ago for some of us) Income Tax did not even exist in Paraguay.

    The United States was the most advanced economy on the planet at the start of the 20th century – it had no Income Tax or Corporation Tax and it had no Central Bank (Federal Reserve) either.

    In some States of America, for example South Dakota, there is no State Income Tax or Corporation Tax to this day – and NO South Dakota does NOT have massive revenue from natural resources taxes (it just has relatively low government spending – low government spending is the key to everything).

    As for the modern Credit Bubble monetary and financial system, and the general Corporate State system – it stinks.

    For example, it has destroyed the Rule of Law – first with such things as “the suspension of cash payments” (legalised contract breaking) then, as far back as 1935, with the Supreme Court ruling (five to four) that it was fine for the government to steal privately owned gold and to “void” (i.e. violate) the gold clauses in all contracts – public and private.

    As the dissenting Justices wrote (correctly wrote) in 1935, this makes a mockery of any talk of “Justice” or the “Rule of Law”.

    The Corporate State is now (2023) without any real limits to its corruption (for example, remember the Covid injections – the truth is still being denounced as “disinformation” on CNBC and other Corporate State media outlets, the government agencies that are supposed to police the drug companies are now funded by the corporations they are supposed to be policing, the corporate and government bureaucracy is fused together) and it is based on the endless Credit Money.

    The next stage, which is being openly planned (no “conspiracy” – it is being done openly) is to make this evil, international rather than national – an international Credit Money system, with a tax cartel, “harmonised” regulations (“regulatory alignment”), and-so-on.

  • Paul Marks

    Chester Draws – “borrowed capital” was indeed important in historic economic development, although reinvested profits were also very important.

    However, the present system has, largely, nothing to do with “borrowed capital” – there is very little “capital” (i.e. Real Savings – the actual sacrifice of consumption).

    Banks today do not, mostly, lend out Real Savings – no Sir. Banks, and other such, mostly create “money” from nothing and when their Credit Bubbles start to collapse (which they inevitably do) they demand bailouts – either openly or (more often) concealed bailouts.

    Nor is this “cheating at the margin” (as it was in the 19th century – or even the early 1900s) – this is not cheating on top of a basically sound economic system.

    The Credit Bubble is-the-system now.

    This is why the banks and the Corporations that are linked to them, are so pro statism – especially international statism (Agenda 2030, United Nations Sustainable Development Goals, the Corporate Statism of the “World Economic Forum” and all the rest of it). They know they are nothing to do with a free market – that they depend on government (on Central Banking). And they know that it is radically inconsistent (too inconsistent even for them) to demand endless Corporate Welfare for themselves, and deny welfare to everyone else (to the people who are vastly poorer than them).

    Is their system sustainable? Certainly not. And making it international, with a “Basic Income” for the poor and international Credit Money for the rich-and-connected will make it worse.

  • Paul Marks

    Johnathan Pearce has mentioned the Cantillon Effect – which I should have mentioned, but failed to do so.

    Yes indeed, as Richard Cantillon pointed out three hundred years ago, Credit Money tends to concentrate income and wealth in the hands of a small elite – and the more Credit Money there is, the more it does this.

    F.A. Hayek mentioned the process in one his essays in “New Studies” (1978) – the money supply is not like water gushing everywhere (as the late Milton Friedman seems to have assumed), an expanding Credit Money supply is more like “treacle” – it does not gush everywhere, it piles up in certain places, and some people get sticky fingers.

    It is Institutionalised Corruption.

    Just in case Chester Draws, or anyone else, still does not understand – the present system is, basically, nothing to do with “borrowed capital”, or “money lending” as a normal person would understand those terms. The present system is a fraud – a “legalised” fraud of truly gigantic proportions.