In the early hours of Monday morning, before financial markets opened, Federal regulators announced the collapse of First Republic Bank (FRB), the second largest ever in US history. This is just mere weeks after the failures of similar mid-sized banks, like Silicon Valley and Signature. Already rumors are circulating that PacWest Bank may be next.
Even though bankers and financial regulators have given assurances, the private banking industry is battered with uncertainty and these crises reveal what many have long known: banking is inherently unstable. It’s prone to boom and bust cycles, with panic about one bank tending to spread to others.
Everytime there’s a banking crisis, regulators argue that they have no choice but to bailout the banks or let the whole economy collapse due to a shortage of credit. This always raises the question: if the government has to step in to insure our deposits every few years, why should we keep our money in private banks at all?
Concerns about the solvency of banks
While there are modern wrinkles to this latest banking crisis, it still has all the elements of a classic bank run. Bank runs happen when depositors rush en masse to withdraw their deposits, causing banks to collapse. This happens because banks keep only a fraction of their deposits as reserves. While we often assume the bank holds our money as cash in a vault, the reality is that every time you withdraw money from an ATM you are demanding immediate repayment for a loan you have made.
Take the scene in the classic Christmas film “It’s a Wonderful Life,” which tells the story of small town banker George Bailey. When the angry citizens of the town come to the bank demanding their money, Bailey says, “You’re thinking of this place all wrong. As if I had the money back in a safe. The money’s not here. Your money’s in Joe’s house. Right next to yours,” he says to another panicked customer. “And in the Kennedy house, and Mrs. Backlin’s house, and a hundred others. Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can.”
This scene points to a fundamental problem for banks: Even if banks were confident that their loans will be repaid, they may still not have enough cash on hand to meet a sudden rush of withdrawals. In other words, financially sound banks could still face bank runs since bank runs depend on mass psychology and often become self-fulfilling prophecies (if everyone rushes to the bank then the bank won’t have enough cash on hand, regardless of whether it made good loans or not). This problem is supposed to have a relatively simple solution: deposit insurance.
Every time you pass by a bank or ATM you will notice there’s often a little sticker with the acronym FDIC. The Federal Deposit Insurance Corporation was created in 1933 after hundreds of banks failed during the Great Depression. FDR and the New Dealers promised citizens that their small deposits would be safe. If your bank did not have enough cash on hand, then the federal government via the FDIC would give you the cash.
So why did FRB, Silicon Valley Bank and Signature Bank fail then? Federal deposit insurance is capped at $250,000 which is more than enough for ordinary people like me and you but is not even enough to pay weekly salaries at many mid-size businesses. In short, many tech companies had deposits much larger than the capped amount and were therefore uninsured.
As soon as a few companies worried about the safety of their deposits the run was on, accelerated by social media. The FDIC quickly intervened, announcing on March 10 that they would insure ALL of SVB’s deposits.
So, what’s the solution?
Why should ordinary people, far from the world of corporate boardrooms and lucrative bonuses of banking, continue to prop up a system that is so unstable and exclusionary? And what would it look like if banks instead promoted local economic development, affordable housing and financial inclusion?
Local and state-owned public banks could better safeguard our money and invest in our communities than big private banks. The US Post Office used to offer checking and savings accounts from 1911 to 1967. The Federal Reserve could allow us all to open accounts with them directly, bypassing the private banks and the need for deposit insurance altogether. Each banking crisis reminds us that much of the banking system should be handled like a public utility, instead of letting bankers treat our deposits as casino chips.
Francisco Perez is a solidarity economy activist, educator and researcher. He currently an Assistant Professor of Economics at the University of Utah. He is the former Director of the Center for Popular Economics, a nonprofit collective of political economists whose programs and publications demystify the economy and put useful economic tools in the hands of people fighting for social and economic justice.