Nobel economist Paul Krugman says the Silicon Valley Bank collapse has led to 'apocalyptic rhetoric' in markets, but almost none of it is true

• The collapse of Silicon Valley Bank has bred "apocalyptic" fears in markets, but most are unfounded, Paul Krugman said.
• The Nobel economist refuted myths about SVB's failure and rescue in an op-ed for the NYT.

The collapse and rescue of Silicon Valley Bank has led to some bleak rhetoric in markets, but almost none of the most commonly voiced fears are correct, according to Nobel economist Paul Krugman.

"The fallout from banking problems has made a murky economic situation even murkier, and it will be a while – maybe forever – before we know whether policymakers made the right call. But I'm hearing a lot of apocalyptic rhetoric right now, none of which seems justified by the available facts," Krugman said in an op-ed for the New York Times on Thursday.

The tech-focused bank failed a week ago, and was taken over by the FDIC to mark the largest bank collapse since the 2008 crisis. Regulators stepped in to fully back SVB's depositors, even those over $250,000, breaking the long standing FDIC threshold for deposit insurance.

Biden has promised the policy move was not a bailout and would come at no cost for taxpayers – but while that's wrong, and that it is a bailout, according to Krugman, he said markets are also off base in their fears that SVB's collapse and rescue could lead to economic doom, refuting four myths about the bank's demise.

SVB failed because it was too "woke"

First is the idea that SVB failed because it was too concerned with diversity and inclusion to conduct proper risk management, which is "ludicrous," Krugman said. SVB was environmentally similar to other banks – so "woke" culture isn't ruining the banking system, the top economist said.

"Banks have been going bust for centuries, since long efore HR departments began including boilerplate language about social responsibility in their mission statements. So the talk about wokeness tells us nothing about bank failures – but a lot about the intellectual and moral bankruptcy of the modern American right," he added.

Regulators didn't need to rescue SVB

Second is the criticism that regulators didn't need to step in, as the bank's collapse was more due to its unique problems rather than a systemic banking issue.

While Krugman believes SVB's collapse wasn't another Lehman Brothers moment, the bank was still a crucial part of the tech sector, which justifies its rescue. He compared it to the bailout of General Motors and Chrysler in 2009, when regulators chose to rescue key players in the auto industry and the economy.

The SVB bailout will increase irresponsible risk-taking at banks

Third are concerns that the SVB bailout could lead to a moral hazard dilemma for bankers, as insuring all depositors could remove the incentive for banks to moderate their risk taking. In fact, the opposite is true, Krugman said:

"Policymakers explicit didn't guarantee all deposits everywhere, and at least so far, we're seeing an outflow of funds from smaller banks to more tightly regulated large banks," he said. "On balance we seem to be seeing the financial system move toward reduced, not increased risk taking."

SVB's collapse will undermine the Fed's inflation fight

The fourth unfounded fear, Krugman says, is that the collapse of Silicon Valley Bank could interfere with the Fed's inflation fight. In the last year, central bankers have raised interest rates 450 basis-points to lower high prices, but markets have dialed back their rate hike expectations, as the Fed is unlikely to raise interest rates aggressively to avoid putting pressure on a fragile-looking banking system.

Krugman remains concerned about inflation, but banking troubles naturally slow the economy – so it's a good thing markets are pricing in lower interest rates, as the Fed no longer has to raise rates as high to lower inflation, he said.

"I'm seeing some people saying that banking problems will cause a recession, and also that financial dominance, by preventing rate hikes, will doom the fight against inflation. You can't believe both things!" Krugman said in a Twitter thread on Friday.

Investors are now pricing in a 76% chance the Fed raises rates by just 25 basis-points next week, and a 24% chance it pauses rate hikes altogether.