- Paul Krugman framed the government's rescue of Silicon Valley Bank as reasonable but maddening.
- The Nobel Prize-winning economist said the safer option was to guarantee its deposits.
Paul Krugman has called the US government's rescue of Silicon Valley Bank a sensible but frustrating decision, and pushed for tighter banking regulations to prevent future failures.
SVB ran into trouble because it invested customers' deposits in long-duration bonds that plunged in value as the Federal Reserve hiked interest rates from nearly zero to upwards of 4.5% over the past 12 months. The lender — a key player in the venture-capital ecosystem — responded by selling $24 billion of bonds and launching a $2 billion capital raise last week.
The bank's scramble for cash sparked fears about its stability among VCs and their portfolio companies, leading to a tidal wave of withdrawals that overwhelmed the bank. The Federal Deposit Insurance Corporation (FDIC) took control of SVB on Friday, and agreed to guarantee all of its deposits beyond the usual $250,000 limit on Sunday.
Krugman argued in a New York Times column on Tuesday that SVB was uniquely vulnerable, and letting its large depositors lose some money probably wouldn't have threatened the wider banking system. However, he emphasized that the risks of allowing SVB to fail greatly outweighed the dangers of intervening.
Still, the Nobel Prize-winning economist expressed reservations about the rescue. He complained it was "infuriating" that SVB was among the regional banks that successfully pushed for looser regulations a few years ago. He also called out the technology industry's tendency to criticize big government until it needs help.
Moreover, Krugman flagged the risk that the government guaranteeing deposits might result in people parking their money in banks without questioning whether it's safe, or how the lender is using their cash. Banks might also feel safe making high-risk loans or investments, if they believe their depositors will be made whole if they lose everything, he continued.
"Heads, they win; tails, the taxpayers lose," the Nobel laureate said.
Krugman, a vocal cryptocurrency skeptic, said it was unreasonable to expect people to evaluate the soundness of banks, and questioned the sophistication of SVB's customer base.
"I don't believe that SVB's depositors were making careful, rational calculations about risks and likely policy responses, because I don't believe that they understood how banking works in the first place," he said. "For heaven's sake, some of SVB's biggest clients were in crypto. Need we say more?"
Krugman concluded that the key takeaway from the SVB fiasco is that banks need to be strongly regulated. Imposing capital requirements helps mitigate losses, and encourages bank bosses to act sensibly or lose money, he said.
"Wouldn't we all, even the ultrarich and large companies, be happier if we didn't have to worry about our banks going down in flames?" he asked.