The implied guarantee of deposits solves one problem, creates another

Bloomberg News

I started covering bank regulation well before I became a parent, but it has been long apparent to me that the skills required to be a successful bank regulator are in many ways the very ones that I use every day to keep my kids in line. 

There are rules (no cookies for breakfast), and there is supervision to enforce those rules. I issue supplementary guidance statements to my kids all the time, including Frequently Asked Questions about the applicability of my rules; no cookies for breakfast does not preclude the possibility of cookies between breakfast and lunch, but cookies in the morning hours should be reserved for circumstances of enhanced market stress, like when Mom and I want to sleep in.

Chief among those parenting/regulating skills is the ability to strongly imply something without actually promising it: If you go to bed at a reasonable hour and don't wake up too early, Mom and I will take you somewhere special and get you a treat (turns out that special place is the hardware store and the treat is Wendy's drive-through).

Treasury Secretary Janet Yellen and her cohorts in the bank regulatory sphere have been relying on a certain sleight of hand to give markets the impression that uninsured deposits will be covered in the event of a bank failure without explicitly promising exactly that. Two Sundays ago — only minutes before markets opened in Asia — Yellen and the Federal Deposit Insurance Corp. announced that they were going to cover the large volumes of uninsured deposits at both Silicon Valley Bank, which had failed the prior Friday, and Signature Bank, which had failed only hours earlier.

In their joint statement announcing that intervention, Yellen, Federal Deposit Insurance Corp. Chair Martin Gruenberg and Federal Reserve Chair Jerome Powell said that the reforms enacted after 2008 "combined with today's actions demonstrate our commitment to take the necessary steps to ensure that depositors' savings remain safe."

That statement was likely designed to tell investors — and more importantly, depositors — that, should other banks with large uninsured deposit bases fail, they will receive similar treatment. Markets did not quite receive that message loud and clear; while some stocks initially made gains on the news, those same stocks continued to drop later in the week. That reversal may be attributable to comments that Yellen made while testifying in the Senate Banking Committee where she hedged on how expansive the government's interventions would be.

Politics and policy

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That brings us to Yellen's remarks this morning, where she told the American Bankers Association's annual Washington summit — and reporters the day before — that she and other banking regulators "have demonstrated our resolute commitment to take the necessary steps to ensure that depositors' savings and the banking system remain safe."

This time, markets seem to have gotten the memo: Shares of First Republic Bank, the most wobbly of the next-most-wobbly midsize banks experiencing a liquidity crunch, jumped 40% on Yellen's remarks amid a broader rebound in the banking sector. Combined with Swiss authorities' brokered acquisition of Credit Suisse by UBS, it seems like the near-term task of quelling the markets has succeeded — for now.

But as with parenting, persistent demands by stakeholders for clarity of policy can have the effect of changing said policy. When my kids wanted to know precisely what the payoff would be for letting their parents sleep and were told it would be a trip to Lowe's and a Frosty, that didn't do the trick. So I changed the policy to say we were going to Chuck E. Cheese in order to achieve the desired outcome — that worked in the short term, but raised the stakes and market expectations in the medium term.

Yellen and the other bank regulators have made the same bargain, and the cost of achieving short-term calm is having to articulate a formal policy regarding just how insured deposits above $250,000 really are. If the policy will be that all deposits are insured up to infinity — as some lawmakers have suggested and others have vehemently opposed — that would render the FDIC's Deposit Insurance Fund woefully inadequate and require steep increases to deposit insurance, which smaller banks have already signaled they are unwilling to pay.

There are other options as well: Raising the deposit insurance cap for some kinds of accounts but not all; raising deposit insurance on a temporary basis; or waiting a while for things to cool down, scooting as many deposits into insured territory as possible and then ripping the Band-Aid off. Each of these options has advantages and disadvantages, greater or lesser degrees of political viability and require greater or lesser degrees of congressional buy-in.

But for the current calm to endure for any length of time, regulators are going to have to articulate some kind of explicit policy regarding deposit insurance that expands the government guarantee of deposits beyond what it was a month ago — and ostensibly remains today for all but two failed banks. "Because I said so" isn't going to cut it.