The SVB and Signature bailouts broke Dodd-Frank's promises

Congress passed the Dodd-Frank Act to "end 'too big to fail' [and] protect the American taxpayer by ending bailouts."  When President Obama signed Dodd-Frank into law in 2010, he assured Americans that "[t]here will be no more tax-funded bailouts, period," and "no firm [will be] somehow protected because it is 'too big to fail.'"  Those promises were broken when federal officials relied on the Deposit Insurance Fund to protect uninsured depositors of Silicon Valley Bank and Signature Bank.

Merriam-Webster defines "bailout" as "a rescue from financial distress." The federal government's decisions to protect SVB's and Signature's uninsured depositors were undeniably bailouts because those decisions rescued uninsured depositors from financial distress. Federal Deposit Insurance Corp. Chairman Martin Gruenberg told Congress that many uninsured depositors of SVB and Signature were businesses that were "at risk of not being able to make payroll and pay suppliers." 

Federal authorities relied on the "systemic risk exception" in the Federal Deposit Insurance Act to justify their bailouts. The FDIC, Federal Reserve and Treasury Department said they were protecting SVB's and Signature's uninsured depositors to avoid or mitigate "serious adverse effects on economic conditions or financial stability."  By invoking the exception, federal agencies treated SVB and Signature as "too big to fail" in the sense that each bank was "so ingrained in [the] financial system or economy that its failure would be disastrous." 

The bailouts of SVB's and Signature's uninsured depositors have clearly placed taxpayer funds at risk. The insurance fund's primary purpose is "to insure the deposits and protect the depositors of insured banks." According to the FDIC, the fund will suffer total losses of $19.3 billion from protecting SVB's and Signature's uninsured depositors. Those losses will consume about 15% of the fund's existing reserves, thereby reducing its ability to protect the insured deposits held by taxpayers in other FDIC-insured banks.

Taxpayers are also at risk of paying higher taxes if the fund's losses from SVB and Signature make it impossible for the fund to cover losses from failures of other large banks. The FDIC would then be forced to borrow from the Treasury under its $100 billion line of credit. The FDIC's obligation to repay those borrowings would be backed by "the full faith and credit of the United States," i.e., the taxpayers.

The FDIC plans to recoup its losses from protecting SVB's and Signature's uninsured depositors by imposing a special assessment on FDIC-insured banks. Requiring community banks to pay that special assessment would be patently unfair, as uninsured depositors in community banks would be highly unlikely to receive similar protection if their banks failed. Since the systemic risk exception was enacted in 1991, the FDIC has never used that provision to protect uninsured depositors in a failed bank with less than $100 billion of assets.

Federal officials should have protected SVB's and Signature's uninsured depositors by following Dodd-Frank's carefully designed framework for dealing with failures of systemically important banks. Under Title II of Dodd-Frank, federal officials should have placed SVB and Signature in receiverships administered by the FDIC under the Orderly Liquidation Authority. The net cost of resolving SVB and Signature under Title II of Dodd-Frank would have been covered by the Treasury's Orderly Liquidation Fund. The FDIC would have paid for that cost by imposing a special assessment on banks with assets of $50 billion or more. Congress established the OLA and OLF to ensure that big banks — not taxpayers or community banks — would cover the costs of resolving failed megabanks.

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Why didn't federal authorities use the OLA and OLF instead of the systemic risk exception? The OLF (unlike the Deposit Insurance Fund) currently has a zero balance, and the FDIC would have been required to borrow funds from the Treasury to resolve SVB and Signature under Title II of Dodd-Frank. Borrowing from the Treasury under Title II was apparently unpalatable to regulators because it would have made crystal clear that the bailouts of SVB's and Signature's uninsured depositors placed taxpayers at risk. In addition, Title II would have required politically powerful megabanks to cover the full cost of resolving SVB and Signature.

Why does the OLF have a zero balance? When Congress was considering Dodd-Frank, then-FDIC Chairman Sheila Bair proposed that large banks should pay risk-based assessments to prefund the OLF. A pre-funded OLF would have given taxpayers an essential shield against the costs of resolving failed megabanks. In addition, risk-based assessments for the OLF would have given the FDIC an effective regulatory tool for discouraging excessive risk-taking by megabanks.

I strongly supported Chairman Bair's proposal. However, big banks vehemently opposed a pre-funded OLF and kept it out of Dodd-Frank. As a result, the OLF has a zero balance, and big banks have never been required to cover the costs of resolving failed megabanks.

Since Dodd-Frank's passage, I and others have urged Congress to authorize the FDIC to pre-fund the OLF by collecting risk-based assessments from big banks. I have repeatedly warned that the systemic risk exception would allow federal regulators to use the Deposit Insurance Fund's reserves as a backdoor bailout fund for "too big to fail" banks while evading Title II of Dodd-Frank. I have called on Congress to repeal the systemic risk exception because it permits federal regulators to impose the costs of "too big to fail" bailouts on taxpayers and community banks.

The federal agencies' unwarranted use of the Deposit Insurance Fund's reserves to bail out SVB's and Signature's uninsured depositors highlights the need for Congress to pre-fund the OLF and repeal the systemic risk exception. Unless Congress acts, Title II of Dodd-Frank will remain a Potemkin village — an elaborate charade that conceals the ability of federal regulators to impose the costs of "too big to fail" bailouts on taxpayers and community banks, despite Dodd-Frank's promises to the contrary.