Last week was a crazy week for financial markets, especially for capital markets. First, the testimony of Jerome Powell signaling additional hikes in interest rates for the foreseeable future, then the failure of the Silicon Valley Bank (SVB) due to a bank run. Hence, capital markets were dragged down, losing a substantial portion of their value. Billionaire hedge fund manager Bill Ackman; founder and CEO of Pershing Square Capital Management; has been very vocal since the failure of the venture-backed bank. He has been pleading for a bailout of the failed bank on the premise that its failure could destroy an important long-term driver of the economy as VC-backed companies rely on SVB for loans and holding their operating cash. He said, “if private capital can’t provide a solution, a highly dilute government-preferred bailout should be considered.”
The U.S. Secretary of the Treasury Janet Yellen asserted that the federal government will not provide a bailout for SVB’s investors after the bank was abruptly shuttered, but said financial regulators are “concerned” about the impact to depositors and working to address their needs. A government bailout means that the government would be using taxpayers’ money to bail out a company that most people probably never heard of and profited from. Many economists, especially those with Keynesian leanings, have blamed the 2008 financial crisis on the government’s failure to bail out investment bank Lehman Brothers. They argued that the financial crisis would have been avoided had Lehman Brothers been bailed out because they were too big and too influential, and its failure would have disrupted the entire financial system.
The problem with government bailouts is that they maintain inefficiencies and perpetuate monopolies. When a very influential company is failing, it suggests that that company has become inefficient and therefore produces results that no longer satisfy consumers. The failure of a major company indicates that it has reached the end of a cycle and, therefore, must fail in order to let emerging companies take over, and innovate the industry. The market is an organic and social institution based on cyclical phenomena. Booms and busts in the business cycle are part of these cyclical phenomena. After a bust, the market usually comes back much stronger than before because the economic agents that were part of the previous cycle have been ousted and a new cycle began with new agents. In the very case of SVB, its failure to raise capital was an indicator to depositors (who are in this case the consumers) that the bank has become inefficient and they feared that this inefficiency would have repercussions on their money. As a result, their distrust in the bank’s inability to repay them triggered them to all go to the bank on the same day to claim their money back.
Bank runs have been the catalyst of financial crises and economic recessions in the United States, especially during the National Banking Era (1863-1913) and the Great Depression. Interestingly, the 2022 Nobel Prize in Economics focused on how bank runs trigger economic recessions. Bill Ackman claimed that if SVB isn’t bailed out by Monday, March 13; then many other big banks will also experience a bank run and this run could then trigger the recession that we’ve all been predicting since 2021. This recession we’ve been waiting for is long overdue. Regardless of what triggers it, if it is bound to happen, then it will end a cycle by weeding out economic agents that became inefficient and give place to a new cycle with new agents that will take markets in another direction.