“Bailouts incentivize and encourage the financial behavior that makes bailouts necessary.” ~ Holman W. Jenkins, Jr.

The fundamental business model of banking is that the bank accepts money from bank depositors and invest almost all of it. A certain amount of depositors’ money, called reserve requirement, must be kept for redeeming customer accounts and customer withdraws. The remaining deposits gets loaned out, often in long-term illiquid loans  and assets.

If customers want to withdraw amounts greater then the reserves, typically refer to as “ run on a bank”, a bank has two options:

• Raise money by selling investments at a profit or loss
• Raise enough money to bridge its cash needs by selling equity in the bank itself hurting shareholders.

Going forward, your bank deposits are implicitly safe from bank failures, but your bank deposits aren’t safe from inflation due to lost of purchasing power, writes Holman W.Jenkins in  WSJ Opinion piece. In essence, the investment risks that large sophisticated uninsured depositors take were shifted to bank shareholders and U.S. taxpayers by the federal government.

Effectively, the FDIC $250K bank deposit insurance limit guarantee is now uncapped. By implicitly guaranteeing all bank deposits, the government’s policy will actually incentivized banks to take even more riskier investment bets with depositers’ cash to garner outsize returns. In short, uninsured deposits were a source of market deposits discipline.

Moral hazard refers to the situation that arises when an individual or bank have the chance to take advantage of a financial deal or situation, knowing that all the risks and fallout will land on another party. It means that one party is open to the option – and therefore the temptation – of taking advantage of another party.

In this case, the secondary party, the tax payers, are the ones that suffers all the consequences of any financial risks taken in a moral hazard situation, leaving the first party free to do as they please, without fear of responsibility. They are able to ignore all moral implications and act in a way that is most beneficial to them.

The government’s actions to implicitly guarantee bank deposits does not actually eliminate the risks of additional bank runs or failures, it only transfers the risk and subsequent obligations to the FDIC and ultimately the U.S. taxpayers. It also encourages financial moral hazard, the taking of extraordinary investment risk with bank assets, by bank chief executives.

Source: Holman W. Jenkins, Jr., “Joe Biden’s $19 Trillion Monday”, The Wall Street Journal, March 15, 2023