Are Taxpayers on the Hook for Silicon Valley Bank Bailout?

Early this week, the Biden administration announced the steps it is taking following the government's takeover of Silicon Valley Bank (SVB), a troubled favorite of the tech community that last week began to collapse after the rapid exodus of some of its deepest-pocketed account holders left it with more obligations than it had money.

The bank's collapse, one of the largest in U.S. history, came shortly after the crash of two banks heavily favored by the cryptocurrency community. The events have shaken public confidence in the U.S. financial sector as well as in the regulators assigned to monitor it.

In remarks after the takeover, President Joe Biden and his treasury secretary, Janet Yellen, made a commitment to the public that those who had money in SVB would be made whole again, all without any expense to taxpayers.

"This is an important point—no losses will be borne by the taxpayers," Biden said Monday. "Let me repeat that: No losses will be borne by the taxpayers."

From a cursory view, Biden is correct. When the Federal Deposit Insurance Commission (FDIC) took over the bank and began cashing out its customers, all of the funds withdrawn were drawn from a pool of money that banks are required to pay into, the Deposit Insurance Fund. The fund is intended to assure those who entrust their money to a bank that they will be able to retrieve that money should the bank go belly up.

Others, however, maintain that is an oversimplistic view of the banking system, one that ignores the reality that the American taxpayer will ultimately pay for the moves the federal government makes.

Just in a different way than Biden described.

The Basics

To understand how taxpayers will be on the hook for the Biden administration's solution to the problem, you first need to understand the fundamentals of SVB's business model.

To operate and still be able to turn a profit, banks don't just hold your money. They lend it out, with interest, or invest it in stable investments that can promise a steady rate of return that helps subsidize other areas of the bank's business model.

In the lead-up to its collapse, SVB officials decided to put the bulk of its customers' money into bonds like federal agency mortgage-backed securities. This type of bond has a minimal credit risk but with the inherent potential for sizable interest rate risk.

However, SVB was primarily investing in a riskier strategy, putting its customers' money into longer-term mortgage securities that take from 10 to 30 years to mature, as opposed to shorter-term bonds that mature in less than five years. And current market conditions were not too kind to that investment strategy.

As federal interest rates rose sharply and prices in the bond market began to crater, approximately $117 billion of the company's $211 billion in assets was contained in those securities, which threatened to make the bank insolvent. Wealthy customers with large amounts of money in SVB began to panic and began withdrawing significant sums of money while publicly encouraging others to follow suit. The bank stood on the verge of collapse.

Breaking the Bank

To stop the bleeding, the Biden administration quickly moved to take over the bank's operations while transferring billions of dollars from the U.S. Treasury to shore up the FDIC so it doesn't lack the money to make up for the bank's losses.

In return, the federal government got all of the securities SVB had invested as collateral "at par," meaning that the government essentially bought SVB's bad securities for a price well beyond what they were currently worth. Meanwhile, returns on that investment are far off in the future, while there are currently very few, if any, customers out there willing to buy what SVB was invested in.

In short, by buying those securities at their original price, the government decided to turn itself into a leveraged lender to a financial entity that few believe will ever get its act together.

"Right now, the Federal Reserve is saying, 'OK, this bond is only worth 60 cents right now, if we sell it, but we're going to accept it, and we're going to loan you $1, and you're going to have to pay that back within a year," EJ Antoni, an economist at the Heritage Foundation, a conservative think tank, told Newsweek.

"Now, the odds of these banks actually being able to right the ship and financially recover and get their house in order within a year, in my opinion, are very, very small. So it's very likely the [Federal Reserve] is going to be stuck with these things," he said.

What Does This Mean?

Saddled with SVB's poor investments, the Federal Reserve now finds itself with a handful of bad options.

It could sell those bonds at a loss to the Treasury Department in the form of something called a "deferred asset, which the department will, one day, need to pay for. Or the Federal Reserve could decide to hold those bonds to maturity, carrying a significant number of low-priced bonds and securities on its balance sheet that will not mature for at least a decade.

In doing the latter, the Fed, which has been enacting steep interest rate hikes, will need to double down on or back away from its anti-inflation strategy. This could leave taxpayers still paying significantly higher interest rates that some believe could lead to unemployment spikes—or they will continue to pay rising prices for goods, with salaries worth less than they once were.

Meanwhile, the Treasury Department, now fresh off of its emergency move to shore up the FDIC, now has significantly less money than it had before, Antoni said. That's money it needs to make up.

One option under consideration is increasing the amount of money banks pay into the insurance pot, which will then gradually be paid back to the Treasury Department. Most likely, those fees will likely be accounted for by a pass-through cost to bank customers at institutions across the United States.

Or Congress could opt to raise taxes, an unlikely prospect in today's divided Congress and with a presidential election less than two years away. Or the Fed could opt for a shift in monetary policy at its next meeting, potentially exacerbating inflation even further.

At this point, critics say, the indirect costs of the federal government's decisions—rather than the direct cost—are what's really going to hit consumers.

"The talk is now limited to the direct payments from FDIC," Richard Curtin, an economist at the University of Michigan, told Newsweek.

"Indirect costs are far more, and include stock losses in retirement portfolios, rising interest rates at banks, etc., as well as increased insurance fees. The recent chatter is merely about the FDIC insurance, the smallest part of the total costs that will be paid by all banks," he said.