Another Window Into America’s Two-Tiered System of Justice

It’s always been the case that the rich, powerful, and connected have an inside track to getting a better deal for themselves, from preferential treatment in the legal system to zoning laws. But this approach has increasingly become an institutionalized way of thinking that is driving the inequalities we see in American society.

Consider something as prosaic as deposit insurance. The Federal Deposit Insurance Corporation (FDIC) insures bank deposits up to $250,000 with the full faith and credit of the US government. If a bank fails, all deposits under $250,000 are seamlessly guaranteed while deposits above that level are contingent on how much cash is recovered from resolving the failed bank. If the FDIC can’t recover enough money from the failed bank to cover all of the uninsured deposits, then those depositors will take a haircut.

But that’s not how it works for the connected. When Silicon Valley Bank (SVB), the house bank of Silicon Valley’s tech world, failed, people in the tech industry screamed that all deposits in the bank—insured or uninsured—should be protected or catastrophe would result. Venture capitalist Jason Calacanis said, “This is DEFCON 1,” claiming that, “hundreds of startups are going to miss payroll if SVB doesn’t find a buyer this weekend, or if the government doesn’t backstop it.” The FDIC quickly capitulated to this pressure and guaranteed 100% of uninsured deposits.

Meanwhile, when the small First Bank of Lindsay in Oklahoma failed this past October, the FDIC followed its normal procedure. Insured depositors got 100% of their money immediately. But only 50% of uninsured deposits were made available when the news broke. Whether the remainder will be recovered will depend on what the FDIC is able to recover from the resolution of the bank. It could end up being 100% of their money, but it could also end up being much less. Regardless, those depositors are going to have to wait to find out how much they will ultimately get back.

There’s clearly a two-tier bank failure regime in at the FDIC: One for connected people’s money and another for ordinary people’s money. As Aaron Klein at the Brookings Institution put it, “we need to have a frank discussion about why bank regulators were OK with a handful of people and businesses in small-town Oklahoma losing money in a bank but not the billionaires and venture capitalists who were bailed out under the guise of protecting small businesses trying to meet payroll.”

Defenders of the SVB bailout will of course claim their situation was unique, involving “systemic risk” or “contagion.” Without government action, they allege, the consequences of the bank’s failure would be much bigger and more consequential than just lost deposits. Whether or not that’s true in this particular case—I think it’s unlikely many businesses would have missed payroll if uninsured depositors had gotten the First Bank of Lindsay treatment and received access to half their money immediately—it’s a legitimate argument. Some situations do pose more risk of cascading failure than others (think Lehman Brothers). And the interests of major businesses and our tech world are legitimate ones to consider.

But over the past two decades, this type of preferential treatment has gone from the exceptional to the ordinary. It’s part of a broader cultural shift: America has come to equate elite interest with the national interest. Not only is this deeply unfair to ordinary Americans, it actively promotes the growth of inequalities. For example, who in their right mind today would want to keep their money in any bank other than one the government has deemed “too big to fail,” or an otherwise connected institution?

The two-tier system is an incentive for further centralization both at the institutional and geographic level. Big institutions with implicit government backing have an enormous competitive advantage in the market. And the places where they are located benefit as well, promoting the geographic inequality that we see.

Economic activity and human capital get hoovered out of places like Lindsay, Oklahoma and reconcentrated in elite cities; cities that are themselves backstopped against failures by government fiat. People say that New York is America’s most powerful and important city in part because of the agglomeration of professional talent that resides there.

This is true, but some of that talent is there because New York has been repeatedly bailed out, the most recent occurrence being the 2007 financial crash, when the federal government rushed to provide hundreds of billions of dollars in relief, much of which made its way directly to Wall Street. Where would NYC be today, and where would many of its most talented residents be, if the federal government had simply allowed the finance industry to go under? That may well have been a terrible choice, but it’s undeniable that the bailouts of those institutions were also a bailout of New York City itself. This concentrating dynamic in turn hollows out civic leadership everywhere else, hobbling these smaller cities’ and towns’ ability to adjust to the adverse changes this system imposes on them.

The bailouts also reduce elite skin in the game, allowing many people and institutions to take foolish risks, and certain places to get away with terrible governance. Why did so many companies have large uninsured deposits sitting in Silicon Valley Bank vulnerable to disappearing in the first place? In part it’s because that was the tacit price of special favors dispensed by SVB to tech firms and founders, including giving sweetheart personal mortgages to tech CEOs. This was foolish money management by companies that should have known better, and arguably tacitly corrupt.

As writer Nassim Taleb has pointed out, while every plane crash makes the next plane crash less likely, every bailout makes the next bailout more likely. Our culture of insulating the connected from pain has buffered them from the discipline of market correction with predictable results.

The number one thing the government could do to start reversing geographic inequality is simply to stop underwriting it. We have to take a broader view of the national interest that recognizes our legitimate stake in the success of elite industries, but also considers the well-being of our ordinary citizens. People who have their money in community banks should be treated as if they are as valuable as those who put their money into Silicon Valley ones.