At SVB, the Market Was the Failure

Silicon Valley Bank’s meltdown offers strong evidence that we live in a simulation. Gathering the unsecured assets of the most prominent and arrogant libertarians in one financial institution and then collapsing it, leaving them all to demand a government rescue, is, well, awfully on the nose.

Let us not bask in schadenfreude. Or at least, let us channel that gloating toward making the moment a teachable one. The various “bailout” narratives have already run their course, indeed circled the track several times, and finished roughly where they began. Everyone supports bailouts for themselves, and no one thinks their own bailout is a bailout. We get it. This was true in the last crisis and will be true in the next one. 

But perhaps there is a lesson here that might have some lasting value: Even sophisticated actors in financial markets are often incompetent. 

Economists have made some progress in recognizing that their assumptions about individuals as rational actors are empirically wrong. But when it comes to big decisions—buying a house, say, or saving for retirement—public policy arguments still seem grounded in some expectation that risks and rewards, costs and benefits, will be well understood and managed. This goes doubly when the players are wealthy investors or entire for-profit enterprises overseen by boards of experienced experts.

Plainly, the assumption is untrue, as demonstrated by the famous venture capitalists pleading for the lives of high-flying start-ups run by highly intelligent founders who apparently took the tens of millions of dollars in their Series Whatever rounds and just left it in checking accounts. The folly here really was extraordinary. I feel at least a bit qualified to render judgment on this matter because when our own little upstart nonprofit managed to cobble together the smallest financial cushion, do you know what I did? I took three months of payroll, moved it to a different financial institution, and put it into short-term Treasury bonds that I presumed would deliver subpar returns as interest rates headed upward. Why? Because as the financial steward of an organization, responsible for a team of employees, I needed capital preservation, diversification, and liquidity.

I usually steer clear of personal and internal organization anecdotes. And I don’t mention this one as some proof of superiority—I’m sure there are other possible catastrophes for which we have not prepared as well as we could or should, and we will rightly feel very foolish if one of them befalls us. Rather, I offer it as a straightforward refutation of laments like, “Well, what were they supposed to do?” and protestations of, “No one does that.” It’s clear what these companies should have done and, yes, many others avail themselves of the option. (The SVB depositors need to understand, as Friends’ Rachel Green shouted at Ross Geller when they broke up, “It’s NOT that common, it DOESN’T happen to every guy, and it IS a big deal.”)

I hope we can emerge from this crisis with significantly reduced faith that financial markets will operate efficiently and in accordance with assumptions of rational and reasonable behavior by “sophisticated” market participants, and significantly increased empathy for those who “misbank,” a word that should enter the lexicon. Misbanking is pervasive, from the struggling single parent who becomes over reliant on payday loans to the middle-class homeowner who overleveraged himself with an adjustable-rate mortgage in 2005 to the pension manager who pays hedge funds enormous fees for middling performance to the shape-rotating technologist who saw everyone else putting their funds in SVB and did the same without a second thought. It’s likely that we all misbank in various ways. Most of us are fortunate to find seats each time the music stops. But we should all dispense with the notion that those less fortunate are irresponsible rubes who got what they deserved.

This lesson applies not only to financial markets. In a confused tweet on Saturday, David Sacks observed, “Blaming depositors for bank failure is like placing the blame for medical malpractice on patients because they didn’t do a good enough job shopping for a doctor. Depositors expect the Fed to ensure that banks are safe.” It’s not a great analogy, seeing as regulators require doctors to carry certain levels of malpractice insurance, whereas here Sacks is demanding the insurance that regulators had explicitly declined to offer. But the broader point stands: Customers of all types are limited in their information, attention, judgment, and agency; public regulation and risk-sharing can therefore benefit them. And whereas Sacks wants to impute the challenges facing an individual patient to a venture-backed start-up, his argument is more compelling in reverse: If venture-backed start-ups cannot manage their most basic financial decisions responsibly, what chance does a consumer have in the health care market?

It’s remarkable how many of market fundamentalism’s policy proposals reduce to a naïve faith in the individual consumer to benefit from an abandonment of public oversight and institutional support. Privatize Social Security, allow alternative investments into 401(k)s, unleash cryptocurrency. Let patients “shop around” in a “free market” for medical care. “Empower” workers by decimating the labor movement and weakening employment relationships. Fix public education through competition. In every case, the crux of the argument is that consumers know what they want and through free choice will optimize their own outcomes. In every case, the response might now begin: “Well that’s quite a set of assumptions you’ve made there. Let me tell you a little story about a bank called SVB.”

A better model embraces the power of markets to offer choice, align incentives, and reward value creation, while also recognizing that markets will only function well if shaped by publicly established rules and participants will only benefit if supported by strong institutions. School choice offers a great example: Yes, parents should have options, but yes also there should be public standards that all providers have to meet. When it comes to retirement, yes, people should be encouraged to save for their own futures, but yes also it is indispensable to have a social insurance system into which everyone pays and from which everyone receives coverage. Yes, families should have options for choosing health insurance not connected to an employer, but yes also the government will need to establish parameters for that insurance, ensure that everyone can and does get coverage, and encourage the formation of groups—such as labor organizations—that can facilitate the process.

The preliminary question that market fundamentalists love to ponder before permitting a public intervention, of whether there is a “market failure,” has been asked and answered. The market failure is that market actors are fallible and their efforts at pursuing their own interests do not necessarily lead smoothly to efficient outcomes that serve themselves or the common good. For policymakers, the task is to make useful rules that provide for good options and strengthen institutions that promote good choices. For all of us, the task is to remember that everyone needs such support, and that those who fall down without it are deserving of our help.