Bail-in and bail-out

The US and Switzerland officials object to the use of world “bailout” (given the notoriety it acquired during the 2007-08 crisis for rewarding rather than punishing the bankers and other wrongdoers) but there is no escaping it now.

The US government has appointed the government-run Federal Deposit Insurance Corporation (FDIC) as “receiver”, is facilitating mergers and takeovers along with regulators and also providing liquidity along with other banks to save its banks. President Biden has assured that all deposits are safe. Notwithstanding the claims of not bailing out, Amiyatosh Purnanandam, a US corporate economist who studies bank bailouts said: “If it looks like a duck, then probably it is a duck. This is absolutely a bailout, plain and simple.”

The case with the Switzerland government is similar.

It has (i) brokered the takeover of Credit Suisse by another Swiss bank UBS at $3.3 billion (at a 60% discount to on $8.7 billion market value of Credit Suisse at the time) (ii) has given a guarantee of $9 billion to the USB against the potential loss from this takeover – more than the acquisition price and market value of the Credit Suisse ($3.3 billion and $8.7 billion, respectively) and also (iii) giving liquidity assistance of $108 billion.

There is another element in it, called “bail-in”.

That is, the Credit Suisse bondholders have lost their entire $17 billion. This “bail-in” is the provision of depositors and bondholders forfeiting their money, which the Indian government wanted to bring in through the Financial Resolution and Deposit Insurance (FRDI) Bill of 2017 (proposing that in case a bank fails the depositors’ money will be used to bail it out, as one of the resolution tools) but the idea was abandoned due to stiff resistance.

Credit Suisse’s failure has been a long-drawn process.

Its market value was rapidly falling for about two years (from over 12 Swiss Franc in 2021 to about 2 in mid-week and then to less than 1 now). The trigger was its large shareholder Saudi National Bank publicly refusing to pump in money last week, plunging its market value to a new record low.

Just days before the bank run, Credit Suisse reported (i) “material weakness” in its financial reporting for 2021 and 2022 – issues related to a “failure to design and maintain an effective risk assessment process to identify and analyze the risk of material misstatements” and various flaws in internal control and communication. This escape from detection for two years is strange given its status as a GSIB.

Further, this revelation came after a series of scandals involving investments, banking practices, management and worse in the past two-three years: (ii) in February 2023, it reported net loss of more than 7 billion Swiss francs for 2022 and warned of a substantial loss in 2023 (iii) it was convicted in cocaine-related money laundering which involved a Bulgarian gang (iv) a Bermuda court ordered compensation of $600 million due to fraud committed by its former advisor (v) Panama Papers-like investigations into its secret accounts (leaked data on thousands of customers) (vi) lost $5.5 billion when US family office Archegos Capital Management defaulted in March 2021 (highly leveraged bets on certain technology stocks backfired) (vii) forced to freeze $10 billion of supply chain finance funds in March 2021 when British financier Greensill Capital collapsed and Swiss regulators rebuked it for “serious” failings in handling business (viii) CEO Tidjane Thiam was forced to quit in March 2020 in a spy scandal, after an investigation found the bank hired private detectives to spy on its former head of wealth management Iqbal Kahn after he left for arch rival UBS.

Nouriel Roubini, known for accurately predicting the 2007-08 Great Recession, warned that the SVB’s collapse had had a “ripple effect” and that Credit Suisse could prove to be a “Lehman moment” (when one institutional failure spreads to another).

Cost of undoing or lack of banking reforms

The US adopted the Glass-Steagall Act of 1933 following the 1929 Great Depression (sparked by banking failures, stock market crash), effectively separating commercial banking (traditional banking) from investment banking (not traditional banking) to restrict bank credits being used for speculative activities (stock market) and instead direct it to productive use in industry, commerce and agriculture. Essentially, this prevented the use of retail deposits (or bonds) to fund investment banking activities. This was reversed in 1999 by the Clinton administration, and it played up in the 2007-08 crisis again. But the situation remains unchanged yet (although in 2020 the US Congress made a strong case for breaking the monopolies of tech giants Apple, Amazon, Facebook and Google).

In contrast, though equally harmed by the 1929 crisis, Europe did not go the whole hog for such separation. Most of it adopted the “universal banking” model in which both commercial and investment banking went hand-in-hand, which endures. In a 2019 reform (“ring-fencing”), the UK requires banking groups with more than £25 billion of retail deposits to split their retail and investment banking activities into legally separate subsidiaries. Credit Suisse, as well as the USB, are both universal banking entities.

The other is the Dodd-Frank Act in 2010, adopted by the US after the 2007-08 crisis, which applied tougher regulatory oversights to smaller banks (asset threshold of $50 billion). This was weakened (the threshold was raised to $250 billion) in May 2018 by the Trump administration. Ironically, Federal Reserve chair Jerome Powell, who was part of this dilution is now fighting to save the SVB and other banks that escaped scrutiny precisely because their assets were less than the $250 billion threshold.

Food for thought

Now consider a few things going forward.

Why not break banks and companies “too big” too big to pose systemic risk, as the Columbia sociologist suggested, instead of celebrating them as “too big to fail” or GSIBs and then bailing them out “through public solvency support”? Multiple such entities have crashed in the past 15 years – from the Lehman Brothers, Fannie Mae, Freddie Mac, Bear Stearns, AIG to Credit Suisse. Why shift the risks of their failures resulting out of their unethical and illegal acts to the public (banks or individuals through tax)?

As for the other factors for these bank runs, why not revert back to more prudent interest rates, rather than near zero for long periods of time; tighter monetary supply, instead of creating debt-fueled enterprises through liquidity infusion; higher corporate tax rates than individual tax rates; tighter regulation on stock markets’ speculative activities, rather than let them be called ‘casino’ and ‘ponzi’ scheme; tighter capital flow, rather than the deregulated or lightly regulated and unhindered global flow of capital; lifting the corporate veil on secret banks, tax havens and shell companies and tighter regulatory oversight, rather than a lax one?

Remember, the Golden Age of Capitalism was during the 1950s-1970s when both developed and developing countries registered the highest ever GDP growth (3.8% and 3%, respectively), the average top corporate tax rate was 70-80% in the US and 99.25-80% in the UK and there was tight control on capital flow and banking activities.

Silvergate Bank

Why are Globally Systemically Important Banks like Credit Suisse failing?