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  • March 22, 2023
  • Chuck Osborne

Where Have all the Capitalists Gone?

In the 1992 movie “Sneakers,” Robert Redford and Ben Kingsley play old college buddies who have not seen each other since Redford’s character, Bishop, narrowly escaped arrest for hacking into a computer system while Kingsley’s character, Cosmo, got caught and ended up in jail. Bishop went on to build a company that is hired to break into banks to test banks’ security systems. Cosmo went on to fake his death in prison and escape to become an underworld boss.

The two former friends meet twenty years later, this time as enemies. Cosmo launches into a monologue, as bad guys usually do in movies, about imagining a sound bank, then spreading a rumor of instability that causes actual instability. It is a good scene in a good movie, and another Hollywood example of understanding that runs on banks have more to do with group psychology than with finance.

Silicon Valley Bank (SVB) was such a bank. It was and would have continued to be just fine, if its commercial clients had not decided to withdraw all their money at once. Their clients were fledgling technology companies – alleged entrepreneurs who should have a degree of business acumen. Yet, they panicked and caused the collapse of the bank that had helped them get started.

Why would they do that? Everyone knows that the Federal Deposit Insurance Corporation guarantees deposits all the way up to $250,000 per depositor. However, it is estimated that more than 85 percent of the deposits at SVB were not insured. That means these “startup” businesses had, on average, approximately $1.7 million sitting in a bank account. No worries for them, however; the Fed has agreed to bail out the depositors and guarantee all assets, even the 85 percent that were above the insurance limit.

This is a lot of things, but one thing it is not is capitalism. There are no bailouts in a capitalist society. To be clear, I am not making a judgment as to whether the Fed took the correct action at the time, I am simply pointing out that what they did would not have happened in a purely capitalistic economy. In fact, in my opinion, the Fed doesn’t really have a choice but to guarantee all depositors because whether they admit it or not (that will be a not), they are at least partially if not entirely to blame for this mess.

The Fed is to blame on two fronts. First, they are the regulator. SVB got into trouble because its liabilities were the customer deposits that could be withdrawn at any time, while its assets have been primarily reported to be five-year Treasury bonds. This creates an asset-liability mismatch: the assets would mature in five years, while the liabilities are day-to-day. This may be confusing to the layperson, but this is bank regulation 101. The regulators, post-Great Financial Crisis, have focused on what the assets are, and in this case they are Treasuries, the “safest” investment one can make. They did not focus on the timing mismatch causing a lack of liquidity. There has been plenty of noise about relaxed regulations for the smaller banks being to blame, but that is just factually wrong. Barney Frank, who co-authored the regulation in question, has even said this. If there is a murder spree in your community, we don’t need to make murder more illegal than it is already; we need to hold politicians and government officials responsible for enforcing the laws and regulations that already exist, and for catching the bad guys.

Secondly, the Fed is to blame for creating this entire environment. Why in the world would a corporation or any individual hold such a high balance in a plain deposit account at the bank? There is a position in larger corporations within the finance department for cash management. This is the money market. Most investors participate through money market mutual funds they have in a brokerage account. Why leave cash sitting in the bank when one could invest in the money market, giving very short-term loans to the government or to high-quality corporations? One can loan as short as overnight. In fact, it is the overnight rate that the Fed actually controls. In the case of Treasury money markets, the funds are guaranteed by the Treasury. This way, even the largest corporations can minimize their exposure to banking risk. The bank account should be nothing more than a pass-through account where money comes in right before going out, and the remaining balance should be at least much closer to the insured amount. So why weren’t these companies doing this? Because the Fed had lowered those rates to zero, no longer making it worth the effort.

It appears that the founders of these technology startups were raising millions of dollars before even having a product, and then just leaving all that money in the bank. That is not entrepreneurial. Steve Jobs started Apple in his garage. Bill Gates had to sell his software to his first customers to have the money to build it. There is nothing capitalistic about companies that have not done anything yet and already have large payrolls and millions of dollars in the bank.

Everyone wants the return, but no one wants to take any risk. There is a segment of our population that starts companies, goes bankrupt, and then posts pictures of their wonderful vacations on the French Riviera. They have no actual skin in the game. They take risks with other people’s money, cause outsized societal damage when it all goes wrong, and float away on their golden parachutes.

If I was a young person today who has not been taught actual economics and has no real understanding of history and this is what I saw in our supposedly capitalistic society, I’d hate capitalism too. However, I am not a young person and I do know better. This isn’t capitalism. The reason, in my opinion, that so many people today look at “the one percent” with disgust is that they no longer believe, as Americans have in the past, that those people have earned their status. It isn’t that they did not work long hours or deliver desired products and services, it is that deep down we all know that, unlike the entrepreneurs of the past, they took no real risk.

If Apple had failed Steve Jobs likely would have been homeless, but the tech “startups” of today have millions of other people’s money just sitting in uninsured bank accounts while they go to dinners and introduce themselves as CEOs. And why not? They know when the stuff hits the fan, the government will not let them suffer.

Milton Friedman said it best when he said, “Underlying most arguments against the free market is a lack of belief in freedom itself….” There is no freedom without responsibility, and one cannot be truly free if she is not free to fail as well as to succeed. This is a mess, but it isn’t capitalism. At least that is my perspective.

Warm regards,

Chuck Osborne, CFA
Managing Director