The Silicon Valley Bank crisis and the waning private sector

What on Earth is going on in the financial sector? A riveted nation just watched a run on suddenly crippled banks avoided by regulatory action. While it feels like ancient history, just days ago policymakers were focusing on financial institutions’ growing use of environmental, social and government (ESG) factors in mutual funds and bonds, and on whether such efforts should be praised, condemned or even outlawed as an overreach.

Ever-present were questions about what might be happening to the evolving U.S. economy and the morality of capitalism itself. Hardly anyone seemed to notice that America’s private sector was disappearing and that everything we do is significantly controlled by politics.

After the failed Silicon Valley Bank was taken over, depositors were assured that their money was safe even as markets do what they do in these situations. The other debates were suspended, at least for a while. Most Americans were probably sleeping better at night believing that the Federal Reserve was in charge. The irony, of course, is that it was the Fed’s interest-rate hikes that caused bank-owned government bonds to plummet in value and thus contributed to the crisis.

As economic historian Robert Higgs explained convincingly in his 1987 book, “Crisis and Leviathan,” America’s economic history is filled with a continuum of crises that brought new modes of government regulation to the rescue, and that once the crises past, the regulation stayed. Yes, the government fire trucks came and put out the fire, but instead of going back to the station, they stayed and became a growing part of the community they saved, paid for with higher taxes. As comforting as it seemed, community members became less cautious believing their homes were more fireproof than before.

As Irving Berlin reminded us, “Cousin Jack insured his shack and now he plays with matches.” Higgs explained that crises cause government to grow in a ratchet-like fashion until it becomes intertwined with economic life. At the same time, moral hazard (the tendency to let down one’s guard because of a feeling of security) enters and things can get worse.

Interestingly, at a recent annual meeting, Bank of America CEO Brian Moynihan faced some of these issues head-on and tried to assure shareholders that “We are capitalists.” His bank would soon be sought as shelter by depositors of smaller banks who were now looking for those deemed “too big to fail” by federal regulators. Higgs’s insight shed new light as safe-haven regulatory requirements and accompanying government assurances put smaller, less-protected regional banks at risk.

Of the bank failures, the president himself reminded us that “That’s how capitalism works.” But it’s not that simple with the growth of the intertwined economy, where politics influences every major corporate decision and turns free-market logic on its head.

Instead of competing mainly to please customers at the lowest price points possible, some firms find they can make more profit working the halls of Congress. And politicians find they can improve their electability by supplying the right regulations, subsidies and protections to the right folks.

It’s naïve to suggest that business interests oppose regulation. They routinely seek and support regulations that bring them competitive advantages. If regulation is inevitable, they try to get it “right.” And then there are all the other interest groups (more of those “right folks” that politicians like) who seek regulations for different reasons.

Regulation that emerged during the Great Recession requiring the Fed to pay interest on bank reserves at its overnight interest rate target is an example. With reserves managed exclusively by the Fed, individual banks no longer work the interbank market, diminishing market pressure for improved financial performance in the process.

So, whatever debates we might need to have, let’s not premise them on the existence of an uninhibited “private sector.” Indeed, the term, traditionally used by policymakers to describe a distinctly different part of the economy from the public sector, is on the wane. A Google Ngram analysis, which counts the frequency of a phrase in the 8 million-book Google collection, shows the term accelerating markedly around 1940, reaching a twin peak between 1985 and 1994, and then falling dramatically.

So what? What difference does it make if the United States no longer has a truly independent private sector? If banks and their depositors are bailed out? If major economic decisions are more strongly influenced by politics than by marketplace activities?

The answer is simple, if oft-ignored: Empirical work tells us that prosperity goes down as an economy becomes more entangled with command-and-control regulation. With ongoing worries about inflation and a slowing economy, we should at the very least acknowledge the obvious flaw in government-provided risk reduction. Better yet, we could open the economy’s door to the beneficial forces of more market competition, not less.

Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University, dean emeritus of the Clemson College of Business and Behavioral Sciences, and a former executive director of the Federal Trade Commission.