Blinded by Their SVB Hysteria, Politicians Risk Fighting the Last War

By William R. Gruver
A version of this piece first appeared in RealClear Markets.

By guaranteeing the safety of all depositors (not just those below the current federal guarantee of $250,000) at Silicon Valley Bank and Signature Bank, have we unwittingly begun to nationalize our banking system? Perhaps so, but it could be that what the Biden administration is doing is even worse.

Treasury Secretary Yellen first said under oath in Senate testimony that the new policy would apply to other failing banks in the future only if the FDIC board, the Fed board, she and the President agreed that it was the proper action. In saying this, she was suggesting a new American banking system. This new banking system would create both moral hazard where bank executives are encouraged to take on more risk than they would without the unlimited federal guarantee, and   crony nationalization where a depositor is protected only if what? If the bank is too big to fail? If the bank is in a region or an industry thought to be vitally important to the nation? If the depositors are influential political donors? If the board of the failing bank includes former members of Congress with eponymous banking regulation? Such socialization of risk and privatization of profit (moral hazard) for what will be perceived to be allies of the administration is antithetical to capitalism and to democracy. It cannot be allowed to stand as policy. 

Then, one week later, the Secretary reversed her position by saying that the administration was not planning to extend the deposit guarantee to all depositors. Her peripatetic policy announcements are inviting more runs that will destroy the remaining trust that depositors have in the banking system. In fact, depositors are already lowering the level of their bank deposits by fleeing to money market funds and shadow banking alternatives, thus trading one set of risks for another and setting the stage for the next round of crisis, emergency stopgaps and new regulation.

Senator Warren and others are calling for more regulation and blaming relaxation of some Dodd-Frank provisions for the current crisis. Targeted additional laws might help, but more laws will never replace sound judgment. Dodd-Frank focused on credit risk, a big contributor to the 2008 bank crisis. It did not address certain axiomatic banking principles like duration risk and industry concentration risk that apparently are not as axiomatic as some presumed.

Trying to address such fundamentals through more laws, however, will never replace competent oversight by regulators and governing boards. Any Banking 101 student should have seen the danger of the asset liability duration mismatch in a rising rate environment. Any competent regulator would view one of the fastest growing banks in the country not having a Chief Risk Officer in place for 8 months as a huge red flag. There were ample signs that could have averted the current crisis under existing regulation had we had in place more competent and more courageous regulators and governing boards.   Legislating intelligence and courage into those responsible for overseeing our banks will be a huge challenge.

Equally challenging is the passivity that large index-based institutions represent among the largest shareholders at many publicly traded corporations. For 90% of the companies comprising the S&P 500, Black Rock, State Street or Vanguard (the 3 biggest index fund managers) are the single largest shareholder. Estimates of the percentage of the American equity markets now owned by index funds range as high as 30%.  These funds by definition (passive) tend not to challenge management. Not having the beneficial owners of these index funds (pensions, endowments and individuals) appropriately represented on the governing boards of public companies potentially creates lax oversight and misaligned fiduciary responsibility that can be particularly worrisome on the compensation and risk committees.

Having said all of the above, as is said about generals who are always fighting the last war, and not the next war, the same can be said of legislators. Inevitably, rightly or wrongly, legislators will write new laws. There will be legislation that addresses some of the causes of the banking crisis of 2023 and by doing so could reduce the chances of a future banking crisis.

When in the 20th Century Carter Glass of Virginia led the passage of two laws that stood the test of time. The first established the Federal Reserve in 1913 and later the Banking Act of 1933, which created the Federal Deposit Insurance Corporation (FDIC) that still federally guarantees depositors today. Glass was looking forward, not just backwards at the causes of proximate banking crises. Like Glass, today’s legislators would be better served by addressing the potential causes of the next crisis, such as the relatively unregulated esoteric money market funds and shadow banking vehicles into which much of the deposit base is now fleeing, as well as the potentially misaligned fiduciary responsibilities created by the size of the index- based shareholders.

William Gruver is a Professor Emeritus at Bucknell University, a retired General Partner at Goldman Sachs, and a senior fellow at the Open Discourse Coalition. 

 Leadership Lessons from the Russia-Ukraine War and Biden’s Response

By William R. Gruver
A version of this piece first appeared in PennLive.

When leaders create and implement a strategy, they can pursue four levers of action known by the acronym DIME: Diplomatic, Information, Military, and Economic. A successful leader usually engages all four. When one of them is overused at the exclusion of one or more of the others, the risk of unintended consequences increases significantly.

As the world watches the Russian invasion of Ukraine, and its response from the United States, the four levers of action are on full display. They remind us that leadership decisions are made to serve a moment, but their unintended consequences can extend over decades.

Russian President Vladimir Putin

President Putin has been too narrow in his application of DIME. He has relied almost exclusively on the M—his Military—to achieve his strategic objectives. By not cutting off Western Europe’s heat (Economic) and not shutting down Ukraine’s communications capabilities (Information), Putin has prevented his military from achieving his objectives more quickly, or perhaps at all.

Putin has used diplomacy successfully in keeping critical countries such as China and India neutral or allied with him. On the other hand, his diplomatic efforts with the West have been absent or a failure. Consequently, in the long term, Putin faces a major unintended outcome—the unification of the North Atlantic Treaty Organization (NATO).

Just a few years ago, NATO was an alliance in search of a mission, with open discussion of having outlived its usefulness. Russia’s invasion of Ukraine ended that talk. Importantly, Russia’s overreliance on its military capabilities pushed Germany out of its post–WWII pacifist era to arm Ukraine, spurred increased military spending across the alliance, and brought more U.S. troops to bolster the eastern flank of NATO. A strengthened and unified NATO will outweigh any short-term military success for Russia in Ukraine.

U.S. President Joe Biden

President Biden’s strategy has intentionally underused the military tools at his disposal, and for good reason. As Carl von Clausewitz, a 19th-century Prussian strategic thinker, first pointed out, to be successful in war, all three components of a country’s “trinity” (its military, its citizens, and its civilian government) must be aligned.

President Biden, and President Trump before him, realized the American citizenry was physically and mentally exhausted after the Iraq and Afghanistan wars. They recognized that, regardless of their personal inclinations or those of their military advisers, most Americans would not stand for American “boots on the ground” in Ukraine.

Similarly, before the invasion, when Russia tested its Information warfare capabilities on American businesses, President Biden did not respond in kind but instead joined Putin for a Geneva summit where they agreed to task experts in both countries to reach an understanding on what should be “off-limits” for cyberattacks.

Thus far, Biden has relied nearly exclusively on the E in DIME—Economic—in pursuit of ending the war. The sanctions imposed against Russia are intended to cripple the Russian economy and bring Russia to the negotiating table. Time will tell, but without a more vigorous use of diplomacy to bring Israel, China, and India alongside the Western powers in employing those sanctions, it will at best take the sanctions much longer to succeed.

President Biden’s reluctance to use more of the arrows in his DIME quiver also (as with Putin) runs the risk of creating unintended consequences on a global scale.

The end of nuclear nonproliferation

In 1994, in what is known as the Budapest Memorandum, Ukraine gave up its nuclear weapons (the third-largest stockpile in the world) in exchange for a security guarantee signed by the UK, the United States., and Russia. In 2014, Russia invaded Ukraine with no military response from the other guarantors. Now, eight years later, Russia is invading again with no military response from the United States or UK.

Combine the bitter experience of Ukraine with the ousting of Libyan leader Muhammar Gadhafi in 2011 (after he agreed to give up his nuclear weapons in 2003), and we are very likely looking at the end of nuclear nonproliferation.

Why did the West support the overthrow of Gadhafi, but exercise no military opposition to Russia when it is in clear violation of the Budapest Memorandum? Answer: Because Russia has the largest nuclear weapons stockpile in the world and has threatened to use it.

Now, if you were Iran, and you saw what happened in Libya, followed by the West’s current military impotency with Russia—would you not acquire nuclear weapons as fast as possible? Would you rely on security guarantees from the West if you were Saudi Arabia?  

The end of the U.S. dollar as the world’s currency

Another unintended consequence of President Biden’s reluctance to use more of his DIME strategic toolkit could spell the end of America as the world’s dominant power. The U.S. dollar has been the dominant international currency since the end of WWI. It has been the world’s reserve currency for nearly 80 years, and remains so today. A reserve currency is used to conduct international trade and is considered safest for other countries to hold in their reserves.

The benefit of being a reserve currency is much lower borrowing costs for the home country and a powerful economic warfare tool—banking sanctions. Exclusion from the American banking system can devastate a country’s ability to trade internationally.

Adversaries of the United States understand the strategic strength that comes with being the issuer of the world’s reserve currency. They also recognize that right now, President Biden is relying nearly exclusively on his Economic lever and not his other three DIME options.

Therefore, Russia and China are moving to counter America’s preferred strategic lever by replacing the U.S. dollar as the world’s reserve currency. Until economic sanctions were placed on Russia, oil that China and the world bought from Saudi Arabia was priced in U.S. dollars. Now, however, the Saudis are considering accepting payment for oil sales in Yuan. Similarly, Russia is insisting on payment for oil and gas exports in rubles, not U.S. dollars.

What would losing the dollar’s reserve currency status mean for America? At the very least, 50–100 basis points in our borrowing costs. For a country as deeply indebted as the United States, those additional costs would likely be paid at the expense of nondiscretionary social and defense spending. It could also mean the end of the United States’ reign as the dominant world power.

Throughout history, reserve currencies have had a shelf life of roughly 100 years. In each instance, on losing their reserve currency status, the issuing nations also lost their position as the world’s dominant power. History will repeat itself for the United States without a better use of the DIME toolkit, and the world would be a much different place post Pax Americana.

As Ukraine fights for its survival, the leadership lessons we can observe from presidents Biden and Putin are identical. Focusing on one element of DIME at the expense of the others might be useful in the short term, but it will lead to grave unintended consequences in the long run.