One of the most famous articles in economics, written by Milton Friedman and published in The New York Times, states: “The businessmen believe that they are defending free enterprise when they declaim that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends; that business has a ‘social conscience’ and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers. In fact they are—or would be if they or any one else took them seriously—preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.”
Written in 1970, this timeless common sense warning could have been written in 1870 or 870. In a competitive economy where profit is driven to zero (efficient market hypothesis), distracted firms will be driven out of business. They’ll make mistakes.
Silicon Valley Bank (SVB) was distracted by its self-imposed environmental, social, and governmental responsibilities, by its corporate culture reflecting the ambitions of its young clients (innocent startups working from home). It thought itself a venture capitalist and that it was perfectly all right if 90 percent of its loans failed, provided 10 percent were very successful.
No risk management. No one to say joint-venturing with your borrowers is not a good idea, that cryptocurrencies (a use of money without precedence) are not a good idea, that investing all your depositors’ cash in long-term government bonds (because at the moment they paid a higher interest rate) was not a good idea.
Finally, when its balance sheet showed Assets: $0, Liabilities: $600 billion (as the rise in interest rates caused the value of those long-term bonds to drop to zero), SVB crashed.
Friedman stated: “The discussions of the ‘social responsibilities of business’ are notable for their analytical looseness and lack of rigor. What does it mean to say that ‘business’ has responsibilities? Only people have responsibilities. A corporation is an artificial person. In this sense it may have artificial responsibilities, but ‘business’ as a whole cannot be said to have responsibilities, even in this vague sense. The first step toward clarity in examining the doctrine of the social responsibility of business is to ask precisely what it implies for whom.”
In other words, does corporate responsibility mean that a corporation should lower its prices so that more people can afford its products?
Does corporate responsibility mean that a corporation should increase the cost of the product (or take a loss) so that less pollution will be generated during manufacturing?
Friedman also stated: “The corporate executive would be spending someone else’s money for a general social interest. Insofar as his actions in accord with his ‘social responsibility’ reduce returns to stockholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customer’s money. Insofar as his actions lower the wages of some employees, he is spending their money.”
Friedman wrote: “This process raises political questions on two levels: principle and consequences. On the level of political principle, the imposition of taxes and the expenditures of tax processes are governmental functions. We have established elaborate constitutional, parliamentary and judicial provision to control these functions, to assure that taxes are imposed so far as possible in accordance with the preferences and desires of the public—after all, “taxation without representation” was one of the battle cries of the American Revolution.”
Friedman wrote: “This is the basic reason why the doctrine of ‘social responsibility’ involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce resources to alternative uses. ... And whether he wants to or not, can he [or she, a corporate CEO] get away with spending stockholders’, customers’ or employees’ money? Will not the stockholders fire him? (Either the present ones or those who take over when his actions in the name of social responsibility have reduced the corporation’s profits and the price of its stock.)”
That was Silicon Valley Bank. Contributing to the bank’s communal mindset, shareholders and management were distracted. Shareholders lost everything. Depositors should have. Bailed out by American socialism, perhaps all banks should be nationalized. Perhaps Marx is correct; if citizens owned the means of production, and workers retained profits, like owners, they wouldn’t be so reckless with the money. Hey, let’s try it! Citizens, you can have SVB; it’s yours!
Would worker unions agree?
Friedman stated: “If union officials try to enforce wage restraint, the consequence is likely to be wildcat strikes, rank-and-file revolts and the emergence of strong competitors for their jobs. We thus have the ironic phenomenon that union leaders—at least in the U.S.—have objected to Government interference with the market far more consistently and courageously than have business leaders. … Those who favor the taxes and expenditures in question have failed to persuade a majority of their fellow citizens to be of like mind. They are seeking to attain by undemocratic procedures what they cannot attain by democratic procedures.”
The very reasoning behind socialist revolutions: The masses will never understand. “Elites,” students of communism who know in their hearts they are so far ahead of the masses that they cannot wait for them to catch up, must, therefore, take action. In the 20th century, the 100 million murdered for that socialist vision, fascism from the right, communism from the left, might not agree.
If workers were in charge—stagehands who traded places with the orchestra—would they have made SVB’s mistakes? For example, would workers have turned down those “huge” depositor accounts (more than any other regional bank), considering that if things went wrong there would be “huge” depositor withdrawals?
SVB didn’t even have a risk officer. No risk management, no hedge. Where was the Fed? Actually, the Fed did notice but didn’t do anything. Those stagehands would have?
Perhaps SVB made the mistake Credit Suisse made (one reason it folded). As Zion’s Bank did in the United States during the 2008 financial crisis, Credit Suisse created an instrument that allowed it to count bonds as meeting capital requirements—because at any time those bonds could be written off and converted into equity (seemingly a cash purchase of stock).
Such jumping of sides on its balance sheet allowed the bank to never look like it was failing. Where was the Fed? According to Tabby Kinder and Antoine Gara in the Financial Times article cited below, SVB’s management was constantly scheming, constantly hiring consultants to do so, like Enron.
Why, then, weren’t large depositors inspecting SVB’s financial statements? (For a business rather than academic analysis of the 2008 financial crisis, read “Rome 476, David Parker Essays, Volume 3.”)
Kinder and Gara wrote in the Financial Times this year: “[SVB] is a west coast bank that operates at the heart of innovation. Empathetic and dependent on relationships, it is not cut-throat like Goldman Sachs.”
Perfect. As west coast liberals “progressed” from the fundamental principles of our Founding Fathers, west coast bankers “progressed” from the fundamental principles of money and banking. Listening to TED Talk gurus, asking others to influence strategy, governance, and culture (which worked for a while as like-minded investors clamored to buy stock in a company they were proud to own), SVB found that its value rose to $44 billion. Yet that over-priced regional bank, playing out of its league, complacent about risk, didn’t hedge its position in the bond market.
What about First Republic Bank, a San Francisco bank turned regional? Beware the hype. In 1985, the bank was a finance company. It borrowed from financial markets and then lent recklessly. The funds didn’t belong to depositors.
By 2007, in anticipation of the 2008 financial crisis and about to fail, First Republic was purchased by Merrill Lynch. Then Merrill Lynch failed.
Jim Herbert, founder, chairman, and CEO of First Republic Bank, wrote: “How did we achieve this level of success? We did this by following our entrepreneurial instincts, which has worked time and again.”
Except when it didn’t work. Did First Republic really change? With the collapse of Merrill Lynch, First Republic in 2010 bought itself back, this time to operate more conservatively—only loaning depositor money.
Why, then, with the collapse of SVB, did First Republic’s stock price collapse? According to one employee, it was bad luck. The media was too quick to associate First Republic with Silicon Valley and Signature Bank, when in fact First Republic’s assets were diversified: no cryptocurrencies, few venture capital loans, deposits not tied to long-term bonds.
But because the media grouped First Republic with SVB, depositors pulled their money. First Republic’s stock price dropped from $170 to $12 a share. Chase and other big banks rushed in to loan it $30 billion. Was the bank solid enough for such an injection? Forty-five days after the drop, First Republic’s share price was still $12.
Herbert wrote, “There are no businesses, only people.”
Was that employee’s statement true, that First Republic was not loaning money to startups? Herbert wrote that his partner, Katherine August-deWilde, specialized in startups, and in 2012, Mike Selfridge, chief banking officer, was hired away from SVB.
“There are no businesses, only people” is only true at the top. At the top there is vision, persistence, and entrepreneurial instinct. First Republic says that entrepreneurialism is its culture, that it looks for and trains employees to operate that way, except that, by definition, an employee is not an entrepreneur.
Caveat emptor!
Forty-eight days after the drop, The New York Times reported “First Republic’s Stock Experiences 50% Drop after Refusal of Queries.”
No one is talking. The market, guessing something’s wrong, had no option but to lower the stock’s value. The New York Stock Exchange halted trading.
Fifty days after the drop, the stock dropped another 50 percent to close at $3.51 a share. It seems that First Republic Bank operated exactly like SVB. It bet on interest rates remaining low forever.
