Major Questions and Moral Hazards: A Tale of Two “Bailouts”

Written By: Henry DuBeau

The federal government’s response to the COVID-19 pandemic has renewed questions about the use of emergency economic powers. When has the executive branch exceeded its authority? And who is more deserving of assistance?

Three weeks ago, the Supreme Court heard arguments in two cases challenging President Biden’s student loan relief program. After a two-and-a-half-year hiatus on federal loan payments due to the pandemic, Biden sought to cancel up to $20,000 in debt for individual borrowers making less than $125,000 per year. The Congressional Budget Office estimates that doing so would cost the government about $400 billion.

Lawyers for the government encountered a hostile bench. To convey their skepticism, some justices invoked the “major questions doctrine,” which requires executive branch agencies to point to clear congressional authorization when acting on issues of major economic and political significance. “We’re talking about half a trillion dollars and 43 million Americans,” expressed Chief Justice Roberts. If the Biden administration prevails, it will likely do so on questions of plaintiffs’ standing to sue and not the merits of case.

The very next week, the second- and third-largest bank failures in American history occurred—Silicon Valley Bank (“SVB”) and Signature Bank, respectively. Citing “systemic risk” to the economy, the Federal Reserve, the FDIC, and the Treasury Department together intervened in a matter of days to guarantee deposits amidst a bank run. Ordinarily, the FDIC insures deposits up to $250,000, and depositors assume the risk for amounts above that. But 94% of SVB’s deposits were uninsured, as were 89% of Signature’s. The banks’ primary clients were businesses, namely venture capital firms and tech startups.

Critics of the intervention decry it as a “moral hazard,” a phenomenon in economics where an actor is incentivized to engage in increasingly risky behavior because they will be protected from the negative consequences of their actions. Naturally, they saw the government’s actions as an extension of the two stimulus bills passed during the 2008 financial crisis. As Washington Post columnist George Will described it, “Here comes capitalism without risk: profits private, losses socialized.”

Given the juxtaposition of these events, some have been quick to identify a double standard. “[I]t’s no wonder,” Senator Elizabeth Warren wrote for the New York Times, “the American people are skeptical of a system that holds millions of struggling student loan borrowers in limbo but steps in overnight to ensure that billion-dollar crypto firms won’t lose a dime in deposits.”

In both instances, the executive branch relied on emergency powers granted by Congress. For student loan relief, President Biden sought to cancel debt through the 2003 “HEROES” Act. Section 2 of the Act allows the Secretary of Education to “waive or modify” any provision related to financial assistance programs “in connection with a war or other military operation or national emergency.” (Some justices questioned whether “waive or modify” included the ability to “cancel” debt.)

And as for SVB and Signature Bank, the Treasury Department cited the “systemic risk” exception contained in the FDIC Improvement Act of 1991. Ordinarily, the FDIC must use the least costly option to wind up insolvent banks. But if compliance with the least-cost rule would have greater adverse effects to the economy, the FDIC may use costlier options—such as exceeding the regular insurance threshold. This designation requires the approval of two-thirds of the Fed’s Board of Governors, two-thirds of the FDIC’s board, and the Treasury Department in consultation with the president.

Whether these interventions are truly “bailouts” is largely a matter of semantics. The word has no formal definition, and the concept is more easily identified by its ends—avoiding the negative consequences of a business’s potential downfall—than its means. The menu of options available to the government includes loans, asset purchases, and cash infusions. These are usually conditioned on changes in management, corporate restructuring, and increased oversight measures.

In public remarks, President Biden and Treasury Secretary Janet Yellen have stressed that the deposit guarantees do not constitute a bailout because they were not funded with taxpayer dollars (as was the case in 2008 and 2009). The FDIC’s deposit insurance fund is funded by assessments on banks and through government bonds. Moreover, they emphasized that the guarantee was meant to protect depositors, not the banks or their shareholders. Indeed, stocks in mid-size regional lenders dropped to a three-year low.

But depositors—including many tech, venture capital, and crypto firms—are being made whole for a substantial risk that could have been avoided. And the costs of assessments may be passed on to bank customers through increased fees and lower interest rates. Additionally, to shore up the Fed’s new low-interest lending program, the Treasury Department announced a $25 billion backstop (i.e., taxpayer money) to cover any losses incurred by the Fed.

For student loan borrowers, President Biden is not providing them cash but canceling debt they already owe. The taxpayer dollars used by the Department of Education have already been disbursed. To the extent that student loan forgiveness represents a taxpayer burden, it is in the form of decreased income to the government over time, money that can be raised elsewhere.

Still, critics of student loan forgiveness contend that the program contributes to wealth inequality. College enrollment is disproportionately comprised of students from wealthier families, and 65% of student debt is held by individuals with incomes higher than the national average. Furthermore, canceling student debt will do nothing to address the underlying problem of the skyrocketing costs of higher education.

Of course, we don’t yet know how the Supreme Court will rule on debt relief. But in both cases, the emergency use of federal funds by the president raises separation-of-powers concerns. For that matter, the Fed and the FDIC may be in for their own comeuppance from the court. Recently, the justices agreed to hear a challenge to the funding structure of the Consumer Financial Protection Bureau which draws its funds from the Fed instead of congressional appropriations. Should the court hold the agency’s funding structure unconstitutional, the Fed and the FDIC would surely become collateral damage to the decision, and the ability of these agencies to respond to economic emergencies without clear congressional authority would be significantly curtailed.


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