Fed Expands its Span of Control over U.S. Banks

“First Republic Seized, Sold to JPMorgan,” reads the headline on page A1 of May 2’s Wall Street Journal. First Republic’s collapse—the second largest bank failure in U.S. history, according to the story’s authors, Rachel Louise Ensign and Ben Eisen—quickly lost half of its deposits ($100 billion) in the wake of the unraveling of Silicon Valley Bank (SVB) in March.

JPMorgan Chase is by far the largest American bank, booking about $2.3 trillion in deposits, more than 10 percent of the national total (see “Deal Fuels Concern over Size of Banks,” Wall Street Journal, May 3, 2023, p. A1). Bank of America is #2, with deposits in the neighborhood of $1.8 trillion (nice neighborhood!). First Republic is smaller, but still big enough to rank amongst the nation’s 20 largest financial institutions just prior to its failure. First Republic seems to have been done in by the same forces that precipitated SVB’s ruin: steady increases in interest rates overseen by the Federal Reserve, which, as every ECON 101 student should know, cause the prices of bonds, treasury securities, and other fixed-income assets on bank balance sheets (like mortgages) to go South.

The Federal Deposit Insurance Corp. (FDIC), whose funds will be depleted by $13 billion to cover the losses of insured and uninsured First Republic depositors alike and will be on the hook for a $50 billion loan to JPMorgan, midwifed the deal. This week’s chain of events is eerily like those that played out in Morgan’s 2008 purchase of Washington Mutual, still history’s largest U.S. bank failure.

Sense a pattern here? I do. Since at least the Great Depression, which witnessed the bankruptcy of thousands of small banks nationwide, the Federal Reserve System has been expanding its regulatory control of America’s financial institutions inexorably. State-chartered banks have been displaced by federally chartered national banks; small community banks have been forced out of business or thrust into the arms of their larger rivals by the costs of complying with one-size-fits-all rules to detect and deter money-laundering by globe-spanning drug cartels and terrorist organizations.

The result is a steady consolidation of the financial services industry into fewer and larger institutions, with a narrowing of choices for banking customers. Moreover, the FDIC’s guaranteeing of deposits more than its $250,000 limit per account magnifies deposit insurance’s moral hazard effects. Additonal risk-taking by bank managers is predictable if investment losses are socialized, while prospective gains are privatized (captured by the institution’s owners). 

If JPMorgan Chase had proposed to purchase a financially sound First Republic in a private transaction before the latter’s deluge, the merger almost surely would have triggered an antitrust law challenge by the U.S. Department of Justice. (The FDIC apparently rejected bids for First Republic by three smaller banks; only JPMorgan had the wherewithal to absorb First Republic lock, stock, and barrel.) Treating First Republic Bank as “Too Big to Fail” has many unfortunate consequences, the most worrisome of which is making banks like JPMorgan even bigger, thus perpetuating a vicious cycle of consolidation and ever-growing bureaucratic control of financial markets by the Federal Reserve.

In a workably competitive marketplace—the heavily regulated financial services industry is far from that mark—the freedom to fail is as important as the freedom to succeed. The FDIC’s announcement at 4 a.m. on May Day that First Republic would be rescued by JPMorgan Chase is proof, if more were needed, that crony capitalism, the very antithesis of a liberal market order, is alive and well in the U.S. economy.