Lower Oil Price Is a Mixed Blessing : Ripple Effect Will Sink Small Banks, May Spur Deregulation
Even as Washington policy councils debate whether to take advantage of OPEC’s collapse by imposing a tax on oil imports or gasoline, there are pressures building elsewhere in the economy that are the direct result of the upheaval in the oil industry. Some of these pressures are bound to merit congressional attention sooner or later. It would be wise for Congress to be aware of them in planning the legislative agenda for 1986.
Just as the oil price shocks of the 1970s had far-reaching effects that were felt throughout the economy, the recent fall in the price of oil will have its own ripple effects. The immediate impact of a $10-a-barrel drop in the market price is the savings that individual households will achieve on heating oil and gasoline--about 25 cents a gallon. While much of that savings is at the expense of American oil companies, the reduction in the cost of imported oil--about $20 billion a year, or $100 a person--is a pure gain for the country.
Households will feel secondary benefits as competitive pressures within the energy industry bring down the price of natural gas, coal and other oil substitutes. The net effect is the possibility of lower inflation and higher real growth than would have been possible without the fall in the price of imported oil.
The OPEC price collapse will have an even greater windfall effect in Europe and Japan. A strong economic resurgence abroad will help bring down the dollar smoothly and boost our export industries.
Of course, all these gains come at the expense of the oil-producing nations, particularly those like Mexico with its huge debt. But other debtor nations will benefit, not only from the price reduction in oil but also from the increased demand for their products as economic activity picks up in Europe, Japan and the United States. The major international banks should find that the improved prospects of the oil-importing debtors outweighs the added risks of increased credit to Mexico and the other oil-exporting debtor nations.
Managing the financial losses of smaller American banks will be more difficult. It’s just a matter of time before the sharp decline in oil prices has a serious adverse effect on the banking industry in states like Texas, Oklahoma and Louisiana. We’ve already seen this happen in some of the farming states, where the slump in agricultural prices has caused bank failures to skyrocket.
At current oil prices, many previously profitable wells and fields will go out of production. Losses and bankruptcies will result not only among small oil producers, but also among oil servicing and supplying companies, drilling-rig owners and even unrelated businesses and owners of real estate in the oil-producing areas. Small and medium-sized business loans tend to be with local banks and the oil-related loans represent a large fraction of the portfolios of small banks in the Southwest. Bank failures in those states will inevitably follow business bankruptcies.
Depositors, of course, are protected by agencies such as the Federal Deposit Insurance Corp. Nevertheless, a major run of bank failures could seriously strain the reserves of the agencies and force the Treasury to assume a more direct role.
These problems would not have arisen if we had a national banking system in which major banks had branches throughout the country. Losses on oil or farm loans would be balanced within a bank’s overall portfolio against gains that result elsewhere from the overall stronger economy.
The source of today’s potential banking instability is the direct result of legislation enacted by the states during the 1930s, explicitly prohibiting interstate banking. Among the major industrial nations, the United States is the only one that restricts the geographic scope of its major banks. The result is a system of 14,000 local banks that are very sensitive to problems affecting the local economy.
Reciprocal interstate arrangements that allow regional banking are becoming more common. But federal legislation to speed the process toward a national banking system is overdue.
The President has already indicated his support for further deregulation of the banking industry. Now the senators and representatives from the oil-producing states should get together and design banking reform that will ultimately offer the best protection for their region against the worst effects of the oil crash.
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