When Bailing Out Failing Banks, America Goes Into Risky Business
From 1943 to 1981, fewer than 10 banks per year failed in the United States. In 1986, 138 banks failed; in 1987, 184, and we are headed for a similar number in 1988.
The last was the most expensive. First RepublicBank Corp. of Texas, with $26.9 billion of assets, was declared insolvent two weeks ago and, in a daring gamble, the North Carolina National Bank, with help from the Federal Deposit Insurance Corp., will try to build a healthy bank out of the remains. (First RepublicBank of Texas is not related to San Francisco’s First Republic Bancorp.)
In one sense, the news from Texas is good. The system is working. Federal bank regulators saw the problem coming and arranged an orderly transfer of the failed bank’s assets. The change was almost invisible to depositors, who were able to carry on business as usual. There were no long lines of frantic customers; no one lost life savings; a wave of panic did not spread through the Texas financial system. So much for the good news.
There is much more bad news.
First, the cost of the bailout: ultimately, $4 billion or more out of an FDIC reserve fund of about $20 billion. A few more rescue operations like this and the FDIC will be as broke as its cousin, the Federal Savings and Loan Insurance Corp., the insolvent agency responsible for insuring deposits at the nation’s troubled savings and loans. In a week of wild talk in Washington, consultants, congressmen, industry representatives and Treasury officials have estimated the deficit facing federal deposit insurance agencies at anywhere from $30 billion to $100 billion.
Only the most optimistic believe that these losses can be covered without help from the government--read taxpayers. This overhang of debt makes a mockery of any plans to balance the federal budget any time soon.
Second, the timing: The United States has enjoyed almost seven years of economic expansion since the end of the last recession. It is not a good sign when U.S. banks fail so frequently at this stage in the business cycle. Admittedly, the current banking crisis is largely limited to a handful of states with economies based on energy and agriculture, but this is no reason for the rest of us to be complacent. A national recession won’t strengthen the economies of Texas, Louisiana and Oklahoma, but it will undermine banks in the rest of the country.
Third, the moral: The financial system has still not come to grips with the effects of deregulation. When the New Deal system of deposit insurance was established, banks and thrifts were kept on a tight leash. Since government was ultimately responsible for insuring their funds, government expected to exert some control on the interest rates paid and the types of risks taken.
These controls were lifted in the 1970s and early 1980s, for reasons that looked good at the time: Volatile interest and inflation rates made controls both unwieldy and unpopular, while competition from unregulated financial institutions--including stockbrokers and money-market funds--was eating into the banks’ business.
Unfortunately, many bankers and savings-and-loan executives abused their new freedom, to make loans that ranged from the imprudent to the illegal. This, combined with the increasing and unpredictable price swings in the value of goods, from oil and farm commodities to stocks and precious metals, stuck the domestic banking business on the horns of a nasty dilemma. Will the prudent, responsible lenders who were cautious (or lucky) in recent years have to pay significantly higher premiums for deposit insurance to cover the costs of bailing out their errant brethren? The sums involved are so large that the higher premiums would undermine the condition of some currently healthy institutions and cut into profits for years to come. This hardly seems fair to the “good” banks and thrifts, but the principal alternative--a taxpayer bailout--is also not so attractive.
Meanwhile, regulators limp along, short of money and short of options. The FSLIC in particular has been struggling with a nasty problem. It currently does not have enough money to pay off the depositors in all of the insolvent savings and loans in the country, and so it permits these “brain dead” institutions to go on accepting deposits and making loans--and losing more money--which makes final resolution harder. The $10-billion federally assisted bailout is not enough to close the gap; $5 billion to $10 billion more will be needed simply to permit closing down insolvent institutions.
U.S. banks have not had a good decade. Ten years ago, Bank of America was the largest in the world, with Citicorp second. Now both banks have been overtaken by the Japanese and Europeans. Here and abroad, U.S. banks face vigorous competition from Japanese firms hoping to accomplish in banking what Honda did in automobiles. Third World loan losses--many by banks that continue to throw good money after bad in the Micawberesque hope that something will turn up--continue to keep investors and lenders wary. Markets have so little faith in banks that in some cases blue-chip industrial companies, once the core clients for large banks’ services, can borrow money more cheaply than banks themselves.
For 55 years, the FDIC and FSLIC have insured the nation’s deposits in banks and thrifts; in all that time, no American depositor has ever lost one nickel of an insured bank deposit. Few government programs have ever benefited so many at so little cost. The challenge facing bankers, Congress and the deposit insurance agencies today is to maintain the integrity of this system under distinctly adverse conditions.
“No easy answers, no pain-free solutions.” This is the message from Texas, a message Americans are likely to hear repeated as more and more festering problems within the financial service industry come to light.
