Boston Bank Failure Eerily Similar to Texas Debacle

What once was known as the Massachusetts economic miracle is turning into what many banking experts believe is a Texas-style financial debacle.

Although widely expected, the sudden seizure by federal regulators Sunday of the three major banks that are part of Boston’s Bank of New England--the third-largest bank failure ever--has sent a sobering chill through the industry and has raised broader questions about the fragility of the nation’s banks in a sliding economy.

Of immediate special concern is the health of other banks in New England and the New York-New Jersey region, both areas where institutions bet heavily on real estate projects that have gone bad. Of longer-range concern is whether the problems sparked by plummeting real estate values will hit Western banks as hard.

“We do know the economy is very weak. We are in a recession by all accounts, and banks are going to fail,” said James Barth, a former government savings and loan and banking expert who now teaches at Auburn University.

Many banking experts say they do not expect the Bank of New England failure to trigger a domino effect. They say that Bank of New England was especially sick and that its problems, such as its high concentration of poor quality real estate loans, were well known.

Since 1983, Bank of New England placed the biggest bet among area banks on the “Massachusetts Miracle,” the high technology and defense boom that helped propel former Gov. Michael S. Dukakis to the Democratic presidential nomination in 1988. Under former Chairman Walter J. Connolly, Bank of New England paid huge prices to acquire other banks, tied up one-third of its loans in risky real estate lending and wagered that the brakes would never be applied on New England’s economic boom.

Despite assurances by regulators that the nation’s banking system is sound, efforts to throw a life preserver to Bank of New England by finding a healthy bank to buy it are eerily reminiscent of what the government did in Texas in 1988 and 1989.

Battered by soft energy prices and real estate values, nine of the 10 largest banks in Texas failed in the late 1980s, forcing regulators to scramble to find healthy out-of-state institutions to bail them out. Two of those rescues--the $2.9-billion bailout of First RepublicBank Corp. in Dallas and the $2.7-billion rescue of MCorp in Dallas--remain the two biggest federal rescues ever.

“Everybody wants to draw the comparison (of New England) to Texas. In one respect, only time will tell, because you don’t know for sure how much softness in the economy there is,” Comptroller of the Currency Robert L. Clarke said in an interview. But, Clarke added, Bank of New England “shouldn’t be taken as representative of the condition of the rest of the system.”

The best known rescue, however, probably is still the 1984 rescue of Continental Illinois Bank in Chicago, which was hit by problem energy loans it acquired from the scandal-plagued Penn Square Bank in Oklahoma. That action, which came amid fears that the nation’s entire financial system was at risk, set a precedent for future government rescues.

Sunday’s action in New England shows also how severely banking confidence has deteriorated amid big losses in recent months, and how its erosion can even cause a bank to fail.

And, the Bank of New England failure has raised questions about why bankers don’t learn lessons every time the industry has a string of loan problems. In the early 1980s, for example, banks charged into foreign lending, and later suffered billions of dollars in losses. Next, banks flocked to make energy loans. After that, it was real estate.

The chain of events in New England began last Thursday, when Bank of New England’s chief executive, Lawrence K. Fish, traveled to Washington to deliver the bad news to Clarke and other bank regulators. Bank of New England’s losses, he said, were so steep that it would need government assistance.

Word leaked out, then the bank disclosed its problems in detail on Friday. Long lines snaked through bank branches Friday and Saturday as depositors rushed to pull out $1 billion in deposits, even though the government guarantees accounts up to $100,000.

Compounding the problem was the earlier closure of a savings bank in Massachusetts and bank and credit union closures in Rhode Island last week stemming from the failure of a private insurance fund that suffered when one of its member institutions failed after an alleged embezzlement. Customers lined up at banks and credit unions, causing a panic in the area and uneasiness across the country.

Clarke, who officially declared the Bank of New England insolvent, said that the growing nervousness among depositors led to Sunday’s action.

“People said, ‘I’m not sure I understand all of this, but I want my money. I’ll worry about understanding it later,’ ” Clarke said.

Regulators, concerned about the impact of the bank closure on the fragile New England economy, took the controversial step of guaranteeing about $2 billion in deposits not covered under the government’s $100,000-per-account limit.

Much of the mess Bank of New England found itself in was caused by the steep slide in New England’s economy that started in 1989. Defense and high technology work slowed, compounded by overbuilding based on overly optimistic economic predictions. Bank of New England was especially vulnerable, having grown from a sleepy bank in 1983 to one of the most aggressive in the area.

It outbid Rhode Island regional giant Fleet/Norstar for the Conifer group in Worcester, Mass., for example, paying a huge 3.5 times the bank’s book value, or net worth.

Sloppy loan practices became apparent when a Chicago businessman, William Stoecker, defaulted on $65 million in loans in 1986. It aggressively pushed home equity loans, which are now looking riskier with the area’s residential real estate market softening.

But its main downfall was betting more heavily than any other bank on New England real estate, which for much of the 1980s seemed like a sure bet. About one-third of its loans were real estate-related, used to finance such projects as office and condominium developments.

“When the economy runs over you, that is more bad luck than (lack of) ability. But they made their own bad luck,” said James Hanbury, a banking analyst with Wertheim Schroder & Co. in New York.

Bank analysts and executives put the blame on Connolly, the former chairman, who made it clear that he wanted to run the biggest bank in the area. One government official, speaking on the condition that he not be identified, said the bank under Connolly was “right at the top of the hit parade” of mismanaged institutions.

The red ink soon became a flood. In December, 1989, the bank said its bad loans totaled a staggering $1.6 billion, an increase of $700 million from three months before. For all of 1989, the bank lost $1.1 billion as bad loans totaled $2.3 billion. Last week, the bank disclosed it would lose up to $450 million in the fourth quarter, with the total of bad loans rising to $3.3 billion. That wiped out its net worth for good.

The result for taxpayers will be a $2.3-billion bill. Regulators are trying to find a buyer for the solvent parts of the bank. The list of banks healthy enough to buy it is small, with Banc One in Columbus, Ohio, and BankAmerica in San Francisco at the top of the list of those that have expressed interest.

C. Todd Conover, former comptroller of the currency, said that Bank of New England was clearly one of the worst off because no one bet more heavily on real estate. Where the bottom is for other banks, he said, is uncertain.

“I don’t think we have solved the real estate risk management problem in this country. The banks and the insurance companies have significant exposure to real estate. The lending practices of a lot of institutions have been sub-par for quite some time,” Conover said.

Although many banks have ignored warnings to diversify their loans, some institutions do appear to have learned from mistakes. BankAmerica Corp., for example, came close to failing in the 1980s as it was hit by bad foreign loans and other problems. After a painful turnaround, the bank is now considered one of the nation’s strongest and best-run banks.

But many banks forget.

“It seems we have to relearn the lessons every generation or so. It seems bankers get burned in an area, and then they lay off, until you get a new generation . . . that has never been through it before,” William Isaac, former chairman of the Federal Deposit Insurance Corp., said.

Clarke, who has repeatedly warned bankers about having too many loans in one area of business, said bankers often kid themselves about the risks they take.

“It’s easy to convince yourself that your circumstances are different and that problems only happen to somebody else,” Clarke said.