banking calm before the storm?

[Jim Devine <jdevine03@xxxxxxxxx>]

moneybox/WaPo's SLATE

Why Don't Banks Fail Anymore?
Is it the strong economy? Better regulation? Luck?

By Daniel Gross
Posted Monday, March 27, 2006, at 4:48 PM ET

The Federal Deposit Insurance Corp. is the Joe DiMaggio of federal
regulators: It's got a tremendous streak going. Yesterday marked the
639th day without a bank failure, the longest run in the institution's
history. (The prior record, 609 days, ended in 1946, the year the best
film about a busted bank, It's a Wonderful Life, premiered.) And 2005
was the first calendar year since the FDIC's inception, in 1934, in
which no banks failed. Meanwhile, in February, President Bush signed
legislation that, for the first time since 1980, would raise the cap
on insured deposits. Are these signs that the vast banking industry
has reached a new plateau of permanent prosperity and competency? Or
is it the calm before the storm?

The FDIC was one of those awful, socialistic, anti-capitalistic,
doomed-for-failure New Deal projects that has, in fact, contributed
enormously to the nation's well-being. "No depositor has lost a single
cent of FDIC-insured funds as a result of a failure," as the FDIC
proudly notes. And it certainly hasn't inhibited the banking industry
from growing.

U.S. banks endured the wretched period between 1980 and 1993, in which
2,500 banks and savings institutions were swept away. FDIC Chief
Economist Richard Brown says 1980-93 was "a 100-year flood" for
banking. Deregulation in the '70s and '80s led to massive industry
expansion without a concomitant rise in risk-management capabilities.
And rolling regional problems—woes in the farm belt and New England,
manufacturing recessions in the Midwest, real estate speculation on
the coasts, and the savings and loan crisis in the Sun Belt—produced
gigantic failures. The wave peaked in 1991, when 124 banks with $53.75
billion in assets failed. Brown notes that the failure rate had less
to do with the national business cycle than with poor decision-making,
incompetence, local problems, and fraud.

But the industry learned its lessons. The combination of government
oversight, competitive pressures, and improved risk-management has
massively reduced the chances of large-scale bank failures. (See the
chart on Page 107 of the FDIC's annual report.) Since 1997, only 36
banks with combined assets of about $5.15 billion have failed. (The
last failure came on June 25, 2004, when the Bank of Ephraim in
Ephraim, Utah, with $45.2 million in deposits, went under.) What's
happened in the last decade? Banks have gotten larger and more
sophisticated at managing risk. According to the FDIC, today about 92
percent of the nation's banks score sufficiently high on measures of
capital and supervisory risk that they don't have to pay any insurance
premiums at all. The process of securitization allows banks to
distribute risks from local loans to financial institutions around the
world. In addition, many weak banks are acquired today before they
have the opportunity to fail.

Perhaps most important, the economic environment of the last
decade—healthy economic growth, low interest rates, and low
inflation—has been nirvana for bankers. Back in the early 1980s, with
inflation rampant, savings and loans were stuck holding 30-year
mortgages that yielded only 7 percent while they had to pay
double-digit interest rates on short-term deposits. "Under the recent
economic conditions, it's been difficult to fail," said Brown.

Indeed, it's possible that the estimated $3.9 trillion in insured
deposits at U.S. banks have never been safer. And so the decision to
boost the cap on insured deposits, which President Bush signed into
law in February, seems unobjectionable. After all, $100,000 in 1980 is
worth nowhere near $100,000 today. (Here are summaries of the Federal
Deposit Insurance Reform Act from the American Bankers Association and
from the FDIC.) In brief, the legislation raised the roof on insured
deposits in retirement accounts by 150 percent, from $100,000 to
$250,000. The cap on insured deposits in nonretirement accounts
remains at $100,000, although the cap could be adjusted for inflation
starting in 2011. (Under current practice, as the FDIC notes, the
$100,000-per-account cap is something of a misnomer. A couple can have
up to $1.1 million in deposits insured in a single institution if they
reside in different types of accounts: individual accounts, joint
accounts, trust accounts, etc.)

And yet. Observers of financial meltdowns have long noted that things
seem calmest and most risk-free just before disaster. The last time
the insurance cap was raised by 150 percent—in 1980, from $40,000 to
$100,000—it helped set off the S&L boom, and subsequent bust, which
wound up costing taxpayers hundreds of billions of dollars.

And there are some clouds on the banking horizon. While loan
delinquencies are very low by historical standards, the FDIC's Brown
notes that small banks are very active in commercial real estate and
commercial lending. "Construction and development lending last year
rose 33 percent for FDIC-insured institutions, the fastest since
1986," he said. Also, he notes, some failures in recent years stemmed
from problems in subprime loans. Now—in a situation where interest
rates are trending upward, the housing market is rolling over, and
subprime borrowers are generally under financial stress—that may add
up to some problems. "The immediate outlook is pretty good," said
Brown. "Longer term, there will be more bank failures; credit will
deteriorate from where it is."

But for now, the streak is still intact—when the sun sets tonight, it
will be 640 days and counting. For bankers, it's still a wonderful
life.

Daniel Gross (www.danielgross.net) writes Slate's "Moneybox" column.
You can e-mail him at moneybox@xxxxxxxxxx

Article URL: http://www.slate.com/id/2138752/

Copyright 2006 Washingtonpost.Newsweek Interactive Co. LLC

[since the government stands behind the FDIC, I don't see it failing.]
--
Jim Devine / "There can be no real individual freedom in the presence
of economic insecurity." -- Chester Bowles