Friday, July 11, 2008

Propping Up the Banks

You nearly always find, when a bank fails, that its balance sheet was worse than it looked. But in the report of tonight’s failure of IndyMac Bank, statements by federal regulators suggest that the bank was not in any condition to be operating.

The key statement to look at is the assertion that it was the withdrawal in the past two weeks of $1.3 billion in deposits that led to the bank’s collapse. Regulators called this a “liquidity crisis,” meaning a run on the bank.

But for a bank with assets of $32 billion, the loss of $1 billion in deposits is an occasion for overnight borrowing from other banks, or possibly for emergency borrowing from the central bank, but not for the forced shutdown of the bank. Only a bank that is living on the edge, or somewhat beyond it, would be brought down by a run on that scale.

Based on that and other statements, and the fact that they waited till after the Friday evening television news for this shutdown, it is probably safe to assume that IndyMac really should have been shut down a few months ago. The regulators, I have to assume, put off the inevitable shutdown — propping up IndyMac and quite possibly burning through another billion or so in government money in the process — because they were afraid that the closure of one major U.S. bank would lead depositors to worry about the 30 or so other major U.S. banks that are known to be in trouble, possibly contributing to a run on one or more of those banks.

But now that the cat is out of the bag, the regulators will not be so hesitant to shut down the next bank that goes under. They don’t have the capacity to prop up all the major banks that are facing serious problems, and now that one massive bank failure is in the news, there will not be much shock value in the next one. The FDIC, which insures U.S. bank deposits and which is now in the awkward position of operating IndyMac, brought dozens of analysts out of retirement to prepare for what could be a cascade of bank failures this year. Unless a miracle occurs to restore all the other banks to sound financial footing, they will not be sitting idle.

In the event that your bank fails, there is a risk, however slight, that you might not have access to any of your accounts for a short period of time. This makes it all the more important not to be living on the edge financially yourself. Make sure you can get by for at least a week or two without your primary bank. For most people, this just means holding credit cards from at least two different banks (and having a balance that is less than 25 percent of the credit limit on each card).

Deposit insurance covers typically only $100,000 per account holder, not per account, in each bank, so it is not entirely safe even in the best of times to have more than that in any one bank. If you need to have more than $100,000 in the bank, it is important, as I have written previously, to have it in multiple banks.