Friday, January 30, 2009

This Week in Bank Failures

I don’t think bank executives have any idea how little esteem the public holds for their banks. It’s not just that people suspect that banks may somehow be responsible for causing a depression (by the way, there isn’t a depression, and probably isn’t going to be one, but in polls last year, most people thought there was or would be one). People just really don’t like dealing with their banks. If there were a way to not have to ever go to a bank any more, people would want to hear about it. I learned about this as I was trying to explain the “bad bank” concept to people this week. It went something like this:

— What do you mean, a “bad bank”?

— Well, the way I understand it, the federal banking regulators would divide up the assets of a bank. The bank would keep the “good” assets, the home loans and auto loans that people are actually making payments on, and the government would take away the “bad” assets, the mortgages that are in default and so on, and put them in another bank, which they’re calling a “bad bank.” And then, in theory, you leave the bank with just “good” assets, so it can keep operating and not go bankrupt. So then you have what they call the “good bank,” with the good assets, and the “bad bank,” with the bad assets, which the government would be stuck with, and they would have to keep pouring money into it because of all the problems with the bad assets. And if they were really going to do this across the whole banking industry, it would take about 13 trillion dollars, an amount of money that no one has, so it isn’t actually going to happen, at least not on the scale that people are talking about on Wall Street today.

— Would this “bad bank” have checking accounts?

— Well, yes, it would have to, it would have to do all the things that a bank does, but that’s not really the idea.

— But could I go to the “bad bank” with my paycheck and open a checking account?

— The “bad bank” wouldn’t have branches, so you couldn’t just go into an office and open an account, but if you knew someone, and could get your hands on the right forms, I suppose it’s possible . . .

— Well, then, why keep the “good bank”? Isn’t the “good bank” run by the same people who screwed up the bank in the first place? Why not just shut down the “good bank” and we can all go to the “bad bank”?

— I suppose that’s possible, but that would mean the government was running the banking system. Some of the people in Washington would consider that communist, and they would go to great lengths to avoid having things come out that way.

— Whatever. Just imagine how much simpler things would be that way. A “bad bank” wouldn’t ever do anything for you, but it wouldn’t be trying to cheat you either. You know, it wouldn’t change your interest rate for no reason, or cancel your credit card and not tell you.

— Um . . . you might have a lower credit limit, though . . .

— Oh, I know, but I shouldn’t be using my credit card so much anyway.

In other words, many people out there who have only a superficial understanding of banking think that the banks are the problem, and that replacing the banks is the solution. Sort of like in football, after your kicker misses five field goals in a row, you take him out and put in someone else who might do better. I have to admit, this take on the “bad bank” concept hadn’t occurred to me, yet the fact that people are asking about the possibility of a government-run bank tells you how badly the banking industry is doing. That is to say, in their fight to survive, banks are burning a lot of bridges.

To appreciate how bad this is, imagine it this way: The Bureau of Furniture Management is bailing out the furniture industry by taking all the “bad” furniture, including the sofas and tables that couldn’t be assembled correctly when they got to the stores. It collects them at a “bad furniture warehouse.” People come in droves to buy the “bad furniture.” “We’ll never have to go back to our old furniture store again!” they say. Of course, that could never happen. It could never happen in furniture, that is, because people like their furniture stores a whole lot more than they like their banks.

Okay, what this means, after a deep breath . . . to quantify the degree to which customers are unhappy, a bank can ask them whether they would prefer banking at the existing bank, or at a hypothetical new bank. This is a conventional measure of customer loyalty that marketing experts use. If customers show more than the slightest level of interest in a hypothetical competitor that doesn’t actually exist, it usually means your business is in trouble. More than a few banks would fail this test right now. This puts more pressure on the banks. After they survive the financial crisis, they have to keep enough customers to survive the economic expansion that follows. When consumers get to freely choose their banks again, why would they choose your bank? It’s a question that may make bank executives gulp, after they finally get around to asking it.

There were more complaints this week about the way banks are using bailout money, and some of the complaints focus on the business of drugs. Instead of making loans that might help the economy, bailed-out U.S. banks are providing nearly $20 billion in financing for this week’s massive pharmaceutical takeover in which Pfizer is buying Wyeth. Far from creating jobs or getting the economy moving, that deal will eliminate jobs and facilitate the slow-motion disintegration that both companies have been participating in for about a decade. Pfizer announced 8,000 layoffs at the same time that it announced the acquisition, and it is widely assumed that a greater number of jobs will be cut, and whole facilities shut down, after the deal closes. On top of all that, the banks consider the Pfizer deal a high-risk loan, yet they were reportedly lining up to participate.

The New York State attorney general is investigating $4 billion in bonuses paid by the now-defunct Merrill Lynch in December at the same time that Bank of America was seeking an additional $20 billion in bailout money in order to complete the Merrill Lynch deal. If the investigation finds that the bonus payments were irregular, the attorney general may ask the recipients to refund the money. The investigation is also expanding to see whether financial information was improperly withheld from stockholders.

Huffington Post is trying to find out whether bailout money may have been used to fund political campaigns. It focused first on a campaign involving Bank of America and AIG last fall that sought to influence legislative decisions on union organizing, but expanded to ask whether there was a conspiracy to funnel bailout money to any particular political organization. The timing and structure of the Wall Street bailout, as a slush fund with only token oversight set up just as a national election was taking place, raised concerns about this prospect from the outset, but Huffington Post is also concerned about other bailout funds coming from the Fed, Treasury, and FDIC.

The FDIC will make payments by check to depositors at MagnetBank of Salt Lake City. Usually when a bank is closed, the FDIC turns its accounts over to another bank, which keeps the offices running for at least a few weeks. This also saves the FDIC a mountain of administrative work, and it saves account holders from having to send new checks to replace the rent and utility checks that were not paid by their bank before it closed. The FDIC tried to find a bank to take over the deposits of MagnetBank, but there were no takers, so it is forced to make insurance payments directly to the depositors. The checks, for more than $250 million, will be mailed out starting Monday morning.

MagnetBank was apparently well managed but poorly positioned. It launched in late 2005 and was officially headquartered in Utah, but operated mainly from its office in Atlanta, at first concentrating on buying shares in other banks’ larger real estate loans. After getting its feet wet during the two worst years ever for real estate lending, it could not find a way to recover. A management shakeup, change in business model, and layoffs 11 months ago were probably too late to make any difference.

Two other small east coast banks closed in a more conventional way tonight. Deposits at Ocala National Bank in Florida and Suburban Federal Savings Bank in Maryland were transferred to other banks.

Ocala National Bank had four offices, all in Ocala, a small city in north central Florida, about an hour north of Orlando. It is an area that, like most of Florida, has especially high unemployment and a resulting high rate of home foreclosures. Its deposits have been taken over by CenterState Bank. CenterState is itself a relatively small bank, with 12 offices in the area between Orlando and Tampa. In addition to paying a premium of 1.7 percent for the deposits, CenterState is buying about a tenth of Ocala National Bank’s assets. The FDIC will sell off the remaining assets later and expects to bear a cost of nearly $100 million.

Suburban Federal Savings Bank was based in Crofton, Maryland, and had seven offices in the suburban center of Maryland between Baltimore and Washington. It had sought to expand its mortgage lending in 2005. That was bad timing, of course, leading to high loan losses. The bank had so many bad real estate loans that since March it has been operating under an order preventing it from writing most kinds of real estate loans It had been looking for a buyer for months, but was unable to find one.

Its deposits have been transferred to Bank of Essex, a small bank located across the Potomac River in Virginia. Bank of Essex had also acquired the deposits of a failed bank in Georgia two months ago. The shutdown may cost the FDIC around $125 million. That is an unusually high amount for such a small bank, probably indicating that the FDIC had been holding off, hoping Suburban Federal Savings Bank would be able to find a buyer on its own.