Friday, March 6, 2009

This Week in Bank Failures

Shutting down banks is a touchy subject. A Newsweek poll released this afternoon claimed, “A somewhat surprising majority (56 percent) supports nationalizing large banks at risk of failing.” What Newsweek didn’t mention is that even though they gave respondents a choice between only two alternatives, government taking control of failing banks or government providing financial support while banks stay privately managed, a full 11 percent of respondents volunteered that neither was appropriate or suggested another option, such as shutting down banks that failed. For an either-or survey to be explicitly rejected by 11 percent of respondents is remarkable, and if Newsweek had offered an orderly shutdown of failed banks as a third alternative, it is fair to guess that it would have been the popular choice.

And there is a reason for that. Putting money into a bank when there is little or no prospect of ever getting it out strikes most people, rightly or wrongly, as a misuse of money, a breach of the basic responsibility that you take on whenever you have money in your control.

Perhaps owing to the same line of thinking, it is getting harder and harder to find people to buy stock in major U.S. banks. With a shortage of buyers, the stock prices are falling. Citigroup, two years ago considered the most valuable bank in the world, saw its stock price fall to $1 yesterday, an 85 percent decline from the beginning of the year, leaving a company with $2 trillion in on-book liabilities with a market value of $5.5 billion.

The only major bank stock to get a boost this week was Wells Fargo, which jumped 15 percent this morning on the announcement that it was cutting its dividend to stockholders from $6 billion per year to less than $1 billion. But even that news interrupted the stock’s downward slide, down 71 percent year to date, for only an hour.

One reason the stock market has frustrated the experts this year is that they don’t see how much money was actually destroyed last year. When you look at the economy as a whole, one person’s monetary loss may be another person’s gain. But it is also possible for money to simply be destroyed, so that no one ends up with it. Stock market experts tend to think money is hiding out somewhere, waiting for a chance to return to the stock market, and that’s when the stock market will start going up again. That is what happened in past stock market routs. But much of the money that they think is “on the sidelines” (a Wall Street term for this kind of money) actually doesn’t exist anymore.

If the money will not be returning to Wall Street anytime soon, it is equally true that it will not be returning to the banks. And that is a greater concern because most of a bank’s activities can’t start until someone deposits money.

Where would we be without deposit insurance? We treat our bank deposits as money — “money in the bank” is the expression — yet we can do so only because the deposit insurance guarantees it. There is a problem with that, though. The Federal Deposit Insurance Corporation (FDIC) is running through its money quickly. A week ago it announced an emergency special assessment of 2 percent of all deposits as of June 30. This special assessment is essentially an admission by the FDIC that its recent insurance premiums, typically .12 to .14 percent annually, have been too low.

This special assessment is probably larger than it should be. It is large enough to wipe out most of a year’s income in the most carefully managed community banks, and some in the banking industry are trying to organize a protest to get the assessment overturned. But that could be a mistake. What if they succeeded, and the FDIC ran out of money around, say, September? If the FDIC were insolvent, money in the bank would no longer be “money in the bank” — in practical terms, it wouldn’t be money at all anymore, but merely a bank deposit that the depositor hopes can be converted back into money later.

If we got to that point, where people started to make a distinction between bank deposits and money, even the most carefully managed community banks would lose more than a year’s income. They would lose many of their depositors at a time when they can least afford to do so. They might even be forced to close their own doors without the FDIC there to help them do it — and with only the local police to help keep the rioting public at bay. That’s the way it used to work in the days before the FDIC, and it is not a pretty picture. So those in the banking industry who are asking the FDIC to let its reserves run out do not realize what they are asking for.

The biggest concern for the FDIC is the larger banks that could singlehandedly wipe out the FDIC’s reserves. In an interview with 60 Minutes that may air Sunday night, FDIC chief Sheila Bair asked whether Congress should take action to prevent banks from becoming so large that they can threaten the entire banking system. It is part of a larger question that Congress needs to address, the question of insurance that grows so large that it is unsustainable. The FDIC is small potatoes compared to what is going on at American International Group (AIG). AIG may at one point have had more than a quadrillion dollars in guarantees outstanding, and it is fair to ask whether any insurance company, no matter how large, how rich, or how well managed, should be permitted to attempt that kind of leverage. Incidentally, AIG got its government bailout restructured this week in a manner so complicated that no one can now say how much money the government has given the company. AIG is being kept standing because its guarantees, as meaningless as they might be, are all that stand between any number of major banks and failure.

The mega-banks have not failed yet, though, and that concern aside, the complaint from community banks that they are being asked to bail out the larger banks is bogus. Most of the bank failures in the past two years have been community banks, and relatively small ones at that. It is a pattern that continued tonight.

In Commerce, Georgia, Freedom Bank of Georgia failed, with $161 million in deposits. Freedom Bank of Georgia had four offices in the area generally north and west of Athens, Georgia. It had agreed with state bank regulators on December 24 to improve its operations and its financial position, which by June had deteriorated to the point where 11 percent of the bank’s loans were in default. At that time, the bank started to look for another bank to buy it out, but there are few options for a troubled bank seeking a buyer this year.

Northeast Georgia Bank, a local bank with 12 offices in 6 counties, took over all the deposits and bought 96 percent of the assets at a 9 percent discount with partial loss protection from the FDIC. Northeast Georgia Bank already had an office in Commerce, but not in the other three towns served by Freedom Bank of Georgia.

Freedom Bank of Georgia was not related to the Freedom Bank that failed in Florida at the end of October.