Friday, May 4, 2012

This Week in Bank Failures

Politicians and pundits in London are seriously considering the question of whether the banking crisis was caused by the banks or by consumer borrowers. According to the logic of those who point the finger at consumers, if consumers had paid back all their loans, the banks would not have had the financial distress that led to the current crisis.

This assumption, I would hasten to point out, is not actually true. As one cabinet minister pointed out, the banks have to lend to somebody. If borrowers paid back all their loans, the banks would suddenly have virtually no interest income, and that would represent a far worse crisis than the banks are in now. Banks, as they normally operate, need borrowers to pay back loans, but not too quickly. It is an awkward position to be in even in the best of times.

And it points to a deeper question behind the current debate, and that is the issue of whether the current banking system is sustainable. If it is true that banks have to make loans at all times, whether creditworthy borrowers are willing to borrow or not, then large-scale loan losses and a subsequent banking crisis would seem to be inevitable whenever the economy’s collective creditworthiness falls below a certain threshold. The collective creditworthiness of the economy will inevitably go up and down, so banking crises can be expected to recur with some regularity. The obvious next question should be, how can the banking system be restructured so that it can fare better when aggregate creditworthiness declines? Part of the answer, I am sure, is that the banking system as a whole must be smaller and must not occupy such a central position in the global economy.

One bank failure was reported tonight. Security Bank, based in North Lauderdale, Florida, had $99 million in deposits and three branch locations. The OCC had issued a prompt corrective action order in March. Banesco USA is taking over over the deposits and purchasing the assets. It says it plans to keep the three branches open.