Friday, November 28, 2008

This Week in Bank Failures

The instant bank.

That’s the FDIC’s newest concept as it seeks investors to buy out failed banks.

Traditionally, failed banks are taken over by other banks, but that approach is showing signs of strain. Last week, for example, a failed Georgia bank was taken over by a smaller bank from Virginia that had no previous history in Georgia. You can imagine the bankers from Virginia getting out their Georgia road maps to find out where their four new locations were.

Georgia and Michigan were the first two states to be hit by the real estate downturn, so it could be hard to find a bank in those states with enough financial strength to take over a failed bank. If the rest of the country follows the same pattern, it may be hard to find a bank anywhere in the country to take over a failed bank by the end of next year.

And the rest of the country is, so far, following the same pattern. Banks earned $1.7 billion in the third quarter. That sounds like it should be the profit of just one hugely successful bank, but it is not. That is the combined profit of every bank insured by the FDIC. To put it another way, the amount of money banks are making in a month is scarcely more than they would make in one day in a good year.

Banks’ financial strength comes primarily from profits, so when banks stop making a profit, it is a problem for the banking system.

The across-the-board decline in banking can be seem in last weekend’s crisis at Citibank, which in some ways is the largest bank in the country. Citi’s stock had fallen by half last week after it announced some of the cutbacks it would need to stay solvent. Federal officials worked over the weekend and apparently all night Sunday night without coming up with the right way to bail out Citibank, so Monday morning, they essentially just gave Citibank $100 billion, then made the deal complicated enough to let people imagine that there were enough strings attached to make it something other than a gift. Wall Street continues to be skeptical about Citi’s chances, however. Despite the size of the bailout, Citi’s market capitalization was only $37 billion. That means, according to investors, the whole company is worth less than half the amount of money the U.S. government just put into it.

With the whole banking system in decline, the FDIC needs to look for capital outside the banking system. That’s where the instant bank comes in. The FDIC announced on Wednesday “a modified bidder qualification process” that “will allow interested parties that do not currently have a bank charter to participate“ in the resolution of failed banks. In the announcement, the FDIC took pains to emphasize that it is streamlining the paperwork involved in becoming a bank owner. The announcement seemed to be timed to avoid scrutiny by the news media during the holiday weekend.

The new instant bank rules seem to open the door for just about anyone who has money and a businesslike approach. The acquiring institution would get a bank charter when the bank takeover was announced. This allows a bank takeover to be carried out by a bank that didn’t exist a moment before. In the unlikely event that the acquiring institution turned out not to qualify to own a bank, the FDIC could work that out later, perhaps by turning the bank over to yet another acquiring institution.

This move would seem to make it easier for foreign banks, oil companies, perhaps even sovereign wealth funds to buy up failed banks. Oil companies would seem to be the most obvious candidates, since they have money to burn and depend on commercial banks, currently in various degrees of financial distress, for their all-important credit card transaction processing. There are other possibilities too, so we’ll have to wait and see what deals emerge. What will people think if their bank fails and is taken over by BP, Wal-Mart, or the United Arab Emirates?

In Britain, a Royal Bank of Scotland (RBS) stock offering expired today, with investors buying just a few million of ₤20 billion in shares that were offered. The stock will instead be bought by the government, which will own 58 percent of the bank. RBS had been the second largest bank in the U.K. and a significant presence on Wall Street, before it was hit by losses.