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Banks in Trouble on the Rise

Bank.jpg
Bank.jpg

As if there weren’t enough already to worry about during this credit crisis, now there’s a possible surge of bank failures ahead.

So far this year, three banks have gone under, and more are in trouble. On Thursday, the Federal Deposit Insurance Corp. said “problem” banks now total 90, up from 76 at the end of last year – meaning the viability of those banks is threatened. Banks also boosted their loan loss provisions to a new record because of real estate loans gone bad, the FDIC said, and chairwoman Sheila Bair urged banks to build additional reserves to ward off more expected losses. Internet sites like the bank implode-o-meter are sprouting up to tally the troubles. As concerns grow, Wall Street analysts predict 150 to 300 bank failures over the next two years.

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Debt-150x150_3238.jpg

Illustration by: Matt Mahurin

“Bank failures are going to be a huge problem,” said Michael Shedlock, an investment adviser who writes the widely followed Mish’s Global Economic Trend Analysis blog. “We’re going to see some big lenders go under.”

But not everyone is as worried. Maybe it’s because they’ve been around this block before. The Savings and Loan debacle - the last major U.S. banking crisis – greatly exceeds the troubles of this current crisis, say some who were major players back then. They point out that people seem to have forgotten that time when it appeared the nation’s entire banking system might fail. The handful of banks shut down by regulators this year, they say, hardly compares to the more than 1,200 banks and thrifts that went under then, and the crisis mode that set in. That crisis also caused a transformation of the banking system, giving it a far stronger position going into the current mess, in their view.

“You’re talking to somebody who had to close down four or five banks a week,” said Robert Clarke, the nation’s top banking regulator as Comptroller of the Currency from 1985 to 1992. “This is child’s play compared to what we’ve seen before.”

A possible increase in bank failures tied to commercial real estate is “the same old thing” that happened in the past, when developers overdid it in terms of construction, said Clarke, now a Houston attorney. He says bank failure fears are a bit hyped today. The failures are likely to be isolated, affecting only some banks with high concentrations of commercial real estate loans in troubled markets. For example, Clarke said, in Houston, which has a growing economy, office buildings are going up for the first time in years, and those lenders are likely to be just fine.

Regulators are placing more banks on the problem list — one lesson learned from the previous crisis is to move more quickly to handle problems before they get worse. The last time around, Clarke said, many banks, thrifts and regulators were in a “state of denial” about the financial messes they faced. “You’ve got to try to get out ahead of the parade,” he said, “if you can.”

One thing this time that does worry him is the amount of losses banks are taking. Citigroup’s writedowns are probably bigger than all the capital it had when he was the bank’s regulator, Clarke said. “It does concern me, because the numbers are so huge.”

The big losses, however, don’t mean the crisis will be as deep as before, said L. William Seidman, who played a central role in the crisis as FDIC chairman from 1985 to 1991, as well as chairman of the Resolution Trust Corp. from 1989 to 1991. The RTC was created by Congress in 1989 to sell off assets from failed institutions. Seidman said he doesn’t expect anywhere near the number of bank failures that occurred from the late 1980s and early 1990s. And this time around, he said, the problems aren’t confined just to banks.

“The losses aren’t as concentrated, and you’re spreading the risk,” Seidman said. “I’m less concerned that the system is going to have a collapse than I was then.”

Though losses are large, banks now can raise capital to offset them, Seidman said. During the S & L crisis, there were no sovereign wealth funds or private equity funds to provide money for banks. They just went under.

And when they failed, the failures were huge, noted Robert Litan, a member of the Commission on the Causes of the Savings and Loan Crisis in the early 1990s, and now a senior fellow at the Brookings Institution. Among the big failures: the Bank of New England. In the early 1990s Rep. John Dingell (D-Mich.), even questioned publicly whether Citibank might be insolvent.

Things may not seem all that good now, but, still, “This does not look like the early 1990s,” Litan said.

Or the early 1980s, well before the S&L crisis, when banks began taking big hits from bad loans to developing countries. Continental Illinois Bank nearly went under, and “it shook the hell out of people when that happened,” Litan said. “The core of the U.S. banking system was said to be threatened.”

Still, there’s reason to be worried today. It’s harder to get credit. The financial markets remain troubled, as the Bear Stearns bailout illustrated.

“We haven’t played this out yet,” Litan said.

But whatever happens, the banking system is far stronger now because of the major regulatory changes that took place after the bank and thrift failures, said John Douglas, former general counsel at the FDIC from 1987 to 1989, and now an attorney in Atlanta.

Those changes include far stricter financial requirements for banks and thrifts, which, prior to that crisis, had been allowed to operate with virtually no capital. Going into this current crisis, banks were in better financial shape than ever before, he said.

“We’re going to see some banks fail, but at the end of the day, it’s going to be much smaller than what we had before,” Douglas said.

During the S & L days, he said, things were so precarious there was a sense of urgency, something he doesn’t see around him today. “It’s was clear we were in the midst of this crisis that was going to the heart of the banking system,” he said.

Shedlock, however, sees the same history in a different way. From his perspective, more individual banks existed during the S & L days, meaning more bank failures. With so many mergers and acquisitions since then, there are fewer banks to fail, in terms of sheer numbers. But the failures will be bigger and more far reaching, and could include major lenders like Wachovia and Washington Mutual, he believes.

The credit crisis is also something that affects consumers in a more direct way than the savings and loan failures. It’s harder or more expensive to get all kinds of loans, from mortgages to car loans, he said. “We have a genuine, more broadly spread crisis than the narrowly focused one in the 1980s,” he said.

That may be true. Seidman, for one, sees more regulation for non-bank lenders coming out of this crisis. But among the memorable events of the S & L debacle were bank runs, like the March 1985 frenzy that descended on Home State Savings Bank in Cincinnati. For the first time since the FDIC was created in the wake of bank runs during the Great Depression, many people felt that their savings might be at risk. The Ohio governor declared a three-day bank holiday that led to biggest shutdown of banks since the 1930s.

So far, nothing similar has happened. But in a hint that what occurred in the past may be a template for the future, even if the crisis turns out very differently this time, the FDIC in February hired 25 retired savings-and-loans examiners and advertised for help in managing the assets of closed banks.

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