Breaking The Bank

By RICHARD HORNIK WASHINGTON

First it was $100 billion, then $200 billion, $500 billion, and now it's $1 trillion or more. As estimates of the cost mounted for the bailout of the savings and loan industry, a taxpayer's only consolation was that at least commercial banks were safe and sound. Or were they? The way things are going, the Federal Deposit Insurance Corporation, which insures commercial bank deposits, may have to be renamed the Future Disaster Inevitable Corporation. In grim testimony before the House Banking Committee last week, Comptroller General Charles Bowsher warned, "Not since it was born in the Great Depression has the federal system of deposit insurance for commercial banks faced such a period of danger as it does today."

Bowsher, citing a General Accounting Office report, said the failure of a single major bank or the onset of a recession could wipe out the FDIC's insurance fund, which has only $12 billion or so on hand to cover the $2 trillion in insured deposits in commercial banks. And if the fund was exhausted, the government might have to provide a bailout with taxpayer money. Just a day after Bowsher's testimony, the Congressional Budget Office predicted that even without a recession, some 630 banks will fail over the next three years and drain the FDIC of more than $20 billion, far more than the insurance fund is likely to have on hand.

Already buffeted by voter outrage over the S&L debacle, which is expected to cost American families $5,000 to $10,000 apiece over the next three decades, Washington legislators responded swiftly. They promised immediate measures to bolster the insurance fund's resources by allowing regulators to boost the insurance premiums that banks pay to cover their deposits. "The American people have had enough of taxpayer bailouts of our deposit insurance system," wrote Donald Riegle Jr., the Senate Banking Committee chairman, in a letter to President Bush. Sensitive to accusations that it aggravated the S&L mess by delaying the cure, the Administration immediately supported a boost in premiums to 19.5 cents per $100 of deposits in 1991, an increase of 63% in one year.

Amid the cries of alarm, some experts caution against equating the banking industry's problems with the thrift disaster. Overall, banks in the U.S. earned $26 billion last year, while S&Ls lost more than $19 billion. "I disagree strongly with the notion that the problem in the banking industry resembles the early stage of the S&L debacle," says Thomas McCandless, who follows the industry for Goldman, Sachs. "The regulatory environment has been much more rigorous than the loosey-goosey kind of overview that occurred in the S&L industry."

Some bankers are concerned that the government would overreact to the problem by piling on burdensome insurance premiums and new regulations that could make problems worse. Says Karen Shaw, a Washington-based banking analyst: "We could turn a safety net into a funeral shroud by wiping out the profitability of many of these banks." Testifying before the House Banking Committee, Federal Reserve Board Chairman Alan Greenspan argued against any immediate increase in the insurance premiums. Instead he favors increasing the amount of capital banks must keep on hand as a cushion against losses, since that safety measure might prevent many banks from failing in the first place.

Such steps may stave off short-term banking crises, but over the long haul, more dramatic changes are needed. During the past 20 years, commercial banks have been muscled out of many of their traditional lines of business by other segments of the financial industry. Most important, few major corporations still borrow from banks; they float their own commercial IOUs. When banks looked for borrowers elsewhere, they ran into one bad risk after another, most notably the Third World countries. Says Katherine Hensel, a banking analyst for Shearson Lehman Hutton: "Just look at the legacy here. On the heels of the ((Third World)) debt problem, other pieces of the pie are beginning to fall apart for banks, such as real estate, LBOs and other highly leveraged transactions. These were pieces of the puzzle that were supposed to generate solid returns of capital. But the pieces aren't working. The banks just never had a period for a breather."

The degree of many banks' distress depends on the condition of their regional economies. Texas banks, many of which collapsed with oil prices in the mid-1980s, are relatively healthy now. Says Bernard Weinstein, an economist for the University of North Texas: "The banking industry nationwide is in trouble, but Texas is a couple years ahead of the curve. Our economy is recovering. Our large financial institutions have all been recapitalized. Higher oil prices will provide enough stimulus to protect us from a recession."

Today the real problem area is the Northeast, particularly New England. The FDIC is opening a "liquidation" office, with a 400-member staff, in Boston to dispose of the real estate it expects to be stuck with as banks in the region go bust. The Bank of New England (assets: $23 billion) "already has one foot in the grave," says an analyst. Even the big Manhattan-based "money center" banks are suffering from plummeting earnings and falling investor confidence. Chase Manhattan's stock has plunged almost 60% in the past year, to 16 5/8. Citicorp is down about 40%, to 17 3/4. Even J.P. Morgan, widely considered among the best managed and best capitalized major banks, has suffered a stock-price decline of 18%, to 32 5/8.

The long-term answer, according to most experts, is to enable banks to restore their profitability by removing their geographical restrictions and allowing them to enter such lucrative financial services as insurance and stock brokerage. As Greenspan testified last week, "A banking system that cannot adapt to the change in competitive and technological environments will no longer be able to attract and maintain the higher capital level that some of our institutions need to operate without excessive reliance on the safety net."

In the meantime, Greenspan also urged federal regulators to take a hint from the GAO report released last week and try to tighten their supervision of banking operations. The report noted that 22 of the 406 banks that failed in 1988 and 1989 never appeared on the FDIC's problem-bank list. "Banks have been able to hide their nonperforming loans," contends Robert Litan, a banking expert at the Brookings Institution. Such subterfuge would be more difficult if banks were to undergo annual on-site inspections. Until 1956 federal regulations required two such audits a year, but by the 1980s some banks saw an inspector only once every two years, or even less often.

Another pressing need is for the government to modify its costly policy of paying off all depositors -- not just the insured ones -- in failed banks. Of the 900 banks that have failed since 1985, fully 99.5% of deposits have been covered. Technically the FDIC does not guarantee deposits over $100,000 or those held by foreigners, but to maintain confidence in the banking system the government has also protected those accounts. The problem is that banks do not pay premiums on those deposits, so the FDIC is essentially providing the coverage free, or eventually at taxpayer expense.

Banking Committee chairman Henry Gonzalez and others have recommended that the FDIC curb its implicit commitment to make every depositor whole. But any such cutback in coverage of all deposits must be done carefully. The dominant fear -- some observers say obsession -- at the FDIC and the Federal Reserve is that large depositors might become so concerned about their money that at the first sign of trouble at an institution they would take it elsewhere, effectively breaking the bank. Analysts like Shaw have proposed that the FDIC restore its "modified payout" system, under which uninsured depositors get a prorated share of a failed bank's remaining assets.

Early next year Congress intends to take up serious discussions of deposit- insurance reform. Gonzalez has unveiled a credible but controversial proposal that would limit deposit coverage, charge deposit-insurance premiums based on the riskiness of a bank's assets, and place some kinds of investments off limits for insured funds. The Treasury Department, which commissioned a yearlong study of banking reform, is expected to deliver its report later this year. None of the proposals will immediately solve the problems of the American banking system, but at least everyone seems to understand that putting off the search for a solution will just make matters worse.

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With reporting by Bernard Baumohl/New York and Deborah Fowler/Houston