For the past two years James Davis and the 3,000 bureaucrats who work for him have led highly unpredictable—and hectic—professional lives. Davis is director of the division of liquidation at the U.S. Federal Deposit Insurance Corp., the Washington-based agency that is responsible for closing down failed U.S. banks. Last year he and his FDIC “hit teams” spent many days—and nights —winding up 79 failed banks, a postDepression record. The FDIC has already closed 96 U.S. banks this year and is expected to see 25 more shut their doors before year’s end, some of them the victims of fraud or bad management, others hurt by weak local economies. Davis, whose agency last week had 1,070 small banks on its “watch list” of threatened banks, says that an equal number will probably close next year. But there are signs that even that failure rate may soon be surpassed. Indeed, many analysts are predicting that literally thousands of the 15,000 banks operating in the United States will disappear in coming years as the country’s banking system undergoes its greatest reorganization since the New Deal’s one in the 1930s.
The major structural problem in U.S. banking is caused by the dizzying number and variety of banks and by 30-year-old federal legislation that effectively prevents most types of banks from setting up national networks. In response, each of the 50 states has adopted its own set of regulations. The result is that 15,000 U.S. companies carry on some form of banking, ranging from one-branch operations to the largest U.S. bank holding company, Citicorp, with assets of more than $150 billion. There are also more than 3,000 savings and loan institutions, known popularly as “thrifts,” which are roughly comparable to Canadian trust companies. An estimated 25 per cent of them are now insolvent. Their overseers form a maze of overlapping federal and state regulatory bodies and deposit insurance systems so confusing that even one of the key regulators, Federal Reserve Board chairman Paul Volcker, called it “a mess.”
Ruling: Earlier this year the Supreme Court handed down a key ruling which challenged federal constraints on interstate banking. The court ruled that each state has the right to allow out-of-state banks to do business within its borders. So far, 21 states have opened their doors to banks from some or all other states, and 10 more are considering doing so. Robert Litan, a senior fellow in economic studies at the Washington-based Brookings Institution, says that over the next five years the Big 15 “money-centre” or commercial banks will move into many states not currently open to them. Combined with the formation of new regional bank empires, that spread should increase competition in the industry. Most analysts also predict widespread closings and mergers. Said Litan: “We could easily lose 1,000 banks—some put the number as high as 5,000.”
Jealousy: But most analysts see little likelihood of a rationalization of the regulatory system. Most states jealously guard their right to regulate. And in Washington a series of regulatory bodies, including the FDIC, the Federal Reserve Board and the Office of the Comptroller of the Currency, frequently get involved in jurisdictional disputes. Efforts in Congress to merge them have failed.
The FDIC will likely continue to shut down banks at a record pace. On May 31 the agency closed seven small banks—four in Nebraska and one each in Arkansas, Minnesota and Oregon—a post-Depression record for shutdowns in a single day. The largest of the seven failed banks had only $100 million in deposits. The failed Nebraska banks, like many of the smaller institutions, concentrated on lending to farmers. According to analysts, 55 per cent of the banks that have closed this year have based their business on agricultural interests, most of them in the Midwest.
With record numbers of closures, Davis and his FDIC “hit teams” have become remarkably proficient. Generally, the team’s members check into a hotel near their target, registering under the name of a nonexistent corporation, while FDIC officials in Washington, along with the relevant state and other federal regulators, decide when to shut the doors. When the order to move in is sent—usually on a Friday—the team members act swiftly. As soon as they reach the bank, one of their members hands a closing order to the bank president, demands the keys and locks the doors. Locksmiths are called in to change all the locks and reset the vault combinations. Then, some team members immediately begin working around the clock to make an inventory of the bank’s available cash, its loan portfolio and its physical assets. Others begin searching files and desks for evidence of illegal activity.
Quick: At the same time, another group armed with portable computers begins drafting refund cheques for depositors. The system works so quickly that, in the case of small banks, insurance refunds for customers with deposits of $100,000 (U.S.) or less (Canadian legislation covers deposits of up to only $60,000) are often available on the Monday after closing. Frequently, the FDIC arranges quick mergers in order to reopen the bank and protect larger deposits. Three of the seven banks closed on May 31—a Friday—either reopened under new management or had their deposits trans-
ferred to another bank by the following Monday.
Not all depositors have been as fortunate. Early in March the Home State Savings Bank of Cincinnati suffered a $150-million loss on transactions with a now-defunct Florida investment company. That loss threatened to overwhelm the state’s $130-million deposit insurance fund and start a run on Ohio’s 70 state-insured thrifts. The state swiftly shut down the entire system. The result: many depositors found their savings frozen for as long as 10 days while state-chartered S&Ls struggled to meet federal requirements that would allow them to reopen.
Two months later the panic spread to Maryland. Financial difficulties at six state-insured thrifts forced the state to take action. Until last week, when the legislature approved a deal allowing the thrifts to reopen as banks under new management, depositors had been able to withdraw only $1,000 each. “The Ohio and Maryland panics are not disasters but warnings,” said economics commentator Robert Samuelson. “I doubt that we have an imminent banking crisis, but the ‘mini-panics’ reflect deeper problems which could undermine faith in the banking system and cost taxpayers billions of dollars.”
Giants: By contrast, the giants of U.S. banking have, for the most part, performed well. Twelve of the 15 largest U.S. banks posted increases in profits in the first half of 1985. The significant exception was BankAmerica, which posted a second-quarter loss of $338 million, the second-largest ever for a U.S. bank. Paul Sacks, president of Multinational Strategies Inc., a New York-based investment consulting firm, says that the higher profits reflect changes in the way U.S. banks operate. Said Sacks: “Those banks that have the skill to make changes have profited. They’ve moved in the direction of British merchant banks, where earnings are based on fees rather than interest. Banks that remain locked in traditionally profitable niches, such as real estate, have not done so well.”
Still, regulators say that they are concerned by at least one trend in big bank operations. Large banks are now guaranteeing bond issues for customers rather than making outright loans. Those guarantees do not appear on a bank’s balance sheet, and as a result there is no requirement to put aside backup capital as there would be for a loan. The top 15 banks have an estimated $1.25 trillion outstanding in those “off-balance-sheet items,” which also include commitments to make loans and purchase foreign currency. Said Irvine Sprague, an FDIC director: “The raw numbers are a little scary.” Federal regulators are considering imposing controls on the practice.
Risks: But if one of the major banks were to get in trouble by following that practice, it is unlikely that authorities would allow it to close. Last year a bad loan portfolio almost collapsed the Chicago-based Continental Illinois Bank, once the sixth-largest in the United States. Washington stepped in and effectively nationalized Continental Illinois by turning over 80 per cent of its stock to the FDIC. Said Brookings’ Litan: “There’s not much of a risk in saving a large bank, except setting a bad precedent. But the risks in letting it go under are tremendous.”
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