ROSS LAVER January 21 1991



ROSS LAVER January 21 1991




Nervous investors and economists have been predicting for months that 1991 would severely test the U.S. banking system. Less than a month into the new year, there is compelling evidence to justify their concerns. Last week, federal bank regulators seized the financially troubled Bank of New England Corp.—a Boston-based institution with assets of $23 billion (U.S.)—in a dramatic attempt to shore up confidence in the bank and avert a widespread run on deposits. Only a few days earlier, Rhode Island Gov. Bruce Sundlun closed 45 banks and credit unions in that state after the collapse of the private company that insured them. Those

events reinforced concerns that the entire U.S. banking system is vulnerable and may need a painful restructuring. Analysts say that the increasing losses at U.S. financial institutions are forcing bankers to cut back on lending, hurting some businesses and dragging North America deeper into recession.

The current crisis in the financial services industry is largely a result of a downturn in the U.S. property market. During most of the 1980s, real estate values rose rapidly in most regions of the United States. Anxious to share in the profits, many bankers relaxed their lending practices and funnelled billions of dollars into highly leveraged commercial and resi-

dential real estate developments. By the late 1980s, however, the market for office space became glutted, forcing down commercial rents. At the same time, the economic slowdown weakened demand for new houses and condominiums. Those two factors produced a wave of bad real estate loans at a time when many U.S. banks are still trying to struggle out from under the heavy losses they incurred in lending to Third World countries.

As the recession tightens its grip, more and more U.S. banks are being pushed into insolvency. “This will be a big year for failures in terms of assets,” says Robert Litan, a senior fellow at the Brookings Institution in Washington. Indeed, the Federal Deposit Insurance Corp. (FDIC)—which guarantees the safety of deposits up to $100,000 per person in any member bank—has predicted that about 180 banks, with assets totalling $70 billion, will fail this year. The toll has become so high that the FDIC insurance fund is now at its lowest level since the Depression of the 1930s, when widespread panic led to a run on many savings institutions. FDIC officials say that the fund will likely lose another $5 billion in 1991, ending the year with only $4 billion.

Canada’s banks have also been hit by a rising tide of bad loans recently, but most experts say that the problems are far less severe than those in the United States. For one thing, 88 per cent of Canada’s bank assets are controlled by six large—and national—institutions: the Royal Bank of Canada, the Canadian Imperial Bank of Commerce, the Bank of Nova Scotia, the Bank of Montreal, the Toronto-Dominion Bank and the National Bank of Canada. By contrast, the United States is home to more than 12,300 individual banks, the majority of which are far smaller. U.S. banks also face restrictions that limit the extent to which they can operate in more than one state.

That leaves them more vulnerable to weaknesses in regional real estate markets.

Said Michael Mackenzie, Ottawa’s superintendent of financial institutions: “The

highly regionalized structure of the U.S. system means that banks there are more susceptible to failure. There are inherent stabilities in the Canadian system.”

The fall in U.S. property values over the past two years has been most severe in the Northeast—particularly in New England, where commercial real estate prices have dropped by up to 60 per cent. Federal regulators had for months been monitoring the health of the Bank of New England Corp., a Boston-based holding company that controls the Bank of New England and two other smaller banks. The Bank of New England Corp., the 33rd-largest in the United States, was until recently one of the region’s most aggressive real estate lenders.

In 1989, it posted a loss of $1.1 billion—in part because many of its borrowers had defaulted on loans to commercial office projects and condominiums. Karen Wilson, a senior regulator with the federal Office of the Comptroller of the Currency, said that the bank’s fundamental problem was “go-go lending that was widespread during the 1980s.”

The bank finally ran out of survival strategies on Jan. 4, when it announced that it expected to lose as much as $450 million in the last three months of 1990—bringing its total losses for the year to $653 million. Over the next two days, anxious depositors withdrew about $1 billion from the bank and its sister institutions, the Connecticut Bank and Trust Co. of Hartford, Conn., and the Maine National Bank of Portland, Me. Finally, on Sunday, Jan. 6, regulators from the comptroller’s office declared the bank insolvent and took it over, along with all of its related banks. They also announced that they were pumping $750 million into the banks and that the total cost of the bailout would likely be $2.3 billion—making it one of the most expensive bank rescues ever.

The collapse was the fourth-largest U.S. bank failure and the first major collapse of the current recession. But other large banks are also facing severe problems. As of Sept. 30,13 per cent of the $2.5 billion in commercial real estate loans at Shawmut National Corp. of

Boston were classified as nonperforming because the borrowers had fallen at least 90 days behind in their payments. A similar proportion of the Bank of Boston’s $3-billion portfolio of commercial real estate loans is nonperforming. By contrast to the situation in the United States, less than five per cent of the value of Canadian banks’ real estate loans are usually classified as nonperforming. Problems with bad loans have also spread down the U.S. East Coast, hitting banks such as Midlantic in New Jersey, MNC Financial Corp. in Maryland and Southeast Banking Corp. in Florida.

Even the country’s most powerful banks are vulnerable. The two largest financial institu-

tions, Citicorp and Chase Manhattan, both based in New York City, have announced major layoffs and slashed the amount of dividends they pay to stockholders in order to improve their financial positions. Some analysts say that a further decline in real estate values could precipitate a massive wave of restructuring in the industry, as weak banks go out of business or form partnerships with healthier institutions. “For a decade or more, they have been making questionable loans,” said Robert Reich, a professor of economics at Harvard University in Cambridge, Mass. “There will undoubtedly be more consolidation and closings of banks.”

In Washington, senior financial regulators said last week that further bank failures are almost inevitable if the economy does not turn around by the middle of the year. They added that there are signs that the recession may worsen. Declared FDIC chairman William Seidman:

“Almost everything we’re seeing in unscientific samples shows we’re not seeing any improvement, and we might see some further decline.”

Seidman also acknowledged that it was “not beyond the realm of possibility that taxpayer money will be needed” to replenish the rapidly shrinking insurance fund.

The prospect of a huge, government-funded bailout of the banking industry has provoked heated debate in Congress and moved banking

reform to the top of President George Bush’s domestic agenda. The controversy has been fuelled in part by widespread voter outrage over the collapse of much of the U.S. savings and loan industry, which is expected to cost

taxpayers more than $500 billion over the next two decades.

Later this month, Treasury Secretary Nicholas Brady will announce a legislative package that will likely be the most sweeping overhaul of the U.S. banking system since the 1930s. One

measure currently under consideration would remove the geographical restrictions on banks in order to encourage the creation of larger, more broadly based institutions. The legislation may also give banks the powers they have traditionally sought in order to compete directly against securities firms, insurance companies and real estate brokerages. Meanwhile, Treasury officials say they are considering ways of limiting the total amount of insurance coverage for individual depositors to $100,000, regardless of the number of accounts they maintain. Currently, some large depositors protect themselves by dividing their savings among several institutions, keeping no more than $100,000 in any single bank.

But even those changes may be insufficient to relieve the strain on the system. Testifying before a Senate committee last week, Seidman outlined a proposal to create another large fund—financed by the banking industry itself—that would inject new money into weak banks. The fund would be used to limit bank failures and encourage banks in depressed regions to continue lending money— averting a so-called credit crunch that could push the economy further into recession. U.S. officials point out that the combination of high loan 1 losses, severe lending restraint and " fears of bank failure helped to drive the United States into the 1930s Depression. The challenge now is to strengthen the U.S. banking system—and bolster public confidence in its stability—before the current recession becomes much graver.