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The bad news about banks


EVERY DAY seems to bring more bad news about banks. Over the weekend William Seidman, chairman of the Federal Deposit Insurance Corp., admitted that bank failures were far worse than he had previously predicted, and that the fund would reach unacceptably low levels.

On Monday three private economists gave even scarier testimony to a House subcommittee. Even if the imminent recession turns out to be mild, they said, the insurance fund could run short.

Bad as the news is, it's not dire. Bank failures -- even if they include a few large money-center banks -- will not become contagious and do not threaten the economy. The Federal Reserve Board and the FDIC have sufficient tools to manage the problem.

In the worst of all outcomes, the taxpayers who are bailing out the savings and loan industry will be hit with another bailout. But that one would be small by comparison, its price measured in tens, not hundreds, of billions.

As the recession spreads across the country, many more commercial banks are expected to fail. Insured depositors will be paid off by the FDIC, which is why the insurance fund is expected to lose $5 billion next year.

The primary problem is structural: restrictive regulations have made it impossible for U.S. banks to make much profit. And because every bank pays the same insurance premium, prudent banks wind up paying for the errors of imprudent ones.

Structural reform is the only long-term answer, and will be the subject of a major report due from the Treasury Department early next year.

But in the meantime, Seidman's insurance fund is leaking and needs to be fortified. He describes a plan by which banks will fork over about $45 billion in higher insurance fees.

They, in turn, will pass these higher costs along to the depositors in the form of lower interest rates. The risk is that the higher fees could throw marginally solvent banks into bankruptcy.

This risk is worth taking for the short term. If necessary, the threat could be mitigated by substituting Treasury funds for part of the higher bank fees.

The proposal Seidman lays out would put enough money into the insurance fund to cover anything but a severe recession; and even in that unlikely case, the fund could be made whole with a modest transfer from taxpayers without undue harm to the economy.

Each release of bad news about banks prompts quick analogies to 1929. Yes, there was a widespread collapse of the banking system then, and yes, that collapse led to general economic collapse. But 1990 bears little resemblance to 1929.

For one thing, there is now deposit insurance, to give depositors ironclad protection and peace of mind. The banking system will be hit with no contagion of depositor panic and withdrawals.

For another, the Federal Reserve System would never repeat the mistake made during the Depression by allowing total bank reserves and the money supply to collapse.

Proposals of the kind Seidman describes won't make U.S. banks healthy; that will take structural reform. But they can relieve the short-run problem of an insurance fund that is running out of money. His message is calming.

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