BLEEDING FROM TENS of billions in bad real estate loans, failed and wounded banks are littering the industry landscape.
The banking crisis has echoes of the early days of the savings and loan debacle mixed with memories of the Depression, when public confidence in financial institutions ebbed sharply.
Since 1984, 1,200 banks have failed, according to government regulators. This year, another 180, worth about $70 billion in assets, are expected to go bust. Moreover, big failures such as the government seizure of Bank of New England Corp. last month will be on the rise, analysts predict; they note that 10 of the nation's 48 biggest banks -- each with more than $10 billion in assets -- have low levels of the capital that provides their financial cushion against future losses.
Making matters worse, the industry's sea of bad loans and shortages of capital has contributed to the recession by forcing banks to curb lending -- "the credit crunch." And the deepening recession is threatening to pull more banks under as more loans go bad.
Against this gloomy backdrop, the Bush administration last week finally released its wide-ranging proposals for long-term bank reform -- proposals it hopes will both strengthen the industry's financial position and make it more competitive domestically and internationally.
Containing a strong dose of financial deregulation, the Treasury Department plan gives banks some brand new powers which they have long coveted, such as permitting interstate banking and letting banks get into the securities and insurance businesses.
The recommended changes would also allow industrial and commercial firms to own banks and would limit federal deposit insurance to two accounts per bank for each person.
The proposals received a lukewarm reception in Congress, with some critics worrying that there were some disturbing parallels between the call for banking deregulation at this time and the deregulation that led to the savings and loan crisis.
"This is not reform," said John Kenneth Galbraith, professor of economics emeritus at Harvard. "It is an extraordinarily obvious exercise in evasion verging at times on insanity. . . . Could anyone think the banking system would have been strengthened if Drexel Burnham had been allowed to unite with Bank of New England?"
And the new Treasury Department proposals left unanswered growing concerns about the health of the Federal Deposit Insurance Corporation's fund that protects accounts up to $100,000. The fund is at its lowest level since it was created during the 1930s, and some experts say it could go into the red next year.
In Congressional testimony last week, FDIC chairman L. William Seidman said the fund could remain solvent and failures could be covered over the next two years by increased borrowing. Mr. Seidman that as much as $20 billion might be required, which would come from increasing the deposit insurance premium banks pay to sustain the FDIC fund.
How did banks get themselves in such a fix? "For a decade or more, banks have been making questionable loans," says Robert Reich, a professor of economics at Harvard. "There will undoubtedly be more consolidations and closings."
"Some of their lending was so excessive that you wonder what those bankers were doing," says William Isaac, a former chairman of FDIC, now a banking consultant in Washington. "The first rule of banking is to diversify your risk."
Riskier types of lending, however, especially for commercial real estate, took off in the early 1980s when many of the banking industry's traditional corporate clients turned to other markets for their funds. By the end of last year's third quarter, $819.7 billion -- 39 percent of $2.1 trillion in bank loans -- were going to real estate. By contrast, according to the FDIC, only 28 percent of all bank loans went to real estate at the end of 1984.
Unfortunately, the real estate bubble finally burst. In the last two years, more and more cities have witnessed rising office-vacancy rates, emptier hotels, unsold condominiums and shopping centers without enough major tenants.
The bad real estate loans only compounded other loan problems for some banks. In the late 1970s many of the nation's largest money center banks, such as Citicorp and Chase Manhattan, lent billions to less developed countries on which they've had to take sizable losses. In addition, the banking industry also staked about $200 billion in loans to corporate buyouts and takeovers which are now increasingly going bad as debt-laden companies find themselves forced into bankruptcy.
Presently, the industry's woes are most intense in New England, where real estate prices have been falling fastest and where the recession has hit the hardest. The takeover of Bank of New England Corp., the nation's 33rd-largest bank, is likely to cost about $2.3 billion, according to the FDIC. But similar problems now stretch up and down the East Coast and have afflicted such well-known banks as Midlantic Corp. in New Jersey, MNC Financial Inc. in Maryland and Southeast Banking Corp. in Florida. Banks in other regions too, including the West Coast, are now also experiencing mounting problems due to bad real estate loans.
"Regulators should have been giving warnings about concentrating so heavily in real estate," says Robert Litan, a senior fellow at the Brookings Institution. "Bankers weren't getting any discouragement. It's a little like what U.S. policy was to Iraq before Aug. 2."
While the majority of the nation's 12,400 banks remain profitable, the worsening plight of the big banks and the prospect of the FDIC fund going insolvent have plainly grabbed the attention of the Bush administration and put its banking reform proposals high on the domestic agenda.
Although the new measures are not being touted as a short-term answer to the banking industry's ills, they are being promoted by the Treasury Department as the best medicine for banks to regain their competitiveness with domestic financial service rivals and foreign ones.
In making his presentation last week, Treasury Secretary Nicholas F. Brady noted that twenty years ago nine of the 30 largest banks in the world were American ones, while today only one of the top 30 is from this country.
Few critics are now denying that banks need new powers to bolster their financial position. The advent of interstate banking, despite the opposition of many smaller banks and some legitimate fears about bank concentration, promises considerable cost savings, as Mr. Brady indicated, and will probably gain congressional approval.
But it seems likely that the debate in Congress is going to be heated over the administration's heavy focus on deregulation as the path to follow given the industry's current malaise and the recent experience with the savings and loan industry.
Letting banks into the sometimes-risky world of securities trading seems particularly dubious. Indeed, Federal Reserve Chairman Alan Greenspan gave the show away a bit in an recent interview with the New York Times when he said that permitting banks to go into the securities business was not a big problem because those already in the business were doing so poorly that banks would be crazy to rush in.
The potential pitfalls of venturing too fast into investment banking were recently underscored at Bank of America, which hired an independent broker-dealer to sell high yield, high risk junk bond mutual funds to its customers. Unfortunately, the customers have filed a spate of suits against the bank because of losses they incurred. Mr. Galbreath says, "Allowing any industrial firm to add a bank is ludicrous, or would seem so to anyone, were it not for the yet worse proposal to allow the banks to get back into floating securities."
Mr. Galbraith and other economists have voiced fears that industrial firms owning banks could lead to greater economic concentration in the United States.
To be sure, the proposals contain some new regulatory safeguards. For instance, the proposals outline new ways in which banks would be encouraged to increase their capital to protect against future losses. Banks that have low capital levels will now be forced to cut dividends and sell off assets to improve their health, procedures that are now done more informally at the request of regulators. Further, only well-capitalized banks would allowed to affiliate with securities and insurance firms under new financial holding company structures. There would be "fire walls" erected between the banks and the securities affiliates in an effort to protect bank customers from greater risks.
Still, Congress and government policy-making agencies are probably going to have to turn their attention first to the pressing issue of how to replenish the nearly bankrupt FDIC insurance fund. The Treasury Department proposals did not address this because there are still too many disagreements between regulators and bankers about how to proceed. Some of Mr. Seidman's recent suggestions about the need for sharp increases in the premiums banks pay to the FDIC's insurance fund have struck fear in the hearts of many bankers.
Some industry trade groups, whose members are hard-pressed for capital, have been meeting with federal regulators for the last two weeks trying to devise a mutually agreeable plan to prevent a taxpayer bailout. One of several ideas now being considered, which has been pushed by the Association of Bank Holding Companies as a cheaper alternative, would be to create a new fund that would assist financially weak banks to raise new capital.
Whatever plan emerges, it seems likely that the dollar figures may have to be revised upward, given the vagaries of the recession and the Persian Gulf conflict. If the recession continues to deepen, rather than being short and mild as the administration has been predicting, the banks' loan problems will also worsen -- which will surely lead to more failures. That would ++ mean that the FDIC would need more funds from banks, or would increase the prospect that taxpayers will have to pick up the tab.
Either way, banks are going to be living with the consequences of their real estate lending binge for some time to come, while the government tries to restore public confidence in an increasingly fragile system.
Peter Stone is a reporter for Legal Times.