Why Don't Banks Fail Anymore?
Is it the strong economy? Better regulation? Luck?
The Federal Deposit Insurance Corp. is the Joe DiMaggio of federal regulators: It's got a tremendous streak going. Yesterday marked the 639th day without a bank failure, the longest run in the institution's history. (The prior record, 609 days, ended in 1946, the year the best film about a busted bank, It's a Wonderful Life,premiered.) And 2005 was the first calendar year since the FDIC's inception, in 1934, in which no banks failed. Meanwhile, in February, President Bush signed legislation that, for the first time since 1980, would raise the cap on insured deposits. Are these signs that the vast banking industry has reached a new plateau of permanent prosperity and competency? Or is it the calm before the storm?
The FDIC was one of those awful, socialistic, anti-capitalistic, doomed-for-failure New Deal projects that has, in fact, contributed enormously to the nation's well-being."No depositor has lost a single cent of FDIC-insured funds as a result of a failure," as the FDIC proudly notes. And it certainly hasn't inhibited the banking industry from growing.
U.S. banks endured the wretched period between 1980 and 1993, in which 2,500 banks and savings institutions were swept away. FDIC Chief Economist Richard Brown says 1980-93 was "a 100-year flood" for banking. Deregulation in the '70s and '80s led to massive industry expansion without a concomitant rise in risk-management capabilities. And rolling regional problems—woes in the farm belt and New England, manufacturing recessions in the Midwest, real estate speculation on the coasts, and the savings and loan crisis in the Sun Belt—produced gigantic failures. The wave peaked in 1991, when 124 banks with $53.75 billion in assets failed. Brown notes that the failure rate had less to do with the national business cycle than with poor decision-making, incompetence, local problems, and fraud.
But the industry learned its lessons. The combination of government oversight, competitive pressures, and improved risk-management has massively reduced the chances of large-scale bank failures. (See the chart on Page 107 of the FDIC's annual report.) Since 1997, only 36 banks with combined assets of about $5.15 billion have failed. (The last failure came on June 25, 2004, when the Bank of Ephraim in Ephraim, Utah, with $45.2 million in deposits, went under.) What's happened in the last decade? Banks have gotten larger and more sophisticated at managing risk. According to the FDIC, today about 92 percent of the nation's banks score sufficiently high on measures of capital and supervisory risk that they don't have to pay any insurance premiums at all. The process of securitization allows banks to distribute risks from local loans to financial institutions around the world. In addition, many weak banks are acquired today before they have the opportunity to fail.
Perhaps most important, the economic environment of the last decade—healthy economic growth, low interest rates, and low inflation—has been nirvana for bankers. Back in the early 1980s, with inflation rampant, savings and loans were stuck holding 30-year mortgages that yielded only 7 percent while they had to pay double-digit interest rates on short-term deposits. "Under the recent economic conditions, it's been difficult to fail," said Brown.
Indeed, it's possible that the estimated $3.9 trillion in insured deposits at U.S. banks have never been safer. And so the decision to boost the cap on insured deposits, which President Bush signed into law in February, seems unobjectionable. After all, $100,000 in 1980 is worth nowhere near $100,000 today. (Here are summaries of the Federal Deposit Insurance Reform Act from the American Bankers Association and from the FDIC.) In brief, the legislation raised the roof on insured deposits in retirement accounts by 150 percent, from $100,000 to $250,000. The cap on insured deposits in nonretirement accounts remains at $100,000, although the cap could be adjusted for inflation starting in 2011. (Under current practice, as the FDIC notes, the $100,000-per-account cap is something of a misnomer. A couple can have up to $1.1 million in deposits insured in a single institution if they reside in different types of accounts: individual accounts, joint accounts, trust accounts, etc.)
And yet. Observers of financial meltdowns have long noted that things seem calmest and most risk-free just before disaster. The last time the insurance cap was raised by 150 percent—in 1980, from $40,000 to $100,000—it helped set off the S&L boom, and subsequent bust, which wound up costing taxpayers hundreds of billions of dollars.
And there are some clouds on the banking horizon. While loan delinquencies are very low by historical standards, the FDIC's Brown notes that small banks are very active in commercial real estate and commercial lending. "Construction and development lending last year rose 33 percent for FDIC-insured institutions, the fastest since 1986," he said. Also, he notes, some failures in recent years stemmed from problems in subprime loans. Now—in a situation where interest rates are trending upward, the housing market is rolling over, and subprime borrowers are generally under financial stress—that may add up to some problems. "The immediate outlook is pretty good," said Brown. "Longer term, there will be more bank failures; credit will deteriorate from where it is."
But for now, the streak is still intact—when the sun sets tonight, it will be 640 days and counting. For bankers, it's still a wonderful life.
Daniel Gross is the Moneybox columnist for Slate and the business columnist for Newsweek. You can e-mail him at firstname.lastname@example.org and follow him on Twitter. His latest book, Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation, has just been published in paperback.
Still from It's a Wonderful Life © Bettmann/Corbis. Photograph of 10-dollar bills on Slate's home page by Alex Wong/Getty Images.