Dead Banks Walking
by Doug French by Doug French
It’s widely acknowledged that hundreds if not thousands of banks are on the ropes and just waiting for regulators to wrap them in yellow tape some Friday evening. However, fewer than forty US banks have been seized this year. The Federal Deposit Insurance Corporation (FDIC) list of problem banks grew to 305 in the first quarter, the highest number since 1994, but of course the names of those banks are not released so that depositors can be forewarned.
The assets of those troubled banks total $220 billion, while the FDIC’s deposit-insurance fund has fallen to $13 billion. Not to fear: the Treasury Department tripled the FDIC’s line of credit to $100 billion in preparation for more losses. So, including the line of credit from taxpayers, the FDIC has just over two cents of reserves to cover each dollar it is insuring.
Sure, the FDIC is not yet staffed up to close down the sick banks as fast as they would like to, but how do these banks remain liquid enough to keep operating? After all, savvy customers surely must study bank balance sheets and income statements to know where to safely place their funds. Doesn’t the average bank depositor know the loan portfolio concentrations and past-due loan balances of their friendly neighborhood bank, only placing their funds in the safest of banks, leaving the worst banks to quickly run out of money and fail? Perhaps the most naive believe that.
Americans seeking high yields on their money are causing deposits at struggling banks to mount in seeming lockstep with their troubles. The result is that banks that should fail are sticking around longer, making the cleanup when they do more costly.
There is no incentive for bank depositors to go to the trouble of determining a bank’s soundness if the government is going to guarantee deposits. Not to mention that most folks aren’t equipped for the job anyway. On the other hand, if a legitimate banking system were in place, it would be based upon honoring property rights. Customers making a deposit in a bank expect the bank to guard, protect, and return their money — at a moment’s notice in the case of demand deposits. After all, that person has not traded a present good for a future good. The depositors believe the bank is warehousing the money for them and that it is available to them at any time. This deposit is not a loan — there is no fixed term, which would be required in the case of a loan — and availability hasn’t transferred.
However, we don’t have legitimate deposit banking but a fractionalized banking system that combines deposit banking with loan banking. Those that sympathize with fractionalized banking will contend that time certificate of deposit accounts are in essence loans from depositors, entitling the bankers to use the funds at their discretion for the term of the CD — just as long as the banker has the money ready when the CD matures. But if the money is lent secured by illiquid assets such as real estate, the banker is clearly not counting on those loans to satisfy expiring CDs and must count on attracting new CD money to pay off the old.
Bankers, pressured to earn returns for shareholders and protected from bank runs by FDIC insurance, have over time lent not only more of their deposits but advanced the money for riskier projects. James Grant in a recent Grant’s Interest Rate Observer reminisced about National City Bank, which back in 1954 had only lent out 41 percent of its deposits, with less than one percent of the portfolio being real-estate loans.
By the end of last year, the total loan-to-deposit ratio for all US banks and thrifts was 87 percent, and 60 percent of all loans were classified as real-estate secured.
Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.