Floyd Norris at the NYT has an important column addressing the string of small-level bank failures that’s been taxing the FDIC:
The severity of the current string of bank failures shows that many of the proposed remedies batted about since the financial crisis erupted would have done nothing to stem this wave of closures. These banks did not get in over their heads with derivatives or hide their bad assets in off-balance sheet vehicles. Nor did their traders make bad bets; they generally had no traders. They did not make loans that they expected to sell quickly, so they had plenty of reason to care that the loans would be repaid.What they did do is see loans go bad, in some cases with stunning rapidity, in volumes that they never thought possible.
He’s talking, of course, about banks like Guaranty and Colonial, which weren’t hybrid retail/investment banks enabled by Glass-Steagall. They just failed the old fashion way. In a lot of cases it was bad construction loans. As commercial real estate falters, that too will bring down a number of non-giant banks.
This is a very similar point to one we made in July — that the initial collapse of large institutions — may have confused our understanding of the crisis, and convinced us that the issue was all about “too big to fail” and “complexity.”
What if things had hapened in a different order?
Would we, instead, be worrying about the tidal waive of small, failing institutions? It’s easy to imagine some of what people would be saying right about now:
- There was no way regulators could have kept an eye on the thousands of tiny banks around the country! They should’ve been much more aggressive about having them merge.
- Small banks are too exposed to a narrow market, and should have merged to diversify risk.
- It’s too hard to coordinate a thousand small banks in a time of crisis. A crisis confined to big banks would make it easier to get a handle on the problem.
And on and on the argument would go.
Sill, it’s not quite that simple. As Paul Kedrosky points out, a major question is the extent to which the small banks had the opportunity to get so bad due to actions taken by the large ones:
But the reason why all these banks had the opportunity to so quickly make so many bad loans, and why so many banks and loans failed so fast, is because of the systemic problems in banking, many of which were tied to loan exotica. In other words, it didn’t matter that the failing banks didn’t pee in the pool, other banks did. And in banking, like life, the notion of a peeing and a non-peeing section in a swimming pool is meaningless.
Maybe they were an enabling factor, but then, this excuse isn’t typicall cited for, say, all the bad loans that small institutions made during the S&L crisis. Basically, small banks can fail like any other. And if there’s a wave of them, it’s going to cost a lot of money to clean up.
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