How Bad Are These Bank Failures?

There are some gut-wrenching predictions floating around these days: Hundreds of banks may fail in the coming years.

Bank analyst Dick Bove thinks it'll be 150 to 200 more. Meredith Whitney thinks the final number will be more than 300. In March, legendary investor Wilbur Ross predicted 800 more banks could fail.

No matter who's right, it's going to be a bloodbath for a good while longer.

Big deal
These are big, scary numbers that shouldn't be trivialized, but perspective is in order.

While the thought of hundreds of banks failing sounds like the Apocalypse, remember, we're a nation of thousands of banks -- 8,195, to be exact.

The point being, a few hundred bank failures wouldn't be as ruinous to the financial system as it sounds. Nor would it even be unprecedented:

Year

Problem Institutions as a Percentage
of Total Insured Institutions

2009

5.1%

2008

3.0%

2007

0.9%

2006

0.6%

2005

0.6%

2004

0.9%

2003

1.3%

2002

1.5%

2001

1.2%

2000

0.9%

1999

0.8%

1998

0.8%

1997

0.8%

1996

1.0%

1995

1.6%

1994

2.5%

1993

4.3%

1992

7.7%

1991

9.9%

1990

9.9%

Source: FDIC, author's calculations.

The last banking crisis in the early '90s saw nearly double the amount of problem institutions -- banks the FDIC deems as possible failures -- as a percentage of total banks compared to today.

Between 1985 and 1992, 2,484 banks either failed or were assisted by the FDIC. Sure, there were nearly twice as many banks back then as there are today, but even adjusting for that doesn't make the prospect of 500 bank failures today seem that calamitous.

Now the bad news
The difference between the early '90s and today is that our current banking system is far more concentrated within a few big players.

Today, four megabanks -- Citigroup (NYSE: C  ) , Bank of America (NYSE: BAC  ) , Wells Fargo (NYSE: WFC  ) , and JPMorgan Chase (NYSE: JPM  ) -- control a staggering 39% of all insured bank deposits in the country. We also allowed banks like Citi and Bank of America to accumulate trillions of dollars of assets though nontraditional-banking operations, then nearly implode last winter -- implosions the FDIC would have had to create miracles to resolve had they actually occurred. Glass-Steagall was created for a reason, you know.

And thanks to ad hoc procedures last fall, nonbanks like Goldman Sachs (NYSE: GS  ) , Morgan Stanley (NYSE: MS  ) , and American Express (NYSE: AXP  ) now officially call themselves "banks," even though their core operations are far different, and often far riskier, than deposit-taking banks.

So while there may be fewer bank failures today, they can be far more costly when they do occur.

You can see this by the average total assets per problem institution:

Year

Average Assets per Problem Institution
(in Millions of Dollars)

2009

$720

2008

$630

2007

$290

2006

$160

2005

$130

2004

$350

2003

$260

2002

$290

2001

$350

2000

$260

1999

$130

1998

$130

1997

$70

1996

$100

1995

$160

1994

$230

1993

$610

1992

$560

1991

$590

1990

$430

Source: FDIC, author's calculations.

What it comes down to is that what started this crisis to begin with: being too big to fail. A few hundred small bank failures isn't much of a problem. But if just one or two banks with hundreds of billions, if not trillions, of dollars in assets fail, both the financial system and the FDIC are put in extraordinarily dangerous positions.

Where to now?
What's the answer? Consolidation is typically viewed as a healthy and necessary function of a recession's recovery. But this time around it's no doubt exacerbating the exact danger that nearly destroyed the global financial system last fall.

A real, true, healthy banking system probably doesn't mean one where the strongest banks swallow up the failed, weak ones, but where the biggest are split apart into smaller, more nimble institutions that aren't systemic nuclear bombs.

"The sooner we modernize our resolution structure, the sooner we can end too big to fail" said FDIC Chairwoman Sheila Bair earlier this year. Agreed. So unless we want the coming wave of bank failures to make history, it's time to get moving, regulators.

Bank on this Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. American Express is a Motley Fool Inside Value recommendation. The Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 21, 2009, at 4:27 PM, 15rollaway wrote:

    Just curious, how many bank failures were there during the Great Depression?

    Thank you

  • Report this Comment On September 21, 2009, at 6:47 PM, plange01 wrote:

    bank failures in a depression are normal and will continue to increase over the next 3-5 years as the depression in the US worsens.....

  • Report this Comment On September 22, 2009, at 2:48 AM, go4buffs wrote:

    Thank you for putting a few 'scary' headlines in perspective. All too often, the 'media' tries to overhype something that may be an issue, but doesn't need to create panic.

    Merely adding the figure of failed banks as a % of the total takes a step often forgotten by the 'media'.

    Thank you, thank you, thank you.

  • Report this Comment On September 22, 2009, at 4:08 AM, paultaut wrote:

    There are supposed to be around 8,000 regional banks out there, so a 5% failure rate would be within the reach of the stats estimated by the people familiar with the Biz Vs Wilbur whose Credentials in this area do not exist.

    The Big boyz have done a substantial amount of Capital raising. Even If they haven't emerged totally out of the woods Yet, they aren't going to go back in Very deeply.

    The Problem Children are the 8,000 others. They are the ones sittting with the Vast Majority of the Commercial Real Estate mortgages, However, If they are allowed to sequester them (hide), they will be able to weather the storm as well. There will be the usual sacrificial lambs allowed to Fail just to show how well the FDIC is doing its Job, Like allowing Hedge Fund money to be used to Buy Banks hovering on the Brink.

    Just an opinion.

  • Report this Comment On September 22, 2009, at 9:06 AM, RaulChapin wrote:

    I think that breaking the big banks up is too much of a discretionary solution, how big do you have to be to be broken up, what if you are a healthy but large institution?

    I think what needs to be changed is how the FDIC premiums are charged. The % charged should go up as the ammount insured goes up. This might seem counter intuitive but thing about it in different terms and it makes sense.

    Say i want to go to an insurance company and buy life insurance for 10 billion dollars, that would likely make me their highest risk, if instead 1 million people get each 10,000$ of insurance each, the total insured is the same but thier risk is lower (unless this 1 million people happen to all have the same risk factors)

    No sane insurance company would insure me for $10 billion, even if i did have that value as a person. If any did, the premiums/insured dollar would have to be much higher than the guy getting $10K insurance.

    The idea is the same. By insuring a bank like Citi, the FDIC puts 10% of all of its risk on one bank, one team and basically one CEO and his decissions.

    This ever increasing premiums (they get relatively higher as the total insured gets higher) would act as a counter balance to the incentinves to grow ever so large.

    If a bank could actually manage to successfully pay the insurance to be extremely large, then they would not be too big to fail, as the price of failure would have been prepaid.

    now the problem would be to make sure the FDIC actually charged the big guys the big bucks... as the responsibility now would be with the regulators (which makes sense as they represent the goverment and in turn the people which are the payers of last resort)

    NOTE: I am a libertarian, so this solution is kind of really ugly for me to suggest, but I am also a realist and I know there is little hope of the solution that sounds better to me would be ever implemented IE: Let the big guys fail, see if they will ever again get too big to fail... but the scary financial armagedon promoted by the ones who "know" (those same ones that did not know enough before or were too "distracted" to pay attention) would keep any "sane" politician from pushing for something like that.

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