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:

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:

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:

• Banks' Next Roadblock: The FDIC
• They're All Too Big to Fail
• First, Fire all the Bad Bankers