FDIC Chairman Sheila Bair recently said that 2010 was a "turnaround year" for the U.S. banking system. Total industry earnings were positive in all four quarters of the year and she noted that "a substantial majority of insured institutions" were taking part in the trend of improving earnings.

Now before you get too skeptical, let's be clear that "turnaround" does not mean "turned around." If what we're looking for is a reversal of trend and a clear sign that things are getting better rather than worse in the industry, I think we can agree with Bair.

Obviously, though, the 884 banks on the Federal Deposit Insurance Corp.'s problem list at the end of the year and the 157 insured banks that failed in 2010 show that the trend toward better needs to hold if we hope to use the word "healthy" in the same sentence as "banking industry" again.

Good for all?
Columnist Peter Atwater isn't so sure that 2010 was as good for all of the banking industry as the industrywide totals suggested. He notes that, thanks to government intervention, the largest banks in the U.S. were improving (in a way) in 2010 while many of our country's smaller banks continued to struggle.

While I partially agree with that sentiment, I think it's notable that big banks were actually hit harder than smaller banks. Delinquency data from the Federal Reserve not only reiterates the "not recovered yet" theme, but clearly shows that the 100 biggest banks in the system saw loan delinquencies spike much higher.

Not that they didn't work hard for those higher delinquency rates -- they were also much more stupid than many smaller banks.

Mattkbankdelinquencies

So in the mid-financial-crisis triage, there was good reason to put bigger banks at the front of the line.

In addition, there simply wasn't a private-market mechanism available to deal with the failure of massive banks. East West Bancorp (Nasdaq: EWBC), Umpqua Holdings (Nasdaq: UMPQ), and First Citizens Bancshares (Nasdaq: FCNCA) are among the many mid-size banks that have taken part in FDIC-assisted transactions. Even larger banks that haven't failed but are in need of backing can find a buyer among a larger player -- think Bank of Montreal (NYSE: BMO) buying Marshall & Ilsley (NYSE: MI).

But who buys Bank of America (NYSE: BAC)? Or Citigroup (NYSE: C)?

Frankly, I think it's moronic that we have banks big enough that the only logical choice is to have the government step in to save them. And though Bair has been vocal about not wanting that to continue to be the case, I'm still a skeptic.

But the point is that the market is better equipped to deal with the trouble at the smaller end of the industry. As such, we should be less worried about struggling smaller banks that can be consolidated, and more concerned about fixing the top end of the system so that the big banks can't hold a gun to the entire industry's head every time they play get-rich-quick games that backfire.

Banks had a better year in 2010? Great. Wake me up when "too big to fail" is no longer a reality.

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