The Bank Crisis And The S&L Fiasco: Two Sides Of A Bad Coin

Is it deja vu all over again? Is the current banking crisis a replay of the savings and loan debacle? Since Yogi Berra has not ruled on the matter, allow me. My answer is: yes and no, but more no than yes.

The major difference is that the savings and loan associations, children of regulation, were designed with a fundamental flaw that commercial banks do not share: They borrowed short to lend long. That's risky when interest rates change, because market values of fixed-rate mortgages fluctuate dramatically while the values of bank deposits hardly move. When interest rates soared in the 1970s and early 1980s, the asset values of many thrifts plunged so far that their net worth became negative at market value. Barring an interest-rate miracle, they were finished.

Congress made a last-ditch effort to save the dying S&Ls by broadening their lending powers and expanding deposit insurance. But Congress forgot--that's the charitable interpretation--one small detail. If you grant new powers to moribund institutions with insured deposits, you'd better watch them carefully. If you don't, even honest executives may succumb to the temptation to use insured deposits to make risky but high-yielding investments. If the gambles pan out, the S&L may be saved. If they don't . . . well, it was doomed anyway--and depositors are protected. When Congress failed to beef up the supervisory agencies, an unseemly number of unscrupulous financial cowboys were attracted by the prospect of gambling with other people's money. Thus did the once-sleepy S&L industry come to be the home of Charlie Keating.

OVER THE CLIFF. None of this resembles the plight of the commercial banks. They closely match the maturity structures of their assets and liabilities, and so are relatively immune to interest-rate swings. They have not received new lending powers. And they are supervised more rigorously than thrifts were. Why, then, are so many banks heading for the tank? It seems they lost money the old-fashioned way: through bad business judgment. Imitating lemmings, too many bankers lent too much money to developing countries, to corporate raiders and defenders, and to real estate developers who, in retrospect and perhaps even in prospect, were poor credit risks. Too many allegedly prudent bankers left their loan portfolios inadequately diversified.

While banks were shooting themselves in the foot, new competitors were shooting them through the heart by encroaching on their traditional territories. Now, all of us can hold checkable balances outside banks--with mutual-fund companies, with stock brokers, and even with thrifts. The best corporations

borrow more than ever on the securities markets and from foreign banks.

So, the banking crisis is not a replay of the S&L crisis. Nonetheless, there are some disquieting similarities. First, severe loan losses have left many banks in a weakened state and, in conjunction with deposit insurance, have created incentives to "bet the bank" on risky ventures. Sound familiar? Second, the Federal Deposit Insurance Corp. is badly underfunded. This, too, sounds familiar--and will soon force Congress to act. The premiums that banks pay for deposit insurance will surely be raised, and there is talk of a one-time levy to bolster the insurance fund.

BENIGN STEPS. Two other ideas are under active discussion but should be approached with caution. Some kind of limit on federal deposit-insurance coverage may well be part of a long-term redesign of the banking system. But it should not be enacted now, in themidst of a recession. The last thing we needin 1991 is a collapse of confidence in deposit insurance.

The other idea--forcing banks to raise more capital--must certainly be part of the long-run solution. A bank's capital is the "deductible" in its deposit-insurance policy: If the bank fails, the FDIC subtracts the deductible and pays the balance to depositors. Thus, more bank capital reduces the FDIC's exposure. But once again, this is the wrong time to do the right thing. With the stock market so sour on bank stocks, it's not a propitious moment to force them to issue new shares. Nor can troubled banks with depressed earnings accumulate much equity by retaining earnings. (But they have no business paying dividends!) So if regulators force banks to raise the ratio of capital to assets, the banks may extend less credit--thereby deepening the recession.

In short, now is not the time to punish the banks, even if they have sinned. In fact, since higher deposit-insurance premiums will impair bank profitability, we should probably be thinking of ways to repair the damage. One relatively benign step is to end the archaic restrictions on interstate banking. Another is to permit or even encourage mergers and consolidations that reduce costs. After all, it is better to weed out redundant banks through mergers than through bankruptcies.

Neither measure offers quick results, but a third one does: By lowering reserve requirements, the Federal Reserve Board can both give bank profits a quick boost and fight recession. By no coincidence, the Fed did precisely this last month. Perhaps it is time for a second dose.

Before it's here, it's on the Bloomberg Terminal.