Our Next Banking Crisis

IF the $150 billion tab for the savings-and-loan bailout seems like a big number to you, keep counting. For while our leaders pretend to ``get tough'' with thrift villains and ready the noose for hapless Neil Bush, a banking crisis that could make the S&L fiasco look pint-sized is just a few bad loans away. The problem is with the United States's 13,000 commercial banks. With $3 trillion, these institutions sport more than three times the deposits of our S&Ls. And they are more vulnerable today than at any time since the Great Depression.

More commercial banks failed in the last two years than ever before. They have written off $75 billion in bad loans since 1986 - when the economy has been strong - compared with just $28 billion throughout the 1950s, '60s, and '70s put together. Absorbing these hits in the past two years has dealt the FDIC insurance fund its first losses ever, and left the fund holding a historic low of 70 cents for every $100 of insured deposits. A mild recession could now bankrupt the fund completely - and then guess who's on the hook again?

There's no mystery to how banks got into this state. They were victims of a slower burning version of the same economic fuse that detonated our S&Ls.

In the old days banks, like S&Ls, had a nice little operation. New Deal legislation placed geographic limits on bank expansion, guaranteeing every bank an uncontested home turf. Commercial banks got the exclusive right to offer checking accounts, which everyone needs. Congress slapped ceilings on the interest rates banks could offer, to make sure no ruinous bidding for deposits would threaten everyone's margins. With newly enacted deposit insurance thrown in, every bank, whatever its size or pedigree, was as good as every other.

The result was a series of regional cartels in which even comatose bankers were sure to be moneymakers. The system relied on its stranglehold on individual depositors and business borrowers. Since most borrowers had few alternative sources of capital, being a successful banker didn't take a genius - you took in money below the mandated interest ceilings and lent it out at a few points more.

This basic structure worked well for decades. Banking failures seemed to be a relic of some bygone era. But beginning in the 1970s, the world changed. First, commercial banks woke up to find their dependable monopolies threatened at every turn. Big businesses got smart and found they could raise funds more cheaply by issuing their commercial paper directly to the markets - they didn't need a middleman to assess how creditworthy they were. meanwhile, the banks' consumer businesses got squeezed as companies like Chrysler, Ford, and General Motors formed finance subsidiaries to make cheap credit an attractive part of their marketing strategies.

The crowning blow, however, was the takeoff of inflation. This brought higher interest rates as lenders demanded compensation for the value their money lost before repayment. As market rates hit the ceilings banks could legally offer, investment management firms launched money market funds promising higher returns. Bank depositors fled in droves, removing the captive source of funds that had kept banks fat and happy for decades. When the old interest rate ceilings were phased out in 1980, that at least helped banks compete. But since all of us had learned that we could safely keep our money elsewhere, the damage had been done.

Thus jilted by their most creditworthy borrowers and squeezed by new competitors, banks were forced to take on riskier business to survive. Commercial banks now have $150 billion invested in high-flying merger and buyout loans, and $400 billion in risky commercial real estate. Another $60 billion in third-world debt sits like time bombs on bank balance sheets.

With portfolios like these, it's no wonder the FDIC's list of ``problem'' banks (though down from its 1987 peak) hovers at five times its early 1980s level. Or that the big rating agencies downgraded Citicorp's once invulnerable debt rating this spring. Meanwhile, the Bush administration's obsession with containing the political damage on the S&L front has left more rookies minding the store on the bank side.

What's to be done? Four things for starters. Banks now teetering on the edge of insolvency should be closed fast before losses mount. Banks should be given the power to enter new and profitable businesses, like insurance and securities underwriting, that arcane rules now forbid. At the same time, federal deposit insurance must be modified, so that Uncle Sam's credit card doesn't stand behind these new ``banking'' activities. And a ``deductible'' should be introduced into deposit insurance - just like the ones we have for car and health insurance - so we'll all have a stake in looking more closely at the kinds of risks our banks are taking.

There's still time to prevent today's warning signs from becoming tomorrow's bleak headlines. But only an active public - informed by an energetic media determined not to be blindsided again - can force our leaders to take action before we stick our children with yet another titanic debt to pay.