Bank failures: How bad will it be?

Bert Ely, principal of Ely & Co., a banking industry consultant, agrees that most community banks are in good shape and that they didn't get heavily involved in subprime, but, he says, they have other problems.

"Banks of all sizes, including community banks, have gone overboard in some areas. One is home equity lending, another is lending to developers for property development, and the third area is commercial real estate. We're going to see some banks fail with these problems. But if regulators move aggressively, the problems can be resolved before the bank becomes insolvent.

"One area where we'll continue to get failures -- and recessions tend to bring this out -- is failures due to fraud; particularly when there's internal fraud of some kind. Fraud is much more likely to bring down a small bank than a large one. Good economic conditions can mask fraud, especially if it's fraudulent lending."

Ely says that failures can lag the business cycle, and if we see a burst of failures, it may not peak until 2009 or 2010.

What happens after a failure
If an FDIC-insured bank does fail, the FDIC usually shuts down the bank on a Friday and reopens it by the following Monday. Even in times such as this, it hasn't been difficult to find a buyer to take over the institution. (For more specific information on what happens after a bank failure, read a Q&A with the FDIC's Barr.)

"The FDIC can carve out all the problem loans and other assets of the bank and just pass a clean institution to the acquiring bank," says FDIC's Barr. "Even if all they want are the branches, then they just take the insured deposits and they get an instant bank. Many times they'll take the front-line employees too.

"We try to market the liabilities as quickly as possible. The FDIC is not a financial institution; we're a liquidator. If they are marketable loans that could easily be sold on the secondary market, we'll try to sell those. If they're troubled loans, then we work with the customers to get them to perform.

"The good news for the taxpayer is that this costs them nothing since the FDIC is funded by charging banks premiums for deposit insurance. Now, if we run out of money, then the full faith and credit of the United States stands behind our insurance fund. Luckily, the FDIC hasn't had to go there, but if you remember back in the 1980s, the insurance fund for (savings and loan associations) actually went out of business and it cost the taxpayers $150 billion."

While insured deposits are covered 100 percent in the event a bank fails, Barr says that over the past 15 years uninsured depositors have received an average of 72 cents on the dollar for the portion of their funds that exceeded the insurance limit. There have been instances where uninsured depositors received 100 percent of their money, but others have received much less, as was the case with the Oakwood Deposit Bank in Ohio in 2002, where uninsured depositors received just 42 percent. While you may recover your uninsured deposits, it can take a long time, even years. On the other hand, insured deposits are paid very quickly, usually within 48 hours.

There are several ways to insure more than $100,000 at a single bank. Read " Are your deposits insured?" for tips on making the most of FDIC coverage.


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