Nagging Questions of Stability

It was a swift, smooth salvage job. Perilously short of cash needed to pay off creditors, Long Island's Security National Bank (assets: $1.8 billion) was close to collapse. Over a hectic weekend in Washington, Comptroller of the Currency James E. Smith declared a formal emergency under the banking laws, then arranged for Justice Department and Federal Reserve Board approval of a quick rescue. When Security National customers showed up at the bank's 86 branches on the following Monday, they were greeted with signs announcing, WE'RE NOW CHEMICAL BANK.

New York's Chemical, the country's seventh biggest bank, paid the defunct Security National company, which had been the 79th largest, $40 million for its assets. Explaining the speedy takeover, Chemical Chairman Donald C. Flatten said that Comptroller Smith "wanted it done quickly." Added Flatten: "The public interest was involved."

Deep Trouble. Security National had been under Government scrutiny for several months because of its increasing reliance on short-term borrowed funds to support its lending activity. An aggressively run outfit that grew rapidly in the early 1970s, Security National had invested heavily in a questionable drive to expand into the competitive New York City banking market. But it began running into deep trouble last year when the housing industry collapsed, and much of its fat portfolio of real estate loans went sour.

Having written off $11.7 million in lost loans during the first nine months of 1974 (v. 3 million in all of 1973), Security National desperately needed to increase its capital. At the same time, however, depositors were steadily pulling out--at least partially because they had been shaken by the failure in October of another overly ambitious Long Island bank, the Franklin National, which suffered from many of the same problems as Security National. Had Security National actually closed its doors, it would have been the fourth sizable bank to go under in the past 16 months.

These failures, and the near collapse of Security National, gave new urgency to a frightening question: Are many more of the 14,616 banks in the U.S. dangerously overextended? Undeniably, the tight squeeze on credit that the Federal Reserve applied last spring and is only now beginning to ease has been especially hard on expansion-minded regional banks like Security National. Unable to raise enough cash by selling stocks or bonds, many of these so-called second-tier banks have been forced to borrow increasing amounts of money from other banks and from the Federal Reserve, often on short terms and at high interest rates, in order to satisfy loan demand. As the recession has gathered steam, meanwhile, bad loans have been mounting.

At the moment, the Treasury is maintaining special surveillance on more than 70 banks whose capital reserves are particularly low in relation to their loans. The Fed has sent out unmistakable signals that it wants banks to slow their rush to diversify. Last year the Fed rejected bids by* four-of the nation's ten largest banks to make acquisitions, citing various reasons including weak capital positions.

Loan losses will undoubtedly increase this year as the recession continues, but the capital scarcity plaguing the banking system is temporarily easing, in part because of the diminished demand for business loans. Moreover, the Fed has been gradually increasing its injections of money into the system since last fall. Last week the Fed reduced the amount of reserves that banks must keep on hand to back up certain types of deposits (chiefly checking accounts); in effect this will make available up to $6 billion more for new bank loans.

Big Deficit. Taken together, the Security National rescue and the Fed's loosening showed that Washington is not going to allow faith in the banking system to be shaken by some individual episodes of bad loans and bad judgment during what may prove to be the worst U.S. recession in 40 years. It also shows the Government's desire to avert a capital squeeze that could result from the heavy Treasury borrowing that will be necessary to cover the Administration's big budget deficit. Last week Treasury Secretary William Simon predicted that federal deficits for the two fiscal years ending June 30, 1976 will hit $85 billion--the biggest deficit in 30 years.

The banking system's present problems stem from a decade of rapid growth, which stretched the resources of many institutions to the limit. The new Congress plans to hold exhaustive hearings later this year, not only on the recent bank failures but also on several broader questions. Among them: whether or not to curb the proliferation of big bank holding companies and whether the U.S. needs a system of credit allocation to help protect credit-sensitive industries like housing from being choked when money is tight. The country's bankers dislike prospects of even more regulation in their heavily controlled industry. "Any business can be ruined by bad management," says Chairman Walter Wriston of New York's First National City Bank. "Regulation won't save it." But to judge from all the rumblings on Capitol Hill about reforming the banking system, Washington believes that it can.

* The four: BankAmerica, Citicorp, Bankers Trust New York and First Chicago.

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