Why So Many Banks Go Belly Up

By Alexander L. Taylor III

Misconduct, mismanagement lead to a near record failure rate

A financial thunderbolt struck the tiny farm community of Danvers (pop. 920) in west-central Illinois one Friday this month. The First National Bank of Danvers, the only bank in town, with 2,560 accounts and about $11 million in deposits, was declared insolvent by federal authorities and shut down until new owners could reopen it under another name. That same day 2,000 miles away, the Oregon Mutual Savings Bank in Portland also closed its doors before being taken over by an Idaho holding company. The bank had seen its net worth fall nearly 20% in just six months. Said President Jack Goetze: "Without a capital infusion, our net worth would have been seriously impaired in another ten months."

Bank failures used to come in isolated outbreaks. During the 1960s and '70s, they averaged fewer than ten a year. But despite the stronger-than-expected economic recovery, they are now occurring at a worrisome rate. Across the U.S., more than one bank a week is failing. By year's end, the number of failures, now 35, should easily beat the post-Depression record of 43 set in 1940. (Runner-up: 1982 with 42 failures.)

In Texas, anxious depositors withdrew $447 million during the first half of the year from the First National Bank of Midland (assets: $1.5 billion), whose loans to oil and gas producers turned sour. Earlier this month, the bank reported a second-quarter loss of $109.3 million. Many banks are now teetering on the brink of collapse. At the end of July, the Federal Deposit Insurance Corporation listed 540 "problem" banks, ranging from small state-chartered ones with too many weak agricultural loans to nationally chartered banks with bad business loans. Among the 540, the FDIC secretly lists dozens as likely to fail unless they are soon merged with healthier financial institutions. Says John Downey, chief national bank examiner for the Comptroller of the Currency: "The number is the highest I've ever seen it."

No longer does a bank failure result in angry customers milling outside locked doors, or widows and orphans being stripped of their life savings. Closings have become so routine that agencies like the FDIC perform them with robot-like precision. Typically, authorities move in after business hours on Friday and freeze accounts. By the following Monday, they have either paid off the depositors or allowed another bank to assume control. But such transitions are not without cost. The FDIC spent $870 million last year, mostly to compensate private financial institutions for taking over bad loans. Moreover, bank shareholders can see their investments vanish when the financial institution goes under.

Part of the blame for the rising number of failures belongs to the recession and its complement of bankruptcies and defaulted loans. But increasingly, the problems are due to poor bank management. Says an FDIC attorney: "We find examples of actionable negligence on the part of bank officers and directors in virtually every case of a closed bank."

Some examples involve sheer stupidity or the failure to make a move at the right time. Two weeks before First National Bank of Danvers failed, its officers filed a suit against former President Terry Winterland, claiming he made loans without adequate collateral. Replies Winterland, 41: "I can't comment without getting my nose crossways, but I'm not the culprit they say I am."

Other cases may involve outright criminal misconduct, such as intentional fraud or dishonesty, by bank officials. In California, scene of a rash of failures, Consultant Gerry Findley says there has been "a pattern of insider abuses that included sweetheart loans and deals to organizations that officers are involved in." After the collapse of Jake Butcher's United American Bank of Knoxville, Tenn., in February brought down another bank formerly controlled by him and five other financial institutions directed by his younger brother C.H., the FDIC identified bad loans totaling hundreds of millions of dollars. Many of them had been made to friends, relatives and business associates.

Bank failures are one effect of the growing deregulation of financial institutions. Since interest rate ceilings on savings deposits were lifted last year, banks have been cut off from easy sources of cheap money and have had to increase sharply the rate of return they pay on deposits. In addition, deregulation has made banking more competitive. In California, the number of banks has surged from 242 four years ago to 387. They must now also compete with such firms as Shearson/American Express, Merrill Lynch and Prudential-Bache, which offer accounts that operate much like the savings and checking accounts once offered only by banks. With everyone striving for more business, risks grow and profit margins shrink.

A banker's job has not been made any easier by the rapid and unpredictable changes in the economy over the past 18 months. Banks that gambled on interest rates going down when they actually went up find themselves paying out more for deposits than they were charging for loans. Real estate investments turned sour after mortgage rates hit 17.5%; oil and gas deals fell apart when energy prices dropped. Other loans that looked profitable when the rate of inflation was expected to be running at 15% became disasters when the rate dropped below 5% and stayed there.

Despite the hard times and high risks, the number of new commercial banks being started still outnumbers failures 10 to 1. A bank is still a good place to make money, and the outlook will improve even more as the recovery gathers force.

-- By Alexander L. Taylor III

Reported by Ross H. Munro/Washington, with other bureaus

With reporting by Ross H. Munro This file is automatically generated by a robot program, so viewer discretion is required.