The 100 grand illusion; the problem with the banks and thrifts that they still haven't fixed.

• Author: Miller, Matthew

The 100 Grand Illusion

They said they fixed it. But they lied.

Even with a year-long debate, massive legislation, and "never again" assurances from every corner, the S&L bailout failed to address the fundamental threat to our banking system. The shocking result? Though we've just forked up a cool $150 billion, our biggest banking crisis is still ahead of us.

The problem is federal deposit insurance. It began in the 1930s as a sensible way of restoring confidence and preventing bank runs. Yet it also transferred all credit risk in the bankng system to the taxpayer, by assuring that the government stood ready to repay depositors whenever some daredevil or dimwit threw money away on nutty loans. Bankers, like trapeze artists, try riskier stunts when they know there's a net beneath them. By 1980, when coverage per account was hiked from $40,000 to $100,000 in a legislative ploy that went virtually unnoticed, that net become more of a fundraising tool for marginal banks than a guardian of the little guy's savings. We learned just how expensive that coverage was when failing S&Ls used deposits attracted by the enlarged federal guarantee to gamble on shopping malls, cattle farms, and junk bonds--and then stuck us with the bill. The price of this blank check? If coverage hadn't been hiked in 1980 and perverted the intent of insured funds, says former FDIC Chairman William Isaac, "We would have saved $50 billion or more."

If those numbers seem big to you, keep counting. Because our 13,000 commercial banks--sporting, at $3 trillion, three times the deposits of the S&Ls--could make today's crisis look pint-sized. There may have been less reason to worry aobut a blank insurance check in the old days, when banks faced little competition and earned stable profits. But because of dramatic changes since the early 1970s, banking is more vulnerable today than at any time since the Depression. Consider: more commercial banks failed (that's right, not S&Ls) in the past two years than ever before. They've written off $75 billion in bad loans since 1986--when the economy has been strong--compared with ust $28 billion over the entire 1948-81 period. Absorbing these hits in the past two years has stuck the FDIC insurance fund with its first losses ever and left the fund holding a historic low of 70 cents for every $100 of insured deposits. Experts say that even a mild recession could now bankrupt the fund completely--and then guess who's on the hook again?

You'd think the potential for a commercial bank sequel to the S&L insurance meltdown would have our leaders sounding the alarm--but you won't find any profiles in courage when it might mean tampering with what is now perceived as virtually a constitutional right. Any proposal to change deposit insurance coverage is "like saying you're going to take away social security benefits," says ex-FDIC chief Isaac. "It would be an enormous political battle." With feel-good politics still the reigning fashion in Washington, there aren't any takers. Treasury Secretary Brady got so scared by the outcry over his early suggestion that depositors pay a tiny fee to help cover the S&L payoff that he's since become. The Invisible Man. Politicians who understand the stakes would sooner sacrifice their first-born than talk about reducing the $100,000 coverage. And even normally gutsy free agents like FDIC chairman William Seidman, who told the National Press Club in 1988 that "a deposit insurance sysem out of control has the potential to 'melt down' and damage the entire U.S. economy," evasively says today, "I haven't got a preferred solution at the moment."

Despite the stakes, villainless themes like "the risks of deposit insurance in a modern bnaking system" won't inspire press coverage, either. "It's not a concept that lends itself to a picture," laments Rep. Charles Schumer, who sits on the House Banking Committee. "They like to focus on misdeeds--it's much easirer to tell a morality story." Wall Street Journal editor Robert Bartley thinks the media blows it because the story doesn't fir the conventional wisdoms that untutored journalists rely on to peg complicated issues. "The stereotype [on banking] has been 'deregulation,'" he says. "Deposit insurance doesn't fit that. Until something happens that changes that stereotype, the deposit insurance angle won't catch on."

We may not have the luxury of waiting. Banks, boxed in by 50-year-old restrictions on their activities, may soon get the power to underwrite stocks and sell insurance. This means our tax dollars could be insuring everything from bum public offerings to burning buildings if the federal safety net isn't cut out from under these new "banking" businesses. A decade ago thrifts got precisely this chance to bankroll newfangled investments with Uncle Sam's credit card. did somebody say deja vu?

Meanwhile, Congress wages more important battles against flag burning and homoerotic art. And Treasury--where the leadership should come from--rests on laurels that would make even shiftless bureaucrats blush. The Brady Commission's post-crash report ons tock market reform went nowhere. The Brady Plan on developing country debt vanished without a trace. Brady's touted program to get corporate America focused on the long-term was never proposed. Now Treasury and the Congress are sitting on a deposit insurance powderkeg, and the silence is deafening.

How did a certifiably good thing like deposit insurance become an agent of ruin? Understanding the transformation requires a brief trot through banking history. Once upon a time banking was a nice little racket. Thaths because the collapse of the banking system in the Great Depression prompted government at all levels to legislate banking competition out of existence. Congress and the states set geographic restrictions on bank expansion, including limits on branching and guild-like hurdles to obtaining new bank charters. Commercial banks got the exclusive right to offer checking accounts, which everyone needs. Competition between banks was deterred by slapping ceilings on the interest rates they could offer to compete for funds. With newly enacted deposit insurance thrown in, each bank, whatever its size or pedigree, was as good as any 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 mortgage-seekers) like you and me and business and mortgage borrowers. Since nobody had alternatives, being a successful banker didn't exactly...