1.  Astronomical growth in number of new banks

 2.  Too many bank presidents, and

 3.  “Flipping” Banks

 As I’ve said before, none of the reasons for this can be stated without bringing in one or several of the others, but for the sake of simplicity, we can think of the three above as the kindling that started the fire.

As stated in the Wall Street Journal article, there was an explosion in the number of banks chartered in Georgia.  I can remember a time when the Georgia Department of Banking and Finance’s monthly newsletter contained anywhere from 10-20 banks in formation for years on end.  Money to start these banks flowed in like floodwater.  There were numerous success stories of banks starting and three years later selling for triple the initial investment.  What people failed to realize is that banks are not all that different from chain restaurants. 

What do I mean by that?

Banks all offer basically the same thing.  They all offer very similar core products.  They all claim to be service oriented.  They all want to be YOUR bank.  Chain restaurants do the same thing.  They have extremely similar food (no matter what they claim).  They all offer “great service and great times.”

Everyone knows when there gets to be too many Applebee’s, Chili’s, and O’Charley’s in one area- one of them goes out of business.  There simply aren’t enough good customers willing to provide enough profit for them all to do extremely well. 

It’s no different in banking.  The only difference is that banks can pretend to find good customers for some time before anybody realizes that there’s a huge problem.  If all of a sudden Chili’s started accepting checks where 10-15% of them got returned, they wouldn’t be able to hide the loss.  On the other side, if Chili’s suddenly starts to literally bribe people to come eat with them by offering free food, they’re probably not going to last long. 

Banks are able to do both of these.  Loans can be made to people or businesses that are extremely unlikely to pay.  Deposits can be brought in by giving away  a lot of money with high interest rates.  Neither of these shows up as problems until years later when those loans that were once deemed safe, start to turn risky.  If you couple those loans with a huge depreciation in the value of the collateral, you get a recipe for disaster.  Throw in deposits that were overpriced to begin with costing even more relatively huge amounts of money to keep, and you’ve got a bank failure. 

Moral of the story:  There were way too many banks, so the natural result in our capitalist society is that there will be an equally large number of them to go out of business.

Similarly, there were too many bank presidents.  As Robert Braswell so conveniently alluded to in the article, basically anybody with a decent background in banking could raise enough capital to start a bank.  Let me emphatically point out that banking is different from almost any other business.  It takes FAR less capital (relatively) to start a bank than it does almost any other business.  This means that if there are losses, they go out of business fairly quickly.  This is where regulators and investors fell asleep at the switch. 

Everyone can’t run a bank.  Even some great bankers eventually fall prey to things like hubris, greed, and flat out being too busy to mind the store.  When you’ve got a few great bankers trying to do business with a ton of terrible ones, you get an equally likely recipe for disaster. 

 Bad bank presidents will grow too quickly with expensive deposits and risky loans.  They won’t manage risk effectively at all.  They won’t do enough homework on their loans or ensure that processes are in place to ensure that fraud is adequately controlled.  They can definitely prosper for a long time, but eventually the music has to stop.  It did.

 With all the bad bank presidents running around and getting approval from regulators because of the flood of capital, good presidents were put into quite a pickle.  They had to compete.  If they didn’t grow as fast as everyone else, they were considered terrible.  This meant that they had to do a lot of the same things that the bad presidents were doing.  And, in the end, if it looks like a duck, walks like a duck, and quacks like a duck; it’s a duck.  Good bank presidents with real knowledge of how to do it the right way eventually became bad.  Because of the extremely competitive nature of banking, it doesn’t take many bad apples to ruin the barrel.  This one is thoroughly ruined.

 Finally, as I’ve already alluded to, banks were being built up and sold in 3-5 years with massive amounts of profit for the people who started them.  Not everyone was doing this.  A lot of people were building banks that they wanted to preserve and run well into the future.  The problem is that investors and regulators only saw the huge growth, huge number of sales at extremely high prices, and no (apparent) losses. 

These banks were being built up with expensive deposits and loans that were built on a real estate bubble that eventually had to explode.  We saw the same thing with the “dot-com” bubble in the late 1990’s.  The reason why this was so much more painful was because of the nature of banks.  I’ve already detailed this to a large extent in “Smoke and Mirrors” in an earlier post.  Basically, banks are built on relatively small amounts of real money.  If something goes wrong, it doesn’t take much to bring one down.  If a lot of things go wrong, you get the current situation.

To get back to the “flipping” analogy- everyone has seen the shows on HGTV, TLC, etc. that show a really crappy house being turned into a nicer and much more expensive one.  The banks were the same way.  They were made to look pretty on the outside, but if you looked behind the curtain, they had deteriorating wood, old electrical wires, and weren’t in all that great of areas.  But, because they looked pretty, i.e. big profit, big growth, seemingly no bad loans- they got snapped up just as fast as somebody could start a new one.  Just as the home flipping business went, so too did the banks. 

In the next part of this series, I’ll delve further into some of the more difficult to explain aspects of the implosion.  Stay tuned.

I thought this would be the perfect platform to briefly describe the most likely scenarios for a bank shutting down, what you can and can’t do following your bank failing, and where to find important information.

Here are the three most common (though not all-inclusive) scenarios.

1. Your bank fails and the FDIC takes it over without finding another bank to buy it.
2. Your bank fails and the FDIC finds a buyer of the deposits.
3. Your bank fails and the FDIC finds a buyer of the whole bank.

Scenario 1

Your bank is known to all regulators and bankers as the ugly, fat, annoying girl. Not only does it have a huge amount of problems on the surface, but it’s made up of such useless deposits and loans that nobody- not even the drunkest guy at the bar- will take her home.

If you have your deposits at this bank and they’re under the FDIC insurance limit, you’ll probably be sent a check for the balance of your account on the Monday following the Friday that the bank closes. If any part of your deposits is over the FDIC limit, you lose that amount of money (ONLY the amount that exceeds the limit). Over the weekend, the FDIC will contract with a big bank like Bank of America or SunTrust to allow transactions on the accounts to post as they normally would. You’ll have to open up another account at another bank immediately.

If you have a loan at this bank, you keep paying your loan, but might have to change where you send your payments. You will be strongly encouraged or flat out told to find another bank to take over your loan. If the loan is unsecured, you might be required to pay it immediately or find another bank to take it over. This is a bad scenario for people with loans, because the FDIC simply doesn’t have the right staff to service the accounts. It will get rid of them as fast as possible or sell them to another bank/private company. This doesn’t always turn out badly for loan customers, but it’s the worst scenario for you.

Scenario 2

To use a similar analogy, bankers and regulators think of you as a really attractive person but you have an STD. You’re hot, but they wouldn’t touch your assets even if you paid them.

If you have a deposit account with this bank, you’re perfectly fine. You won’t have to do anything but get used to a new bank’s name on your checks, debit cards, statements, etc. You’ll probably even get to work with the same staff with which you’re used to working. You’ll see the same smiling faces and hopefully get the same great service. Your accounts will also continue to be fully insured and you’ll have the peace of mind that comes with a stronger bank.

The only downside in this scenario is that the rate you’re currently paid on things with variable rates (money markets, savings accounts, checking with interest, etc) might be changed to a much lower rate. CD rates should be honored until maturity, but you will probably not be paid nearly as well when they renew.

If you have a loan with this bank, you’re in the same boat as Scenario 1 customers. The FDIC wants to get rid of you, and it doesn’t particularly care how it does it. See Scenario 1 for the breakdown.

Scenario 3

Keeping with the theme, your bank is as hot as Miss America (or Brad Pitt, for the ladies), has a great personality, and unfortunately was dumb enough to swallow a gallon e coli bacteria. With the proper penicillin, this will once again be an awesome bank.

If you have a deposit account with this bank, just like in Scenario 2, you’re perfectly fine. Go ahead and go on that weekend trip and don’t worry about your debit card working. Again, your accounts are fully FDIC insured immediately.

If you have a loan with this bank, you’re in luck. The new bank wants you and values you. They might give some customers a hard time, but they want to keep the vast majority of them. If you’re a bad loan customer (Don’t act like you don’t know you are), you’ll probably be harassed until you go away, get foreclosed on, or agree to some kind of painful workout. If you’re a good customer, just write the new bank name on your loan payments and keep rolling along merrily.

Important Information:

If your bank fails (or you think it might have failed), it is absolutely critical that you go to the following website:

www.fdic.gov

In the upper left hand corner, you will see something that says “Bank Closing Information – (Day the bank Closed)” and underneath, it will list the closed banks for that week. Click on your bank name and read EVERYTHING on each page. This will tell you exactly what you need to know regarding your accounts and what changes to expect, if any. It will also give you some interesting information detailing the transaction that took place and the loss to the FDIC fund.

The FDIC will also post information on every door and drive through window of every branch immediately upon closing the bank. This will basically detail the same information that you can find on the website.

Finally, always remember that your accounts, no matter how ugly or attractive your bank is, are fully insured up to the FDIC limit if they have a sign that says “FDIC Insured” posted in the lobby. There is absolutely no reason to worry about your money if you keep it under this limit. You will ALWAYS be paid that money…unless of course, the FDIC and US Government fall… but let’s not get into that just yet.