America's community banking crisis may go down as one of the biggest nonevents of the current financial crisis.
This is, perversely, both an indictment and a testimony to the regulatory system charged with overseeing our financial institutions and protecting consumers.
"FDIC Friday" has been a fixture on the calendar since 2008. That's the day dark-suited staff from the Federal Deposit Insurance Corp. quietly swoop into a city to shut down a troubled bank. It's happened almost 300 times during the past two years, with 2010 seeing the most bank failures in almost two decades.
In Minnesota, eight banks closed in 2010, up from five in 2009. The biggest, Community Security Bank of New Prague, had assets of $108 million. The smallest, First American State Bank of Minnesota, in Hancock, had assets of $18.2 million. You can now buy that bank's headquarters building from the FDIC for $80,000.
Subsequent audits revealed shockingly lax and inconsistent oversight on the part of multiple federal and state agencies. Some banks, including First Integrity Bank in Staples and Community National Bank in Lino Lakes, were done in by wide-scale fraud. Others were victimized by a combination of incompetence, naivete and wishful thinking.
Each banker, it seems, was as certain as the next that real estate values would never fall. When that notion proved wrong, those bank executives turned desperate. Prosperan Bank in Oakdale, hoping to goose its returns, shifted its investment portfolio from government-backed securities to riskier, privately issued mortgage-backed and asset-backed securities.
America's big banks pioneered these same practices, albeit on a much grander scale, and have been vilified for almost taking down the world financial system.
But make no mistake: The collapse of America's community banks has been costly. In Minnesota alone, it has cost the FDIC's insurance fund $277 million, and that total could rise depending on the prices paid for toxic assets still to be sold. The FDIC estimates that bank failures and asset sales will cost its insurance fund $52 billion between 2010 and 2014.
And in many regions, community banks bear a big responsibility for the glut of residential and commercial space that will suppress real estate values for years to come.
But the public response to this mess has been muted, at best, and for one good reason: The same regulatory system that failed to prevent the problems in the first place stepped in and arranged an orderly transfer/liquidation that protected depositors. Customers could also take comfort in the fact that their accounts were insured by the FDIC for up to $250,000.
The good news is that the pace of bank closings slowed during the second half of 2010. While the FDIC's official list of problem banks includes 860 institutions, it's budget for next year is slightly smaller based on expectations that bank seizures have peaked. As the economy strengthens, banks will be able to raise more capital and sell some of their distressed loans. "I think we'll see fewer bank failures in 2011," said Steve Erdall, a Minnesota-based consultant to community banks.
The new financial reform law that was signed earlier this year includes provisions that will affect community banks, but the regulations have yet to be drafted. In an interview last week, the incoming chair of the House Financial Services Committee, Rep. Spencer Bachus, R-Ala., gave a preview of what to expect.
"In Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks," Bachus said.
That's what got us into trouble in the first place.
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