Pillars Of Sand

By John Greenwald

Guards posted outside dozens of shuttered financial offices in Rhode Island last week were ominous portents for the troubled U.S. banking industry. Only ) hours after he was sworn in on New Year's Day, Governor Bruce Sundlun shut down 45 banks and credit unions to prevent a run on deposits in the wake of the collapse of the private firm that insured them. While such private insurance has become a rarity, the closings aggravated the growing anxiety about the health of the entire financial system, as the U.S., already reeling from the savings and loan debacle, sinks into a new recession.

Not since the Great Depression has the outlook for so many banks seemed so grim. The epicenter of distress is the downtrodden Northeast, where lenders in New York and New England are writing off bad loans at a furious pace. Many of the worst headaches are in New York City, which is home to seven of the 10 largest U.S. banks. Experts predict that such giants as Citicorp, the biggest U.S. banking company, Chase Manhattan (No. 3) or Chemical (No. 8) may have to merge with other large firms to survive. "There is a high chance for a major consolidation over the next one or two years," says James McDermott, who follows the industry for the Wall Street investment firm Keefe Bruyette.

Such a marriage would be just part of a broad upheaval that seems certain to reshape American banking this year. From Main Street to Wall Street to the White House, 1991 looms as a watershed for the staggering industry. Calling financial reform a top domestic priority, George Bush is preparing a proposal to free banks from regulations that bar them from crossing state lines or diversifying into new fields. Congress began to put forth its own proposals last week. Meanwhile, more than 1,000 of the nation's 12,400 commercial banks are on the government's watch list of troubled lenders, a level four times as great as during the 1981-82 recession. And the Federal Deposit Insurance Corp. expects 180 banks with total assets of $70 billion to fail this year. The cost of closing them will drain more than half the cash now in the FDIC fund that insures bank deposits, leaving a meager $4 billion on hand, unless something is done to shore up the fund.

The industry's problems have affected consumers and companies by discouraging banks from lending to any but their most creditworthy customers. The resulting credit crunch helped bring on the recession and drive up unemployment, which the government said last week reached 6.1% in December, the highest level in more than three years. Moreover, big banks have kept lending rates high to bolster sagging profits, which fell to $3.8 billion in the third quarter of 1990, down from $5.3 billion in the April-June period. Most major banks waited until last week to lower their prime rate a half- point, to 9 1/2%, even though the Federal Reserve Board had dropped its discount rate, on which the prime is largely based, two weeks earlier. Many banks are raising service charges for everything from automated-teller-machine transactions to penalties for bounced checks.

The biggest risk is the prospect of a widespread bank collapse. The trigger could be a protracted war in the Persian Gulf, which could, in turn, deepen the recession and force debt-laden companies into massive loan defaults. Collapsing banks would aggravate the downward spiral by drying up credit and leaving taxpayers with another painful bailout bill. The disaster scenario may be plausible, but most experts doubt that bank failures will come close to the magnitude of the S&L fiasco, which will cost Americans as much as $1 trillion over the next 30 years. Despite the banking industry's problems, 89% of U.S. commercial banks were profitable in last year's third quarter. The S&L industry, by contrast, lost $1.5 billion during the period.

Big banks have been sliding into trouble since the 1970s, when many of their best customers began drifting away. Major companies found they could raise funds more cheaply by borrowing in money markets, rather than turning to banks. And depositors could get higher returns and adequate safety by putting their savings into money-market funds instead of passbook accounts. The defections left banks to chase riskier business, such as Third World lending or leveraged buyouts, to keep their profits up. "Banks just can't compete with other providers of services that they have traditionally offered," says Gary Gorton, a finance professor at the Wharton School. "So banks have had what is left over."

Many of the biggest high rollers were New York City banks that lavished loans on everyone from Latin American dictators to Donald Trump. At the same time, they helped finance the 1980s real estate boom that has filled U.S. cities with vacant office towers and dotted suburbia with empty condominiums. "Citicorp was hurt the most," says Thomas Brown, a Paine Webber banking analyst. "Then come Chemical, Chase and Bank of New York."

The banks took part of their lumps in huge write-offs last year. Conceding that the full value of many loans will never be collected, Citicorp said it % expects to report at least $300 million in losses for the fourth quarter. Chase lost $623 million in the third quarter, while Chemical reported a $43.7 million deficit for the same period. The problems have taken their toll on workers as the troubled banks have slashed payrolls and shuttered divisions and offices. New York City banks have eliminated 15,000 jobs since 1987, or 8% of their work force.

Attrition has been heavy across New England, where bad real estate loans have put some banks on the endangered list. Boston's Bank of New England said last week that it may report a loss of as much as $450 million for the fourth quarter. The deficit moved the troubled bank to the verge of collapse.

The pain was most immediate in Rhode Island last week when bewildered customers learned that more than half the state's banks and credit unions closed their doors. "I've had all my money in here since 1967," said a tearful depositor who found herself locked out of her credit union. "It's $10,000. It's my life's savings. And now I might lose it all." Sundlun shut the institutions after their private insurer, the Rhode Island Share & Deposit Indemnity Corp., was sapped by the failure of a Providence bank whose president vanished in November with $13 million in funds. While 22 credit unions were scheduled to reopen this week under federal deposit insurance, Sundlun pledged to bail out shuttered lenders that are too weak to qualify for such coverage.

Banking's woes are spreading beyond the Northeast. In California, where banks are generally suffering less than in other regions, Security Pacific Corp. last month projected a loss of at least $320 million for the fourth quarter. More than half the bank's problems stemmed from loans outside California, particularly to builders in Arizona. Experts are worried that a further downturn in California's slumping real estate market could cause a flood of red ink at the state's other big banks.

The shaky health of the industry led Congress last week to introduce bills to shore up federal deposit insurance and strengthen federal bank supervision. Sponsors included Henry Gonzalez, the Texas Democrat who chairs the House Banking Committee. Meanwhile, the Treasury Department is drafting plans to permit banks to enter new fields to increase their profitability. The key points in the proposals:

Federal deposit insurance. All sides want to rescue the FDIC fund. The Administration is considering plans to levy a special assessment on banks or raise their insurance premiums to add at least $25 billion. The proposals would limit depositors to a total of $100,000 in federal insurance; in the S&L bailout, some big customers are being repaid the full $100,000 for each of several accounts.

New lines of business. To give banks a broader base of profits, the Administration wants to scuttle Depression-era laws that severely limit bank activities. It would allow banks to underwrite securities and may urge that they be permitted to sell insurance or to affiliate with other types of companies. Banks would be prevented by so-called fire walls from risking federally insured deposits in the new ventures. Moreover, only healthy, well- capitalized banking companies would be permitted to enter new fields.

Interstate banking. The White House would permit banks to open branches across state lines and thereby create nationwide networks of loans and deposits. While most states permit some form of interstate banking, their separate policies subject banks to a crazy-quilt pattern of rules and regulations.

Government supervision. The Administration and Congress want to consolidate the federal authority to regulate banking. That would simplify a regulatory process that is parceled out among such agencies as the Federal Reserve Board, the Comptroller of the Currency and the FDIC.

The proposals to broaden banks' powers are certain to inspire a wide range of opponents, from insurance companies to small-town bankers. "Full national branch banking is only going to lead to greatly increased financial concentration," says Kenneth Guenther, executive vice president of the Independent Bankers Association of America. "It only means that the big will get bigger." Such arguments lead congressional staff members to consider the expansion of banking powers a long shot at best.

In any event, 1991 will see a major shake-out among banks as weak ones fail or merge with stronger partners. But barring a severe worsening of the recession, most of the industry should survive the slump. "If the New York banks can pull through, the present situation is very manageable," says John McCoy, chairman of Ohio's financially robust Banc One Corp. Concurs Thomas Theobald, chairman of Continental Bank in Chicago, which the government rescued from a brush with bankruptcy in 1984: "The system has had its heart attack, but we view that as a warning and a way to recovery. It's not fun. It's tough. But, thank God, we're going through it." Since confidence in the economy is so closely tied to the fitness of banks, everyone can only hope that they are right.

With reporting by Robert Ajemian/Boston, John E. Gallagher/New York and Michael Riley/Washington