Special Report: Crisis in Banking: Requium for a Heavyweight

By John Greenwald

Call it a tale of two bank failures. When Boston-based Bank of New England Corp. collapsed last week, federal regulators rushed to bail out the region's fourth largest banking company (assets: $22 billion). To prevent a run on deposits that could spread throughout troubled New England and beyond, Washington even stood behind deposits of more than $100,000, the limit covered by federal insurance. But when the small, black-owned Freedom National Bank (assets: $121 million) failed last November in New York City's Harlem, the Federal Deposit Insurance Corporation saw no risk of a widespread panic and let holders of large deposits suffer heavy losses. Stunned charities, churches and other customers lost $11 million in accounts that exceeded the $100,000 limit.

Such favored treatment for the customers of big banks was a heated issue last week, as consumers and politicians braced for a possible wave of new banking failures. "The situation is patently unfair -- just plain wrong," said Henry Gonzalez, the Texas Democrat who heads the House Banking Committee. Concurred John Jacob, president of the National Urban League, which lost more than $200,000 at Freedom National because of the government's double standard: "I think it is grossly discriminatory against banks that happen to be small." Amid the outcry, the FDIC said it was reviewing its policy at Freedom National.

The question of fairness could arise often this year if a prolonged Middle East war creates an oil-price shock and plunges the U.S. into a deeper recession. In a gloomy assessment of the banking outlook, FDIC chairman L. William Seidman warned Congress last week that more big banks could go bust in 1991 unless the current recession is "short and shallow." A run of large failures would swiftly bankrupt the FDIC's deposit-insurance fund, which stood at $9 billion last month. Even without a sharp downturn, Seidman said, the fund will fall to a record low of $4 billion by the end of 1991, as an estimated 180 banking firms fail.

For American savers, already reeling from the savings and loan debacle, the banking crisis has inspired rising anxiety about the safety of their money. In a TIME/CNN poll of 1,000 adults surveyed last week by the firm Yankelovich Clancy Shulman, just 7% said they felt very confident about the soundness of U.S. banks, while 59% said they were only somewhat confident or not confident at all. Bigness is not necessarily reassuring: 52% said they had more faith in local banks than in larger ones, while 36% felt safer with their money in major institutions.

Few experts expect bank failures to come close to rivaling the S&L fiasco, which could cost taxpayers as much as $1 trillion over the next 30 years. U.S. banks have a total of $200 billion of capital to cushion losses, for example, while the S&L industry was virtually broke throughout the 1980s. Seidman told Congress that taxpayer funds would not be needed to finance bank bailouts under current economic conditions. But he added that "it is certainly not beyond the realm of possibility that taxpayer money will be needed" if conditions deteriorate sharply.

To help calm public fears, the Bush Administration is racing to prepare plans to reshape the U.S. financial system. The White House wants to make banks more profitable by scuttling laws that bar them from branching across state lines and diversifying into fields like the sale of securities. The Administration is also considering adding $25 billion to the FDIC fund through a special assessment on banks or an increase in their insurance premiums -- though that added cost could force some of the weakest institutions to go under.

The Bank of New England collapse may have ended prospects for a long-sought reform to limit federal-insurance coverage. The Administration and leading lawmakers want to restrict depositors to a total of $100,000 in federal insurance per bank; in the S&L bailout, some big customers are being repaid the full $100,000 for each of several accounts in a single institution. Yet any move to cut back this blanket coverage could lead to the type of bank panics that the FDIC sought to avert in New England. "You only exacerbate the problem of runs when you limit insurance," says Lawrence White, a New York University economist who advocates bailing out all depositors at failed banks in the name of fairness.

In fact, the FDIC has consistently covered all depositors in large bank failures to prevent runs. "The government can get away with relatively small- scale pocket picking," says Bert Ely, a financial consultant based in Alexandria, Va. "But on a major scale you cannot do it. The consequences are just too significant."

Regulators moved swiftly last week to keep the failure at the Bank of New England Corp. from rippling through the region's ailing economy. They acted when nervous depositors withdrew $800 million from the holding company's three major banks, including the flagship Bank of New England, after the firm predicted a loss of up to $450 million for the fourth quarter of 1990. On Jan. 6, a Sunday, the government seized the banks and said it would immediately pump in $750 million as part of a $2.3 billion bailout financed by the FDIC fund. The rescue covered more than $2 billion in accounts worth more than $100,000, and $55 million in uninsured deposits at foreign branches.

While depositors kept their money, Bank of New England Corp. creditors and share-owners took a drubbing. Bondholders with a $706 million stake in the company saw their portfolios shrink to about $35 million, since the government now owned the firm's loans and most other assets. Owners of Bank of New England stock, which fell from $9 a share a year ago to about 50 cents a share just before the bankruptcy, saw their investments vanish. The losers included CBS president Laurence Tisch and his brother Preston, who held some 500,000 shares they acquired last year as part of a contrarian strategy of investing in troubled banks in the hope of a rebound.

For its part, the FDIC hopes to sell the failed banks to a strong institution by the end of the year. But the agency will have to swallow up to $6 billion of sour loans, and the messy task of liquidating them, to make the deal appealing to buyers. The FDIC said it was talking with six possible suitors for the banks, including Ohio's prosperous Banc One Corp. and San Francisco-based BankAmerica Corp., the second largest U.S. banking company behind Citicorp in New York City.

Many other banks could do well just to survive the recession. Troubled lenders include such giants as Citicorp, which expects to report a loss of up to $400 million for the fourth quarter of 1990, and neighboring behemoths Chase Manhattan and Chemical Bank. While such firms seem unlikely to fail, they could wind up as merger partners with other big banking companies. Experts are particularly gloomy about the prospect for banks in New England. According to Gerard Cassidy, who follows the industry for the investment firm Tucker, Anthony, as many as 24 of the region's medium-size banks with assets of as much as $2 billion each could fail in 1991. Also under pressure is MNC Financial, a Baltimore-based banking company (assets: about $27 billion) that lost $241.9 million in the first nine months of last year.

For the U.S. banking system, 1991 will be the maximum-stress test. The extent of the pain will depend on such influences as the outcome of the Persian Gulf crisis. But with too many banks chasing too little business in a slumping economy, the industry is headed for contraction. How the government responds to the shake-out will determine the shape of U.S. banking for the rest of the 1990s -- and beyond.

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Steve Hart

CAPTION: A WEAKENING SAFETY NET

With reporting by Robert Ajemian/Boston, Gisela Bolte/Washington and Kathryn Jackson Fallon/New York