Why Banks Fail—And Why They Fail on Friday

While the large banks have survived in one form or another, a spate of small- and medium-size banks are closing across the country at a rate of four to six per week—and almost always on Fridays.  In 2009, 140 community and regional banks failed.  A little over halfway through 2010, already 108 have failed.  

Each failure brings in the Federal Deposit Insurance Corporation (FDIC) to orchestrate a transition of assets from the failed bank to another depository institution, when possible.  These have ranged in amount, for example, from the Ideal Federal Savings Bank in Baltimore, Md., which had about $6.3 million in assets to the Midwest Bank and Trust Company in Elmwood Park, Ill., which carried about $3.17 billion in assets.  Taken together, these failings amount to an organized reshuffling of millions—even billions—of dollars each week across the country.

To learn why so many banks are failing—and why so many are failing on Fridays—Big Think spoke with NYU professor Lawrence J. White, who studies the industry and who, with professor Rebel Cole of DePaul University, has co-authored a study on the failures of commercial banks in 2009 and the first half of 2010.  

"It's clear that we went through this expansionary phase of lending," says White, "and for the small banks it turns out it wasn't residential mortgages that have done them in." Instead, he said, it was lending to commercial enterprises that grew with the boom in residential real estate. 

"Whether it was making loans on commercial properties like shopping centers, strip malls, hotels or other commercial properties, or making loans on multi-family apartment units, or making loans for construction or development," says White, "those are three real-estate-related areas that are high risk, and when the economy goes into the tank that kind of enterprise suffers, and the institutions that have lent money to those kinds of enterprises suffer as well."

Rather than the residential real estate itself or the derivatives trading of mortgage-backed securities, it was this commercial lending that turned out to be toxic for these smaller banks, according to White.  He adds that for the last major wave of commercial bank failures in the 1980s and early 1990s commercial real estate was a major factor as well. 

"There are hundreds more that will fail over the next year or two," says White. "The FDIC can't get to them all at once, it doesn't have the personnel."  Instead, the FDIC closes a few each week, coming in each Friday evening and working through the night to have everything accomplished by Saturday morning. 

As for the FDIC practice of closing banks of Friday, White says: "It goes back to when banks were not open on Saturday and Sunday, when there were no ATMs, so when you closed the bank on Friday you had the weekend to sort things out."

Conducting the receivership and takeover of bank assets at the end of the week, at the end of the business day, when many people are shuffling off for the weekend, the FDIC says is the least disruptive option for depositors.  In response to this, a Web site and Twitter account have sprung up to track "Bank Fail Friday" each week, linking to the FDIC press release for each new failure.

Even as new banks are added to the FDIC failure list each Friday, White says it is important to keep these numbers in context: "Remember there are about 8,000 banks in the United States, so even if we loose a couple of hundred a year we still have lots of banks out there."

"It's not like there is going to be this financial hole in the landscape," he adds.

This weekly reminder of economic fragility will likely continue for some time, according to White, who says bank failures are a lagging indicator and estimated it will be a year or two after the economy recovers before the closures finally slow down. 

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