Strong Banks and Weak Banks

Tue, 03 Feb 2009 15:46:02 +0000

My first reaction to the headline of Binyamin Appelbaum's article in today's Washington Post, "Despite Federal Aid, Many Banks Fail to Revive Lending," was, How is this news? After all, this is what happens when you pump money into distressed institutions. You get gifts to non-insured creditors, not loans to potentially risky borrowers.

But Appelbaum's article is worth a read, because he tells a clear story about how the opposite of new loans is playing out in the DC area. Here are two excerpts:

EagleBank's struggles are part of a broader national pattern and illustrate the complexity of the government's attempt to prop up the economy. Rather than investing in the banks best equipped to increase lending, the government invested disproportionately in banks that needed money to solve problems. Those banks often were ill-equipped to increase lending because of financial limitations such as a lack of deposits.

[...]

But in the Washington area, the banks that got federal investments mostly were not those that reaped the deposits.

The deposits flowed disproportionately to the strongest banks and the weakest. The strongest banks, which tended not to apply for government money, attracted customers seeking safety, and customers seeking loans, by demanding that borrowers also become depositors. The weakest banks attracted customers by offering eye-catching interest rates. National companies called deposit brokers funnel money to the banks that offer the highest rates, and executives say competition in recent months has been fierce.

That last paragraph should give us pause -- these banks are playing with the government's money. A more active FDIC -- closing weak banks rather than having the Treasury prop them up -- would serve us well right now.