Failing banks make people uneasy. Many people naturally wonder how they would be affected if their own bank went belly up. Such concerns amplify other financial worries, such as fear of getting laid off, that motivate households to cut their spending. So the national economy as a whole is affected.
While recent bank failures made headlines, the chance that any one household’s bank will fail are much lower than in the 1980s, when thousands of savings and loans and farm-dependent banks crashed.
If it does happen, most households don’t have to worry about their deposits. They can count on Federal Deposit Insurance Corp. coverage of up to $100,000 per person per bank. (Joint accounts and IRAs have higher limits; for details, go to fdic.gov.) Even if a wave of bank failures depleted the FDIC’s financial reserves, Congress would appropriate funds from the U.S. Treasury to cover losses.
In most cases when regulators decide to close a bank, the FDIC tries to get a healthy bank to take over the failing one. The FDIC takes over the bad loans, or their value is discounted sharply in the sale.
In such cases, depositors scarcely notice a thing. In many cases, all the deposits are covered, regardless of amount. The new owners often just change the signs on the bank and get new letterhead.
In other cases, a healthy bank may acquire the deposits and good loans, but the existing facilities are shut down. Depositors may not have the same access to convenient facilities, but there is little disruption, if any, to the money in their accounts. If they don’t like the new bank, they can always shift their business elsewhere. Again, even depositors with more than the $100,000 limit often don’t lose anything.
Don’t count on that, however. In severe cases, and IndyMac Bank was one, large depositors may lose all or part of their money above the $100,000 limit. With IndyMac, large depositors were assured they could withdraw up to 50 percent of their deposits. Anything above that depends on how the liquidation turns out.
Note that these terms are controversial. The IndyMac failure may cost the FDIC insurance fund some $4 billion. Many ask why depositors should get more than the statutory minimum while the government takes that big a hit, particularly given great uncertainty about how bad the economic downturn may get.
If you borrowed money from the bank, your worries are limited. Someone will buy the bank’s loan portfolio, and your loan payments will go to this new owner. Again, the process can be nearly invisible to the borrower. The new owner of the loan cannot force you to pay the loan early, regardless of whether it is a six-month unsecured note or a 30-year mortgage.
But the new owners don’t have to make any new loans to you if they don’t want to. So if you have a small business and frequently borrow for the short term to finance inventory or goods in production, you will have to establish your creditworthiness for the new owner. In an economic downturn, it may be harder to get such credit from the new owners of your existing loans than from the now-failed bank where you did business for years.
Moreover, there is no guarantee that whatever firm buys the loans of a failed bank is necessarily an ongoing banking business. A loan portfolio may end up with a firm specializing in “workouts,” collecting as much as possible from a set of questionable loans.
If you are not up to date on your loan payments or not in condition to make all eventual payments due, your luck can vary. Your loan may end up in the hands of a collection firm that combines the worst qualities of Ebenezer Scrooge, Simon Legree and Shylock and will use every legal tactic to make you pay. There also may be cases, particularly if you are a smelt in a net full of tuna, where the liquidator may settle for a reduced sum and not waste resources pursuing more. Don’t count on it, however.
The news is not good if you happen to own stock in a bank that fails. Kiss your money goodbye. In the old days, when stock certificates were physically printed on snazzy paper, you could at least use the shares to wallpaper your bathroom. But with a modern share that exists only as a computer entry, you don’t even have that option.
Yes, stockholders are the residual claimants on the net worth of a firm, after everyone else with some claim is satisfied. So if a bank was only slightly under water when it closed, and if the FDIC succeeded in selling its assets at very favorable terms, there might be something left for the stockholders. In real life, there seldom is.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.