Is Your Bank at Risk of Failure?

Nov. 19, 2007 Special to ABCNEWS.com — -- Concerns about liquidity in the banking system have raised the possibility that there will be an increase in bank failures in the next year or so.

Bank failures in the U.S. are rare--the three logged so far this year are out of nearly 8,000 banks in existence--and there have been just 28 since 2000. From mid-2004 until this February. there were no failures, the largest span of time without any since the Great Depression.

But the credit meltdown that has simmered since the summer has depleted capital levels, and banks are getting stuck with mortgage-related assets, the values of which have declined sharply in the last few months. Regulators have been fretting about the problem since early this year.

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"Some have come to believe that the FDIC should not spend any time worrying about or planning for a large bank failure because these banks have become so well diversified and sophisticated in their risk management," said FDIC Chairman Sheila Bair in a speech to the Exchequer Club in Washington, D.C., in March. But, she added, "it does not mean we can rule out potential problems."

Banks fail because they either run out of capital to support their ongoing operations, their asset values drop below that of their liabilities, or fraud forces regulators to step in and take over. Most bank failures are of small institutions. There have been just two failed banks with more than $1 billion of assets since 2000.

If your bank is failing, you probably won't know about it. Regulators deliberately keep a pending closure secret to avoid a mad rush to remove deposits--a run on the bank, if you will. For one thing, a sale of the institution is often possible at the last minute, eliminating the need for federal intervention. But a buyer isn't going to take on the deal if all the deposits rush out the door. For many customers, the first time they know their bank has been shut down is when their credit card gets declined or they walk to their branch and notice it's closed.

Deposits for regular accounts are insured by the federal government's deposit insurance fund, but only up to the $100,000 cap. Any money over that means you have to wait in line with other creditors for recovery. That can take years, and you might not get 100% of it back. Some accounts, like individual retirement accounts, are insured for up to $250,000. Of course, if you're married and have multiple accounts in different categories at the same bank, each of those accounts is insured. Ask your bank if you have questions.

Among the most spectacular failures: Six years ago, the Pritzker family of Hyatt hotel fame (No. 149 on the Forbes richest Americans list), paid $450 million to avoid being punished for the failure of Superior Bank F.S.B., which they co-owned with New York real estate developer Alan Dworman.

The government seized Superior in 2000 after it collapsed because of poor lending practices and shoddy bookkeeping. Its failure cost the government $1 billion.

The Pritzkers' settlement was the largest with banking regulators since 1992, when Michael Milken, Drexel Burnham Lambert and dozens of other companies paid $1 billion to settle allegations that they convinced savings and loans to buy risky junk bonds with government-insured deposits, accelerating the thrift industry's collapse in the late 1980s.

First National Bank of Keystone, once a pillar of its West Virginia mining community, was hailed throughout the 1990s as one of the best-performing banks in the nation. The company went from a sleepy backwater with $102 million in assets to a $1.1 billion institution in the span of just seven years.

That fast growth raised suspicions with regulators, however, who began digging around. Ultimately, they would uncover a massive fraud and cover-up involving senior executives and board members, some of whom went to prison for obstruction. One of the executives had buried critical bank documents on the grounds of a ranch she owned. Keystone's failure cost nearly $850 million.

Honors for the costliest failure on record go to Republic Bank of Dallas, which collapsed in 1988 and cost the deposit fund nearly $3 billion.

Then as now, the controversy was over the concept of "too big to fail," or the idea that the government would step in to shore up a failing bank no matter what, purely to stave off harm to the system as a whole. Too big to fail was applied to the federal bailout of Continental Illinois in the 1980s and, at least in spirit, to the private $3.6 billion bailout (with the Federal Reserve's encouragement) of Long-Term Capital Management, a hedge fund, in 1998.