Idaho Politics by William L. Spence: Banks should be freed to fail - at times, with safeguards

WILLIAM L. SPENCE, politics reporter, The Lewiston TribuneMay 29, 2013 

William L. Spence

"Failure is not an option." That quote, attributed to NASA Flight Director Gene Krantz during the Apollo 13 mission, is one we can all appreciate. It epitomizes America's can-do spirit and speaks to our heroic image of ourselves, the idea that we refuse to be defeated, no matter the odds.

But there is another, harsher perspective on failure, as expressed in 1963 by U.S. Rep. Wright Patman, D-Texas, during a dedication ceremony for the Federal Deposit Insurance Corp.'s new headquarters building in Washington, D.C.

"I think we should have more bank failures," said Patman, who later served as chairman of the House Committee on Banking and Currency. "The record of the last several years of almost no bank failures - and finally, last year, no failures at all - is to me a danger signal that we've gone too far in the direction of bank safety."

It was an odd place to make such a claim, given the FDIC has been credited with restoring public confidence in the banking system and ending the string of failures that nearly crippled the country during the Great Depression.

From 1921 through 1933, when the FDIC was created, more than 15,000 banks failed nationwide - roughly half of all commercial banks in the country, including 4,000 in 1933 alone.

Yet only nine banks failed the following year, after the FDIC began insuring deposits and supervising bank lending practices. Fewer than 3,500 have failed in all the years since, and more than $200 billion in losses have been covered.

By all rights the independent agency, which is funded entirely through assessments on member bank deposits and earnings on investments, should be considered a resounding success.

Why, then, would Patman sense danger?

Because the purpose of the FDIC, he said, isn't to prevent banks from failing by swaddling them in overly cautious regulations, but to protect depositors from the consequences of risk.

"Where there is risk-taking, there are inevitably some failures," he said. "When we are tempted to boast of no bank failures, let us remember that several thousand other businesses may have failed because banks didn't take as many reasonable risks as they might have."

The agency itself acknowledged this concern during its 50th anniversary celebration, when it said "the existence of deposit insurance … [has] provided too much comfort to large depositors and other bank creditors. With a perception of minimum risk, there's little incentive for depositors to exert the degree of market discipline present in other industries."

In other words, without a "buyer beware" factor, consumers won't put the brakes on profligate lending practices by moving their money to safer institutions.

Now fast-forward to the recent report regarding the 2011 failure of the Bank of Whitman in Washington state. It said a variety of factors contributed to the failure, including nepotism, a domineering CEO who pursued a risky rapid-growth strategy, inadequate internal controls and a weak board of directors. But it also noted that federal bank examiners knew of the problems years earlier and failed to take decisive corrective action.

"The need for stronger supervisory action sooner has been a consistent theme in our failed bank reviews," according to the report.

Thus, we're left in an ambiguous middle ground - unwilling to put depositors at risk and let "market discipline" keep lenders in check, yet equally reluctant to have regulators step in and dictate behavior.

So when is failure an acceptable option?

This is the fundamental conundrum any legislative body must address, whether dealing with banking regulations or gun control, health reform or environmental safety.

Somewhere between the long lines of panicked bank depositors and the suffocating embrace of the modern nanny state there is an appropriate role for government in attempting to minimize risk and prevent failure. But to what extent? When should it stay out of the way and let people suffer the consequences of their actions, versus stepping in and trying to protect, if not the actors themselves, at least the innocent bystanders?

The heroic vision of NASA's Krantz could serve as a starting point in that conversation, but Patman's FDIC model may be a better choice. Rather than eliminate all risk-taking, it tries to minimize the effect on those who don't benefit, while letting investors and managers know that failure is most certainly still an option.

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