Building the Next Banking Disaster

The Federal Deposit Insurance Corp. has taken on $80 billion in risk to help small banks consolidate.

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Call it role reversal, but  this morning The New York Times is loudly trumpeting a bullish view of banking, while The Wall Street Journal leads with dark predictions for the Federal Deposit Insurance Corp. What's going on? While the Times joins a handful of weekend stories that are pumping their fists over the $14 billion profit the Fed made from bailout loans, the Journal is focused on the next big problem--too much bank consolidation underwritten by $80 billion of guarantees from Uncle Sam.

Which way do pundits lean? The sort of pessimism seen in the Journal seems like the safer bet at the moment. Many financial writers argue that profits from bailouts are only short-term, at best, as the most stable borrowers always pay back first. And while the government guarantees billions more, the increase in bank size is a move that pundits fear will reproduce the same conditions that caused the crisis in the first place.

Why is bank growth so dangerous?

  • Banks Should Be Shrinking, says Felix Salmon at Reuters. "It's urgent that the government (probably through the FDIC) start imposing a surcharge on bank size. If this state of affairs is allowed to continue, there will be hundreds of unnecessary bank failures -- maybe there already have been."
  • Increasing Domination of Goldman Sachs and Superbanks, fears Simon Johnson at Baseline Scenario. "The smaller banks really do not seem to understand how they have been done in by the big banks - if they did get it, they'd be up on Capitol Hill and all over the media arguing strenuously for much tougher controls on bad big bank behavior. The lack of leadership among non-large banks is remarkable.

Why is the $14 billion figure nothing to write home about?

  • $14 Billion Profit Is Short Term, warns Douglas A. McIntyre at 24/7 Wall Street. "The weakness of the analysis is that it is only a snapshot in time that might lead taxpayers to believe that the Fed will provide profits that could help offset the federal deficit. That may not be true at all. The Fed still faces a banking system in which most large firms still have toxic assets, although most of the losses against them have already been taken."
  • Bizarre Logic, says Yves Smith at Naked Capitalism. "By extension, we should be really happy if financial firms throw themselves off the cliff again en masse, since that will give us all the opportunity to make even more money by rescuing them!"
  • Nothing More Than Smoke and Mirrors, laughs Barry Ritholz. "What this is more appropriately described as is a return of capital; to call this a profit is to ignore trillions of dollars in taxpayer monies that have been spent, lent, guaranteed, drawn against and otherwise consumed in what will likely be the greatest transfer of wealth in the planet's history."
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