The Federal Deposit Insurance Corporation was created by the Banking Act which was signed into law by President Franklin Roosevelt on June 16, 1933. In the years following the stock market crash of 1929, many banks had failed and the anxiety of the population culminated in a final great rush on banks on March 3, 1933. With thousands of people seeking withdrawals at the same time, most banks were unable to meet the demands of customers. The Federal government declared a bank holiday to pause the panic and set about creating a system of safety nets, checks and balances to stabilize the American financial system.
“We had a bad banking situation. Some of our bankers had shown themselves either incompetent or dishonest in their handling of the people's funds. They had used the money entrusted to them in speculations and unwise loans. This was of course not true in the vast majority of our banks but it was true in enough of them to shock the people for a time into a sense of insecurity and to put them into a frame of mind where they did not differentiate, but seemed to assume that the acts of a comparative few had tainted them all. It was the Government's job to straighten out this situation and do it as quickly as possible -- and the job is being performed.” Franklin Delano Roosevelt, March 12, 1933
In 1980 the FDIC raised the rate of coverage from $40,000 to $100,000 per depositor per institution to help deal with the savings & loan meltdown. In October of 2008, in the wake of a new financial crisis, the FDIC raised the coverage to $250,000.
According to an Associated Press story in late November, the FDIC stated that the list of banks it considers to be in trouble rose 50% during the third quarter, to 171 out of the 8,500 FDIC-insured institutions. While this represents only 2% of the insured institutions, most of the others are also feeling some impact of the subprime mortgage market and resultant tightening of credit.
To explore the impact of this significant change, we asked Philip Smith, president of Gerrish McCreary Smith, to share his thoughts on its impact. Gerrish McCreary Smith, Consultants and Attorneys, is a law firm and affiliated consulting firm specializing in the representation of financial institutions across the country and is based in Memphis
SCA: With the extra safety, are enough people likely to sell off stocks and go to banks in such numbers that the plummeting marketing is made worse?
PS: There probably won’t be a big run to escape the market; the possible exception is investors who are not able to stay in for the long run. Most investors are sophisticated enough to know that selling low and getting back in later when the prices rise is not a good strategy.
SCA: To the extent that individuals have $250,000 sitting in a saving account, the elevation to that amount makes sense, but people are invested in many other things – equities, mutual finds, homes, real estate, and more. How does the raised level impact the bigger picture for American investing?
PS: Bankers are telling me that the extensive news coverage has customers calling with more questions in the past two months than in the past 10 years. People are learning more about investment instruments and how banking works by watching the news. With savings at stake, individual investors are becoming actively more engaged.
There are still investors alive today who experienced pre-FDIC banking and the crisis that brought the FDIC into being. It is important to remember that not one dollar of insured deposits has been lost in an FDIC-insured bank since the inception of the program. So, yes, FDIC changes are relevant.
SCA: The FDIC directors voted to approve the bank debt guarantee program. Will this free up credit for the banks?
PS: At the moment, it is too soon to tell how effective this will be. If the larger institutions do use it to make loans to smaller institutions which in turn make more loans to consumers and in the community, then, yes, it will free up credit and be successful. Another important part of the program is an unlimited, 100% guarantee for non-interest bearing commercial accounts. This means that corporations can have guarantees for large cash accounts such as payroll and similar transactions, without having to shift funds among several banks. This not only helps the corporations but it also helps banks, provided the banks do not opt out of this “liquidity guarantee” for which there is a fee, by keeping money stable and not moving around from bank to bank unnecessarily.
SCA: I know you work with banks all over the US, but speak for a moment about the Memphis area banking industry. Some are stating they will participate in the bailout, some are as yet undecided. What are the implications of participating or not? Are there strings tied to those dollars?
PS:. The government essentially mandated that the nine largest banks in the US participate in order to bolster consumer confidence. The strings that are attached include such things as restrictions on dividends, the ability to buy back shares, executive compensation, and more. These restrictions impact smaller banks more than the larger banks, and may make the small banks more hesitant to participate.
Also, there are implications and perceived implications. In some sections of the country the idea of a bank needing to be “bailed out” is a stigma that could affect its ability to retain and attract customers and could offer ample ammunition to competing banks for negative advertising campaigns. In Memphis I think we’ll see a little bit of everything: banks that apply and qualify, banks that probably shouldn’t qualify that do because of their size, banks that apply and then elect not to participate and banks that won’t even think about taking the “government money”. Regardless of the strategy, customers shouldn’t use the program as a barometer of the health of a particular institution.
SCA: What message should TARP (Troubled Asset Recovery Program) participation send to customers?
PS: There is a lot of pressure on larger banks to sign up. At the same time the Treasury Department is making the situation more complex by not establishing hard and fast rules about who will qualify and who won’t. This muddles the public perception. Some people might think that a bank which does not participate is not safe or that one which does is in trouble. The customer should not assume anything based on participation alone.
SCA: We’ve seen big changes in Memphis banking in recent years with Suntrust buying NBC, Regions taking Union Planters, First Tennessee pulling back from its national focus, and a plethora of new, smaller, community banks emerging. How does this bode for Memphis area banking customers?
PS: This gives local baking customer more choices. The smaller banks have different strengths and serve different niches. And we still have the larger banks with their abilities to serve different needs.
SCA: Polish off your crystal ball, and tell us what else we ought to watch for in coming months in banking, locally and nationally.
PS: There will probably be more bank failures nationally. If so, this will probably result in more bank regulations which may or may not be helpful to the industry. There may be more financial service providers moving toward banking as American Express has done. Perhaps Wal-Mart will try again. The one thing we can look to with certainty is continued segregation of large and small banks. The small banks can find opportunities in the troubles of the large banks. This is an area to watch.