Banking Stocks Take a Lashing

"There's nothing bad or wrong with broker deposits; we just have to be sure as regulators they are used in a safe and sound manner," said Scott Polakoff, chief operating officer of the Office of Thrift Supervision. "The risk is adopting a too-aggressive growth strategy that is funded by broker deposits. Because it's a very fast way to grow, it has to be done in a safe and sound fashion."

Since last summer, banks have faced a daunting predicament. Borrowers are defaulting in droves on all kinds of commercial real estate loans, home mortgages and consumer debt and can't pay the banks back.

That leaves the banks without the cash to pay back depositors who want to withdraw their money. In addition, they are struggling to sell their loans on the credit markets because investors know that the quality of the debt has deteriorated.

During the boom years of 2003 to 2006, banks used this hot money to fuel excessive growth, according to banking regulators. Now these banks are facing the consequence of their aggressive tactics. Five of the past six banks to fail heavily relied on brokered accounts to raise funds.

"Obviously with all that's gone on in the industry, there are a lot of concerns right here," said Timothy Long, senior deputy comptroller at the Office of the Comptroller of the Currency. "The use of brokered deposits -- all of the regulators are looking at this and reviewing it. It can be a potential source of problems for banks to get themselves in trouble. It does have me concerned in certain situations."

At IndyMac, for instance, 37 percent of all its deposits were in brokered accounts. Just a few weeks before it collapsed, IndyMac advertised a 4.35 percent interest rate for opening an online, one-year certificate of deposit.

"The banks are paying the highest rates in the country for these deposits," said Peter G. Fitzgerald, chief executive of Chain Bridge Bank in McLean. "And that hot money can dry up in a nanosecond because there is a whiff that the bank is facing trouble."

The risks are spread throughout the financial system. Today 3,334 institutions reported brokered deposits totaling $602 billion. Eight years ago, the amount was minuscule, FDIC analysts said.

Separately, banks are heavily leaning on the Federal Home Loan Banks, which may be putting tax dollars at risk, lawmakers said. That banking system, which includes 12 privately funded institutions around the country and carries an implicit backing by the federal government, had loaned $621 billion to banks in the beginning of 2007. By the end of March, that figure had risen 36 percent, to $842 billion.

Some Democrats blamed regulators for not being vigilant enough. Sen. Charles E. Schumer (D-N.Y.) said he had been sounding the alarm for weeks on the over-reliance of high interest rate brokered deposits, a main source of hot money.

"Profligate practices, combined with lax oversight, are what got us where we are today," Schumer said. "Brokered deposits and home loan bank advances exist in order to provide important liquidity to our banking system. But more and more, it appears they've been abused by some institutions to bankroll shoddy lending practices while the regulators turned a blind eye."

Some federal regulators said Friday that IndyMac was the second-largest U.S. bank to fail but revised that ranking to third after taking into account a savings and loan that closed in 1988.

The FDIC announced yesterday that it would freeze foreclosures on bank-owned loans in IndyMac's portfolio to see whether the mortgages could be modified, which would allow homeowners to stay in their homes.