The series of financial shocks emanating from New England is expected to push Congress and the Bush administration to move quickly to replenish the dwindling federal deposit insurance fund and to enact far-reaching reforms to protect the nation's banking system, banking experts said yesterday.
The failure of Bank of New England Corp. and the collapse of Rhode Island's private deposit insurance system "focuses people's attention and that's good," said a senior Treasury official. "We clearly have a banking system that's under tremendous stress."
The official said the troubles of New England financial institutions show the need for the administration's soon-to-be released reform package. It is expected to call for revamping the deposit insurance system, allowing regulators to take earlier action to prevent bank failures and rewriting the rules of banking in an effort to make the industry healthier and more competitive.
But other banking specialists said Congress may be reluctant to tackle far-reaching legislation when the banking system is in a crisis. Instead, the lawmakers may provide new funds for the Federal Deposit Insurance Corp. and the savings and loan cleanup and put off more controversial measures.
Several banking experts predicted that the decision by the FDIC to cover all the depositors in Bank of New England banks, including those with accounts of more than $100,000, will make it more difficult to limit deposit insurance coverage and end the practice of protecting all depositors in banks deemed "too big too fail" because their collapse would damage the financial system.
Reformers have been arguing for months that no bank should be "too big too fail." They say that the government could save billions of dollars if it would stop covering big depositors and foreign accounts that are technically not insured by the FDIC but are routinely protected when multibillion-dollar banks go broke.
FDIC Chairman L. William Seidman yesterday acknowledged it will cost $200 million to $300 million to protect the uninsured depositors in Bank of New England institutions, bringing the total cost to about $2.3 billion. But not even the most outspoken critics of the "too big too fail" doctrine disputed the need to cover all of the deposits. They cited the necessity of protecting public confidence in the northeastern financial institutions that are faltering under the weight of crashing real estate values and a severe regional recession.
Depositors all over New England were unnerved by the New Year's Day failure of Rhode Island's private deposit insurance fund, which left 300,000 savings accounts in shuttered banks and credit unions. Depositors also were scared by the way the FDIC handled the failures of two smaller institutions, Freedom National Bank in Harlem and Capital Bank and Trust in Boston. In both cases, the FDIC did not protect deposits of over $100,000, causing substantial losses for charitable groups and local governments that had money in those institutions.
Confusion over whether their money was safe set off runs on banks all over the region after Bank of New England disclosed its deteriorating financial condition on Friday. Depositors pulled millions of dollars out of healthy and ailing banks alike, in many cases withdrawing money from small accounts that were fully insured.
In the midst of spreading panic, the government had to do whatever was necessary to protect other banks, credit unions and savings and loan associations, banking experts agree.
But that necessity demonstrates that it may be close to impossible to achieve the goal of the administration and many congressional banking reformers who want to limit deposit insurance coverage and abandon the practice of insuring all depositors in big banks.
The New England events prove it is a myth that the government can abandon the "too big too fail" doctrine, said Kenneth Guenther, executive vice president of the Independent Bankers Association.
Guenther said the FDIC's decision to protect all depositors of Bank of New England banks but not all depositors of Freedom National and Capital banks "is one of the inequities in the system." But, he said, "I think we have to live with that inequity for the stability of the system."
Guenther and Robert Dugger, chief economist of the American Bankers Association agreed that, as Dugger put it, "events of the last week are very favorable for legislation. The issue of deposit insurance reform and the need for financial modernization are highlighted."
The two banking industry groups say Rhode Island savers would be protected by a plan advocated yesterday by House Banking Committee Chairman Henry B. Gonzalez (D-Tex.) to require any financial institution that takes deposits to have federal deposit insurance. Rhode Island's is the latest in a series of private state-chartered deposit insurance systems that have failed in recent years.
The failure of Bank of New England also might have been averted under various reforms being promoted by the administration and Democratic leaders of congressional banking committees. Those plans would require banks to build stronger financial reserves to protect against losses and would allow banking regulators to intervene earlier when banks get in trouble.
Bank of New England's financial problems became evident more than a year ago. Under the administration plan, regulators would have been able to step in immediately and force changes in the banks operated by the holding company before they failed, a Treasury official said.