Rhode Island's newly inaugurated governor was forced to close down 45 banks and credit unions yesterday after the private fund that insures their deposits collapsed before a federal rescue mission could be completed.
Only two hours after he was sworn in, Democrat Bruce Sundlun moved to mend one of the last holes in the nation's banking safety net, ordering all of Rhode Island's privately insured financial institutions to close their doors until they can qualify for federal deposit insurance to protect their 300,000 accounts.
Some of the institutions will be granted federal insurance coverage today, but others are not strong enough financially to qualify for federal protection, leaving their depositors' savings in potential jeopardy, government officials said last night.
The Rhode Island situation is a virtual rerun of what happened in Maryland in 1985 when the state's private savings and loan deposit insurance system was wiped out by the problems of a few institutions.
In Rhode Island, the trouble began just before Thanksgiving, when the president of one of the privately insured banks disappeared and authorities found several million dollars missing. That incident triggered a run on one bank, which spread to other institutions when depositors became worried about whether the private insurance fund could protect their savings.
Six weeks ago, the National Credit Union Administration and the Federal Deposit Insurance Corp., which protect deposits in federally insured credit unions and banks, began an emergency effort to bring the Rhode Island institutions and their $1.7 billion in deposits under the federal umbrella.
But before federal regulators could complete the examinations needed to determine whether the Rhode Island institutions qualify for federal deposit insurance, nervous savers began withdrawing their money, threatening to bring down the private insurance system.
On Monday the governor-elect was notified that the private fund was almost out of cash and the state would be asked to take it over.
Immediately after his inauguration yesterday, Sundlun called a press conference to announce that the state had ordered the Rhode Island Share and Deposit Indemnity Fund into conservatorship, effectively putting it out of business.
The Rhode Island governor declared a bank holiday and ordered all 45 privately insured institutions to freeze their accounts as of today.
"I'm not going to leave depositors out there naked and liable to a run," he said.
"We have to put the brakes on and bring this situation under control."
The action does not affect the 38 other Rhode Island banks and credit unions that are federally insured and handle the overwhelming majority of the deposits in the state.
The Rhode Island incident is the latest evidence of the severe distress facing the nation's financial system.
Though bank failures were down last year, the FDIC's insurance fund has dwindled to its lowest level in history.
At the same time, there is growing concern that the savings and loan industry will never recover from its ailments despite the massive government rescue underway.
The banking and thrift industry's problems are expected to force Congress to begin a massive rewrite of banking laws when it reconvenes later this month. The Bush administration plans to make its recommendations on what to do within the next few days.
The Rhode Island situation also provides new evidence that the federal safety net protecting depositors may not be as complete as is often assumed. Well over 99 percent of all accounts in all U.S. financial institutions are protected by federal deposit insurance, but there remain a handful of states that permit some banks, savings and loans and credit unlions to operate without federal insurance.
Despite the costly lesson of its savings and loan industry, Maryland remains one of eight states that permit some credit unions to operate without federal deposit insurance. Nationwide, about 3 percent of all credit union deposits are not insured by the government.
The privately insured institutions in Rhode Island include 35 credit unions, two conventional banks and eight "loan and investment banks" a unique type of specialized bank that exists only in that state. The privately insured Rhode Island banks are all small, but some of the state's biggest credit unions are part of the private insurance plan.
The New Years Eve emergency apparently was triggered when word leaked out that some of the Rhode Island credit unions would not qualify for federal insurance. At least one credit union was hit by a run of withdrawals on Monday, a state official said, and several others had been losing deposits for the past month.
Though these institutions were not in any financial trouble, they could not meet their depositors' demands for cash. The private insurance fund was supposed to provide its members with cash to meet such demands, but it too began to run out of money. State officials said yesterday that they have not been able to determine how much cash is left in the fund, but it could be as little as $2 million to cover the $1.7 billion in deposits.
A criminal investigation is underway of Heritage Loan and Investment Co., the bank that triggered the crisis. A warrant has been issued for the arrest of Heritage's president, Joseph Mollicone Jr., who was last seen Nov. 8 getting on an airplane for a flight to New Jersey.