Sunday, March 08, 2009

Testing FDR's Legacy (Part 2)


In my last post I offered up some of FDR's legacy, policies developed from the cause or impact of the Great Depression, which are being tested in the current unpleasantness. I have another one that I did not mention but certainly needs mentioning.

Lots of bank failures occurred during the Great Depression. People no longer trusted banks as a place for simple savings accounts. According to Wikipedia, some 4,000 banks failed at the beginning of the Great Depression at an average asset value of $900,000 each, which according to my math results in total asset value of $3.6 billion – both of these numbers are off the scale of their respective axes of the above chart.

The Federal Deposit Insurance Corporation was set up to protect deposits so people would go back in banks and put their money in them so it could be used to loan out again and get the economy rolling. The message since then has been banks may fail but your money was safe. As the chart shows, the FDIC is now being tested like it has never been tested before – or at least since the 1950's.

The number of banks that have failed is no where near the number that failed after the burst of the savings and loan bubble, peaking in 1989, but a whole lot more assets have been put at risk. The FDIC has never faced anything like this before. The amount of assets at risk during the saving and loan bubble of the early 90's is not even 10% of today's assets at risk.

I keep hearing stories that local small banks are in good shape. They were not the ones loaning out money to people who really couldn't afford them to pay for property that is now no where near what the original loans was worth. They were not the ones buying sub-prime loans backed investments. It was the big banks, the really big banks. That's why the red line is so low in 2008 and the blue line is so high. Of the axis stretching assets in 2008, two banks account for 90 percent of that, Citibank and Washington Mutual Bank.

How the FDIC will fare in the current crisis remains to be seen. Since it is back by the U.S. government it will not fail. Everybody covered by the FDIC will remain whole, and the economy will be the better for it. No matter how great this depression is, the FDIC, and as noted in my previous posts, unemployment insurance and Social Security will lessen its greatest. They are the FDR legacies from his administration of that Great Depression.

I wonder what lessons we have learned from our recent crisis. What policies may come from this? Maybe the rating agencies such as Standard and Poor should work for the buyer and not the seller. If only those sub-prime backed investments had been rated to reflect their uncertainty instead of to gaining favor – and further business – from the seller, this might not have ever happened.

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