Is there an ‘upside’ to bank failures? 

You may have missed Monday’s article in the Wall Street Journal about the 279 US banks that have failed since the Great Recession started.

In one paragraph, the article’s authors try to strike an optimistic note by venturing that “the upside of [bank] failures is that they can represent a healthy cleansing of a sector that grew too fast, with bank assets more than doubling to $13.8 trillion in the decade that ended in 2008.”

The article mentions that many of the banks that have failed to date “were opportunistic latecomers” to the real estate bubble of the last few years.

This observation could be read as inferring that the US banking system is better off without these alleged slick quick-buck artists. Each failure of an “opportunistic latecomer” is in fact worth celebrating, if you take this view - call it the “creative destruction” theory of bank failures.

But I don’t think that this is the article’s true intention, since it also acknowledges that many economists see the number of bank failures as “an enduring threat to capital, lending and the economy.”

When we try to measure the economy’s vital signs, let there be no mistake – there’s nothing to cheer every time the Federal Deposit Insurance Corporation (FDIC) has to close down a bank due to its real estate loan portfolio going sour. This is particularly true when the FDIC has to close down a small community bank.

Many Americans, it seems fair to say, take the role of the nation’s community banks for granted.

What do these banks do that is different from larger banks? For starters, a community bank typically reinvests the money deposited with it into the surrounding community, making loans to local small businesses, farms, etc. It doesn’t take the deposits and loan them out in Shanghai or Bonn. It helps stimulate economic growth at home.

You may not find many community banks with offices along Wall Street, but that doesn’t mean they don’t serve an important economic role. Nor does it mean that they have only a small, bit-part to play in restoring health to the national economy.

By talking about how there could be an “upside” to bank failures, I think the Journal was just trying to be provocative and stir up readers.

But it bears repeating – it is no upside to bank failures, especially of smaller banks. 

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Neil Hrab

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