Rube Goldberg's cartoons used to demonstrate how small actions can trigger much larger actions.

For example, wwter dripping on a lever would release canaries; once the birds were out of the cage, their flopping wings would fan into flame a smoldering fir - and soon the fire department would be on the scene.

Bankers - and bank examinaers - can benefit from a refresher course on Rube Goldberg. For every action taken by a bank, or the economy as a whole, seems to affect other actions and bring about furhter impacts and counter-responses that either intensity or soften the final result.

Worrisom Questions

After one of my talks, a few years ago, this subject came up with an old-time banker.

"Is it true," he asked, "that if all the banks in the United States go under at the same time, the Federal Deposit Insurance Corp. wouldn't have enough money to cover the losses?"

"Yes, sir," I replied.

He wanted to know if that worried me.

"No, sir," I said, "because if every bank is going under, the Federal Reserve would create enough money to fully fund the FDIC and avoid the insured depositor's losses."

Next he asked: "But wouldn't that be inflationary?"

I explained that the deflation of massive bank failure wouldn't permit any simultaneous worries about inflation. In other words, I was trying to say, you can't bake and freeze at the same time.

Bakking or Freezing

This notion brings to mind a conversation with my old friend Thomas F. O'Neill, a principal of Sandler O'Neill Partners, a New Yord bank investment firm. Tom was telling me that many bankers are preparing their portfolios for a set fo disasters that - these days - are just as contradictory as baking and freezing.

This school of bankers, and their examiners, look solely at net interest margin and worry about the negative gap that would develop if interest rates go up.

"If rates rise 4%, we are in deep trouble," they cry. "We'd better do everything possible to curb longer-term investing, so that we can build liquidity for this possibility."

Clossing the Gap

The way Tom O'Neill sees it, this combination is as impossible as my banker's vision of the nation facing drastic depression and inflation at the same time.

"I work with one bankk that has 15% nonperforming real estate loans - which is eating them alive," Tom explains. "This bank has a negative gap and is building liquidity at the expense of profits to cover the losses it would face in a sharphy rising interest rate scenario.

"But they don't see the main point: The same economic recovery that would bring about the drastic rise in interest rates - hurting their gap-derived earnings - would also bail out much of the bank's real estate portfolio. So they would recapture a ton of money set aside as reserves.

"The increased earnings, in this case, would more than offset the impact of the negative gap.

Getting Worse, Not Better

When it comes to economic conditions and interest rates, actions that impact other actions can sometimes made matters even worse, instead of moderating the damage.

The First National Bank of Amarillo, Tex., Tried to be cautious in the days before Texas banks faced their notorious difficulties of the late 1980s.

"We felt that energy and agriculture were in for trouble, and we didn't want to concentrate all our loans in those areas," the bank's top people told me. "So we looked for loans to mom-and-pop stores, auto deadlers, and consumer loans in order to diversify.

"But when agriculture and energy went down, they took these other borrowers with them."

Covariant Risk

When bankers consider the way one problem can cause others, they call it covariant risk. To ignore this potential damage is to leave the bank wide open to unexpected - and unpleasant - surprises.

As Rube Goldberg's inventions would emphasize, bankers - and especially regulators - must also look at the good side. Sometimes an economic development that looks at first as though it would hurt the bank is accompanied by another economic force that can help at the same time.

This is worrisome to those bankers who understand this immunizing impact and want to take advantage of it.

All too often, examiners and regulators - who play so large a role in determining bank policy - see only the bad side. So the banks are forced to plan and operate as if these offsettig advantages did not exits.

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