Sticky Dilemma: When to Drop |Too Big to Fail'

With a number of large regional banks severely weakened by losses on real estate loans, federal regulators may soon be faced once again with the "too big to fail" dilemma.

The question is, if a bank with $10 billion to $20 billion in assets fails, should people with accounts in excess of $100,000 be covered by federal insurance?

Traditionally, regulators have stepped in and made all depositors whole when a big bank collapses. Not doing so, they fear, could cause a panic.

And all signs indicate that if a big bank does indeed fail anytime soon, regulators will once again protect all depositors. The chairman of the Federal Deposit Insurance Corp., L. William Seidman, has said repeatedly that he isn't going to be the one to risk shocking the fragile banking system by pulling the plug on a big bank's largest depositors.

Time for New Doctrine?

But some bankers and industry observers think now is the time to abandon the "too big too fail" policy, which discriminates against small banks and undermines market discipline.

One of the weakest big institutions is Southeast Banking Corp., an $11.3 billion-asset company based in Miami. A string of big losses has pushed Tier 1 capital to 2.2% of risk-based assets, well below the 4% minimum that takes effect next year.

Southeast has said it is in discussions with possible acquirers and that any transaction might require federal assistance.

Officials, pointing to adequate liquidity and $317 million in common shareholder equity, insist that the company is nowhere near failure.

Dim Chance for Survival

But with each quarterly loss, its prospects darken. "One possibility that looks increasingly unlikely is that Southeast will survive on its own without a government takeover," said Richard Stillinger, a bank analyst with Keefe, Bruyette & Woods. "The chance of that seems dimmer and dimmer."

If Southeast were to collapse, some observers think it would be an ideal place to end the |Too Big to Fail' policy.

"You've got to start somewhere and this is clearly where we ought to do it: $10 billion to $12 billion in assets, in a non-money-center city," said Kenneth Thomas, president of K.H. Thomas Associates, a Miami-based bank consultant.

"It's time to let large depositors know that they must exercise judgment and discipline when dealing with financial institutions," said Richard Kovacevich, president and chief operating office of Minneapolis-based Norwest Corp. "I'm not singling out Southeast... but there is simply not enough money in the banking system to protect unsound lending practices or whatever causes the problems."

Mr. Thomas listed several reasons why the $12-billion-asset Miami bank could be a likely candidate:

* Losses of $203 million in 1990, and $117 million in the first quarter of 1991 have been well publicized, so the "smart money," or funds held by companies and large investors, have fled. Deposits fell by $2.3 billion in the first quarter of 1991, compared to the first quarter of 1990;

* The international ripple would be minimal because average balances in Southeast's offshore offices have declined to $134 million in the first quarter, compared to $651 million for the same time the year before. The bank also doesn't participate in foreign exchange contracts.

* There are large banks in the region, such as Sun Trust Banks Inc. of Miami, Barnett Banks Inc. of Jacksonville, and NCNB Corp. of Charlotte that would act to stabilize the region.

But the current consensus is that regulators are unlikely to use Southeast as a test case. That suggests that it may take years to change a policy that is widely viewed as wrongheaded.

Most experts say that before regulators can safely abandon the policy, the U.S. economy must be strong and the deposit insurance system altered.

And even some of the most vocal opponents of to-big-to fail say it would be a mistake to try it anywhere now because of the industry's current problems.

For one thing, it could spark runs in other weakened big banks, such as Baltimore's MNC Financial Inc., Houston-based First City Bancorporation of Texas, Bank of Boston Corp., and Shawmut National Corp. of Hartford, Conn., they said.

"This climate is really very, very shaky," said Kenneth Guenther, executive director of the Independent Bankers Association of America, whose small-bank members have argued that protecting large institutions drives deposits out of their banks. "Those recommending that big banks ruthlessly fail are doing a great disservice."

Alfred Lerner, chairman of MNC Financial, said his bank is making progress after sustaining huge losses in 1990, but to fail to fully protect all depositors now would spook the industry.

"There are certain games like Russian roulette where you never win twice," he said.

Even if Southeast works out its problems, or isn't used as a test, regulators are bound to have to face the "too big to fail" quandary sooner or later. Already the House and Senate bills on reforming the banking industry propose dates to erase the doctrine.

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