More Mega-Banks, Freer Mega-Banks --Greater Risk?

Left to its own devices, the free market can work some amazing feats. The commercial development of the Internet, for example.

A Commerce Department report last week estimated that more than 100 million people use online services, up from just 3 million in 1994. Those are the government’s guesses--who knows what the actual figures are? But Internet use obviously has risen exponentially since ‘94, and the feds have been wise to stay out of the way, leaving the Net largely unregulated.

That makes it possible for companies like K-Tel International, famous (or infamous, perhaps) for hawking its “best of” music compilations via TV ads, to announce that it now will market its music over the Internet as well. And before a single recording has been sold, K-Tel’s announcement drove its previously thinly traded stock up 332% last week, from $6.63 to $28.69 on Nasdaq.

Therein, too, lies the beauty of the free market: It allows investors, rather than bureaucrats, to decide the merits of a particular enterprise and who should get capital. Whether K-Tel really deserves to be more than a thinly traded $7 stock remains to be seen. If last week’s excited buyers grossly overpaid, that’s their problem--not taxpayers’.

When the subject is banking, however, the issue of just how “free” markets should be requires more thoughtful discussion, because the comfort of federal deposit insurance means taxpayers in fact could be at significant risk from poor decision-making by bankers and investors.

Last week, BankAmerica Corp. and NationsBank agreed to a merger that would create the biggest U.S. bank by far in terms of deposits: more than $340 billion.

The deal, which adds another exclamation point to this year’s unprecedented pace of corporate merger activity, was warmly received by Wall Street--but then, practically every news event is warmly received by Wall Street nowadays.

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Can BankAmerica and NationsBank create a highly successful, coast-to-coast, customer-friendly financial supermarket, if only the government will let them?

Hugh McColl, NationsBank’s forceful chief executive, insists it can be done, despite the popular wisdom that 1) most big mergers don’t work out well and 2) most consumers don’t want a one-stop financial supermarket.

McColl, in an interview with Times reporters last week, said the notion that most consumers prefer small banks to big banks is “empirically incorrect”--otherwise, big banks wouldn’t get big in the first place, he said.

To put it another way, in a free market small banks become big banks not because the government wants them to become big (the Asian model, now discredited), but because consumers are making rational decisions about which institution serves them best.

If consumers eagerly embrace mega-stores like Wal-Mart, what’s to stop them from embracing a mega-bank if it meets their needs?

That is McColl’s mantra. “It’s depth of service, product and price--that’s what made America great,” he said, sounding somewhat evangelical, but defining clearly how he expects the merged BankAmerica/NationsBank to deliver in the free market.

Yet the cry of the free-marketeers in the banking field has resounded before--with some unfortunate consequences.

In the 1920s commercial banks’ ability to freewheelingly engage in securities trading and underwriting helped set the stage for the stock market crash of 1929 and the Great Depression--and led to enactment of the Glass-Steagall Act, separating the banking and securities businesses.

In the early 1980s, the term “too big to fail” joined the lexicon of bank-speak, when Citicorp and other U.S. financial giants were threatened by Latin American countries’ sudden inability or unwillingness to repay the billions of dollars they had generously been lent by Yankee bankers.

The mega-banks, the government quickly decided, were indeed too big to fail. So, as author Robert Kuttner described in his 1997 book “Everything for Sale: The Virtues and Limits of Markets” (Alfred A. Knopf): “The money-center banks were allowed by an indulgent Federal Reserve Board to carry their underwater loans at book value rather than at market value [in the ‘80s]. Had the regulatory authorities followed their own usual rules, several of the largest money-center banks would have been ruled insolvent.”

By the late 1980s, meanwhile, the deregulation of the savings and loan business had attracted a horde of thieves in the guise of S&L; presidents and real estate developers who in effect looted federally insured savings to engage in wildly speculative activities.

The total bill to close or merge hundreds of insolvent S&Ls;, as estimated by the General Accounting Office in 1996: $481 billion.

It’s misleading to think of that sum as having gone down a rat hole, of course. By covering insured deposits and paying other bills associated with S&Ls;’ disastrous investments, the government protected the economy from much more severe stress. Still, it was hardly an efficient use of capital--and isn’t the latter what free markets are supposed to assure?

Even more recently, the bank and thrift failures of the early 1990s, following the recession of 1990-91 and the major real estate busts in California and elsewhere, sent the Federal Deposit Insurance Corp. fund--which backs the $100,000-per-account deposit insurance pledge--into the red for the first time in its now 64-year history.

But they don’t call it federal deposit insurance for nothing: Aside from the bank-paid insurance premiums that primarily fund the FDIC, the agency also has a $30-billion credit line with the U.S. Treasury (i.e., with you and me).

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Today, happily, after 7 1/2 years of economic growth the U.S. banking system has never looked healthier. And the replenished FDIC fund, at $28.3 billion in assets, is equivalent to 1.38% of total insured deposits. That is the highest percentage since 1966.

But as bankers again petition the government to further free up their business and to bless the growing number of mega-mergers, it’s worth remembering the lessons of the past. Even the most zealous free-market champions ought to admit that banking is different from other industries, if for no other reason than that taxpayers can be asked to pay for the mistakes of aggressive or simply unlucky lenders.

Is that grounds enough to deny Hugh McColl a chance to create his super bank? Probably not. But as with so many other aspects of our rip-roaring free markets today, a BankAmerica/NationsBank merger suggests that the risks are rising with the opportunities.

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Tom Petruno can be reached at tom.petruno@latimes.com

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FDIC Fund: A Brief History

The Federal Deposit Insurance Corp.’s fund--the capital backing the government’s $100,000-per-account bank deposit insurance guarantee--went into the hole in the early 1990s because of bank and thrift failures. The fund’s assets have since been replenished. Fund asset totals at year’s end, in billions:

1997: $28.3 billion

Source: FDIC