(By Shah Gilani
) When the Federal Deposit Insurance Corp. (FDIC) released its list of "problem banks" this week, 702 institutions holding $402.8 billion in assets were found to be in trouble.
That's the longest list in 17 years, and it's only going to get worse. In fact, regulators are expecting the number of troubled lenders to grow at an accelerating rate this year
. They claim that an uptick in commercial-real-estate losses will serve as the key culprit
But the real
culprit - the one that regulators won't talk about publicly - is the funding scheme banks employ to load themselves up on speculative loans. T his scheme - far removed from most investor radar screens - has played a major role in the banking sector's growing woes, and will continue to contribute heavily to bank failures in years to come.
- The centerpiece to this risky strategy is a funding vehicle known officially as a "brokered deposit." However, due to the narcotic-like effects brokered deposits can have on a bank's balance sheet, industry insiders have adopted a more-appropriate moniker - referring to them as "hot money."
The Birth of "Hot Money"
Brokered deposits have helped banks grow explosively from tame domestic companions into muscular monsters that are capable of ripping the face off of economic prosperity when the lending institutions blow up.
To understand all the forces at play here, we need to look back nearly 50 years.
As far back as the 1960s, depositors searching for high-yielding savings and thrift accounts were matched up by brokers who steered them to banks offering the best yields.
Say, for example, you have $1 million that you want to deposit. A "deposit broker" would take the cash, and break it up into several smaller portions, each of them below the maximum allowed to qualify for federal deposit insurance. Those deposits would be spread among banks that are customers of the broker.
That cash provides the banks with money that they can turn around and lend. And it also provides the Federal Deposit Insurance Corp
. with fees for its insurance fund.
deposits also have a dark side.
Fueled by hot-money deposits, banks too often shift into a turbocharged growth mode. They expand into markets they don't know and concentrate their loans, instead of spreading their risks. When the music stops, as it did in 2008, these banks crash and burn.
As early as 1963, regulators tagged brokered deposits as problematic. They limited any bank's holding of them to only 5% of total deposits. Regulators were worried that upward pressure on interest rates from banks trying to attract depositors would spread across the economy. Later, some brave and stalwart regulators screamed that these deposits were causing bank failures and threatened the entire banking system.
In 1984, William M. Isaac
, chairman of the FDIC, personally identified the origins of what would later become the U.S. savings and loan crisis
. He railed about how S&Ls and thrifts were paying high yields to attract brokered deposits and using the money to make crazy, speculative loans and bets. He proposed killing the brokered deposits business altogether.
Banks, of course, loved brokered deposits. And they fought hard against the FDIC's initiative to kill the hot-money juggernaut.
Special interest groups were intent on seeing the brokered-deposit business flourish. And they'd already won some extraordinary trophies.
The Deposit Institutions Deregulation and Monetary Control Act of 1980
proved to be their first bonanza
. It removed the 5% limit on brokered deposits imposed by regulators in 1963. It phased out a ceiling on the interest rates that banks could pay. And it raised FDIC insurance from $40,000 to $100,000 (in 2008, insurance was raised to $250,000). The 1980 Act was shepherded through Congress by U.S. President Ronald Reagan
's new treasury secretary, Donald T.