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Commercial bank bailout looms, some experts say

Maybe banks should compete in the Olympics.

They set record profits in this year's first quarter and again in the second. Over the next few weeks, they're likely to report another all-time high for the third quarter that ended Sept. 30.

Not bad for a recession.

Still, some of the nation's top banking experts have looked behind those heady numbers and they are worried. Real worried.

The number of "problem banks" identified by the Federal Deposit Insurance Corp. is barely shrinking. And the size of assets at problem banks is near record highs (see chart).

Worst of all, the FDIC is more than $5-billion in the red.

Is depositor money in danger? No. But taxpayer money may be. The smell of a bailout of commercial banks is in the air.

If this story has the familiar election-year ring of the savings and loan crisis, it should.

In 1988, presidential candidates George Bush and Michael Dukakis chose to ignore the S

&

L problem. A week after becoming president, Bush asked Congress for $50-billion in taxpayer money to clean up the S

&

L mess.

This election year, Bush and Bill Clinton have remained mum about the plight of commercial banks.

Enter the "December surprise."

Several banking experts believe the federal government will acknowledge after the November election that a lot of banks are in trouble and that the FDIC will need taxpayer money to deal with it.

That scenario is supported by economist Dan Brumbaugh (who coined the phrase "December surprise"), Boston College professor Ed Kane, Auburn University's James Barth, Edward W. Hill of Cleveland State University and others.

The FDIC, Kane told Congress this past summer, "is following in the same ruts in the same roads of forebearance and cover-up that previously led the FSLIC (the now-defunct S

&

L insurance fund) to ruin."

To be sure, the idea of a bank bailout is controversial.

"Is a bank crisis looming? No," said Prudential Securities bank analyst George Salem _ once dubbed "Doctor Gloom and Doom" for his bearish outlook on banking.

He thinks low interest rates and cost cutting have made banks better prepared for adversity than they were in 1990.

Gary Stern, president of the Federal Reserve Bank of Minneapolis, seems a lot less sure.

Banking problems like those that led to the S

&

L crisis are not over, Stern said. "We have not seen the last of the problems caused by excessive risk-taking. If we are not vigilant, the taxpayers may be exposed at some future point, as well."

Here are four popular banking myths a growing number of experts want to debunk:

Myth 1: Record bank profits in 1992 will revive the industry and halt the industry's downward spiral.

Wrong, argue economists Roger J. Vaughan and Cleveland State's Hill, authors of the newly published Banking on the Brink: The Troubled Future of American Finance.

"America now has two banking industries. One is strong, profitable and internationally competitive. The other is dying," they write.

They estimate that 1,500 banks with $1-trillion in assets, out of 12,000 with $3.4-trillion, "are in deep trouble."

Myth 2: The FDIC, which insures bank deposits to $100,000, will be able to get back into the black by charging higher premiums to the banking industry.

Doubtful. The FDIC's cost of closing banks has exceeded its income from premiums since 1984.

Last month the FDIC, under heavy pressure from banks and the Bush administration, spared most of the nation's banks from paying more for insurance. Instead, it voted to raise premiums in 1993 only on banks in greater-than-average danger of failing.

The FDIC argued the new system would compel weaker banks to improve their condition in order to become eligible for cheaper premiums.

"The opposite will happen," said Kane of Boston College. Weak banks will pursue riskier activities hoping to earn more money to cover their higher costs.

The FDIC can borrow up to $75-billion from the Treasury Department _ taxpayer money _ to cover expenses of insuring deposits and closing banks. The FDIC is supposed to pay that loan back by increasing the insurance premiums it charges banks.

Myth 3: The pace of bank failures has stabilized and won't increase in the coming months.

Before the year began, the FDIC said it expected 200 banks with $116-billion in assets to fail in 1992. So far, 83 banks with $27.8-billion in assets have failed.

While some troubled banks may have revived, low interest rates have probably served only to delay the day of reckoning for many institutions.

On Dec. 19, a new rule takes effect that requires the FDIC to seize within 90 days any bank with capital less than 2 percent of total assets. The FDIC has some leeway if it sees improvement in these banks, but far less than now.

Myth 4: Because banks are making fewer loans and investing more in government securities, the industry is reducing its exposure to risk and potential losses.

It's more likely that banks are not reducing their risks _ just substituting one kind for another, said Auburn professor Barth.

Banks have cut way back on lending and lowered their credit risks. Instead, banks now are investing more money in government securities.

That's raising the interest-rate risk of banks, said Barth. If short-term rates go up, banks will have to pay more for deposits. But they still won't make more from their longer-term investments. That, said Barth, could squeeze some banks.

_ Information from the Associated Press was used in this story.

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