(Photo: flickr.com)

Depositor confidence in the banking system is vital to the working of the modern economy. Banks lend out money assuming that they are not going to face a situation where all their depositors demand to withdraw funds simultaneously. At the same time, depositors entrust their money to the bank, believing they can withdraw it when they need to do so. A hundred years ago, many people still kept their savings at home. Those who deposited money in a bank would often rush to take their money out at the first rumors of trouble. These “runs” on banks were common causes of the bank collapses these depositors feared. The establishment of the FDIC in 1913 was prompted by a financial crisis in 1907 when the US Stock Exchange fell by 50 percent. This triggered many runs on banks and trust companies.

What Happens When a Bank Fails?

As soon as a state bank is unable to pay off all its creditors, the FDIC intervenes. They try to act in a way that does not draw public attention – the last thing they want is to cause a run on the bank. Their staff of bank analysts, accountants and other financial professionals makes a detailed survey of the bank’s assets. The aim is both to reach an assessment of the bank’s value as well as uncovering the reason for its failure.

The FDIC has the authority to close a bank, or alternatively take control of its management. Generally the preferred approach is to seek a buyer who is interested in taking over the failed bank. The FDIC is willing to offer inducements to buyers of failed banks. For example, they might agree to reimburse the takeover bank for 80 percent of the losses it is going to incur through acquiring delinquent loans.

Has Depositor Confidence Been Damaged Beyond Repair?

FDIC statistics show that over a 120 banks have collapsed in 2009 and the year is still not over. Compare this with 2007, when there were just three bank collapses. The FDIC recognizes the need to address public concern over loss of deposits due to bank collapses. This is one of the prime reasons why they guarantee deposits of up to $100,000 in banks with FDIC insurance. Sheila Bair, Chairman of the FDIC, seeks to reassure Americans that the crisis is under control: “Our projection right now is bank failures will continue at a pretty good clip through 2011. Again, we’re prepared for it; we’re ready for it. The rate of healing in the economy will drive the rate of healing of the banking sector.”

Are Bank Failures Unmitigated Disasters?

To the wealthiest depositors and investors who stand to lose a considerable amount, there is no doubt that a bank collapsing is very bad news. Management and employees are also going to be concerned over the loss of jobs that is almost inevitably going to happen. However, from a macro-economic perspective, failure is not necessarily a great disaster. While the recent spate of bank collapses has certainly damaged confidence in the U.S. economy, some economists argue that over the long term there may be benefits. The disappearance of the weakest banks is viewed by these analysts as a healthy development that strengthens the economy.

Will the Federal Reserve create the framework consumers need to experience debt relief? (Photo: flickr.com)

Due to the recession, people are looking for debt relief more than ever.  Credit lenders are no longer as readily available as they once were.  Mortgages are difficult to handle.  The unemployment rate continues to rise.  Because of these problems, the Obama administration is calling for a new “financial rulebook.”  The administration aims to arm the Federal Reserve with increased power to regulate risk of large institutions in the financial industry. The goal is to police banks whose potential failure could cause economic instability to the nation.

The Federal Reserve also wants to create a strong framework of regulations and have a part in coordinating responsibilities within the financial system.  Investors would have increased protection, with the Fed focusing a committee on consumer products such as credit cards and annuities.  Treasury Secretary Timothy Geithner stated that the overhaul will “eliminate gaps in the financial system that encouraged risky behavior leading up to the meltdown [of the recession].” Geithner added, “We had a financial system that was fundamentally too unstable and fragile, and it did a bad job of basic protection of consumers and investors. Those are things we have to change.”

Unveiling the Plan

This week, President Obama is supposed to introduce his overhaul plan to the media. Initially the plan was for an intense restructuring that would consolidate all financial directives into one agency.  Senator Chuck Schumer of New York was a strong supporter of the consolidation, believing that “retaining multiple regulatory entities preserves the regulatory arbitrage that allows institutions to pick the oversight scheme that benefits them the most, often at the expense of consumers and the health of the system overall.”  This plan was ultimately vetoed by the Obama administration.

Another vetoed plan was to merge the Securities and Exchange Commission and the Commodity Futures Trading Commission.  Supporters believe the merging would offer a greater security in investments, bringing debt relief to aging Americans when they most need it, at retirement.

What We Should Expect

The plan to be unveiled will most likely leave the Fed, the OCC and the Federal Deposit Insurance Corp as the largest banking regulators.  In addition, the plan will impose “robust reporting requirements” on asset-backed securities and require banks that sell them to keep a financial involvement in their performance.  As Geithner stated, “We want the regulators to have a financial interest in the development of the products they are selling to ensure they are acting honestly and focused on growth.”

Easing the Strain of the Recession

Consumers are anticipating the new plans, hoping they will offer debt relief and ease the strain of the recession.   Banking Coordinator Susan Largina of Bank of America, stated, “We’re seeing a more hopeful clientele coming in. They want to believe the good news the media is interspersing throughout the daily news… It’s our job to maintain that hope by increasing the benefits and long-term viability of our banking products.”

Consumers Want Answers

With the new financial rulebook coming to the marketplace, consumers are waiting impatiently for answers.  They have suffered through the economy as best they could manage, using credit cards, tapping into savings and budgeting wisely.  With the recession coming to a close, consumers see debt relief as something they can reach in the near future. Hopefully with the new financial changes in the economy, banks and lending institutions will help consumers find their way back to a normal life.