Bank’s failure bad news for other local banks

Washington banks staggered by bad real estate and construction loans received a most untimely $15 million state summons last month.

One of their financial brethren had failed, and they were on the hook for government deposits left on the table when the Federal Deposit Insurance Corp. took over the assets and deposits of Bank of Clark County. An obscure entity called the Washington State Public Deposit Protection Commission, or PDPC, was suddenly at their teller windows demanding a withdrawal.

They paid up, but they do not want to repeat the experience. Neither does the state.

Local governments – counties, cities, school districts, etc. – have more than $8 billion in cash stashed in Washington banks and savings and loans. In 1969, the PDPC was created to make sure government deposits uninsured by FDIC would be covered in the event a bank or thrift became insolvent.

The financial institutions agreed to a levy pro-rated based on whatever share they held of public funds at the time of an insolvency. For example, let’s say there are $1 billion in such funds deposited in all Washington banks, and one holding $100 million fails. A bank holding $1 million in deposits would have to write a check for $1,000 to cover its share of the lost funds.

The same holds true for thrifts, which are levied separately.

Although there were some modifications to the law over the past four decades, nobody gave the PDPC much thought. No bank or thrift in Washington had failed since 1993.

Then, in September, Washington Mutual Bank imploded in the biggest-ever failure of a U.S. bank or thrift. There were $700 million in government deposits in WAMU vaults. Forcing other Washington thrifts to make good on those deposits would have all but wiped out the industry.

Fortunately, JP Morgan Chase took over the government deposits when it took over WAMU.

No so for Umpqua Bank of Roseberg, Ore., which acquired Bank of Clark County assets and deposits. In fact, the FDIC did not even offer the public deposits to Umpqua. Why would the FDIC, under stress because of bank failures elsewhere, cover the $15 million if that loss can be handled within Washington?

So 93 Washington banks sent the PDPC checks for amounts running from $4.1 million for Bank of America down to $231 for the Farmington State Bank.

To avoid a repeat – all too probable given the damage done by the current recession – Treasurer Jim McIntire has asked the Legislature to revamp the way the PDPC protects public deposits. If enacted, each institution would, in effect, self-insure public money by setting aside collateral equal to the funds on deposit. If the bank fails, the PDPC gets the collateral.

Most other states have similar arrangements.

The bill would also allow the Department of Financial Institutions to share more information with the Treasurer about the condition of the banks it examines. Now, the treasurer has to ask for the information. But if he is unaware there is a problem, he will not ask any questions.

In the universe of regulatory breakdowns that have brought our financial system to its knees, that blind spot is miniscule. But, as McIntire said in testimony supporting the reforms, Washington’s economic vitality depends on the health of its banks.

The $15 million for Bank of Clark County may be a small cut, but it hurts just the same.