COLUMN ONE : U.S. Banks: A Crisis in Making? : Stiff competition and bad management have put the industry in deep trouble. The government is moving to help. But there are disturbing parallels to the S&L; debacle.

WASHINGTON —  Is the nation’s troubled banking system stumbling down the same road that led to the savings and loan debacle?

And if it is, does America’s vast network of commercial banks, with branches on almost every street corner, deserve to be saved?

Those questions are taking on a new sense of urgency, as the number of federal takeovers of sick banks grows--and intensifies the debate over the Bush Administration’s campaign to overhaul the nation’s antiquated banking laws.

Squeezed by tough competition, dismal management at many institutions and the loss of many of its best customers, the banking industry is in deep trouble. This year, federal regulators are expected to shut down another 180 insolvent banks, bringing the total since 1985 to more than 1,200. Now, roughly as many banks are failing each year as were closed from 1942 to 1980.

The troubles permeating U.S. banks have made the nation’s financial system more fragile than at any time since the Great Depression, posing new risks to the economy if the recession gets any worse. Many fragile banks, struggling to clean up balance sheets that are smirched by failed real estate loans, are loath to make new loans needed to finance a revival of the economy.

After repeated assurances that banks cannot go the way of S&Ls;, regulators last month began telling Congress that they need a $70-billion temporary line of credit available to pay off depositors at failed banks.

“The people are beginning to smell a new taxpayer bailout,” warns Rep. Henry B. Gonzalez (D-Tex.), chairman of the House Banking Committee. His alarm comes as the country is already deeply involved in paying the massive bill for the S&L; debacle, which will cost at least $130 billion and, ultimately, perhaps as much as $400 billion.

Paradoxically, the Administration’s effort comes at a time when many experts wonder whether thousands of banks are not already obsolete. Banks are losing much of their importance in today’s mobile, affluent, high-technology society, but they are still operating under federal and state laws that were designed for a simpler America without computers, jet planes or interstate highways.

Only one American bank--Citicorp--still appears on the list of the world’s 25 biggest financial institutions. The roster is dominated by Japanese banks.

Meanwhile, a new generation of financial institutions--mutual funds, money market accounts, consumer finance and mortgage companies--has emerged to provide sophisticated new services to customers who once were solely dependent on banks.

Certainly the vast majority of Americans still need banks to cash their paychecks, save some money and borrow. The businessman, the farmer and the fledgling entrepreneur all turn to the local lending officer when they need someone who is willing to take a chance on them. The community banker still has a better feel for the needs of the local economy than anyone else. “We know them, we live next door to them,” says Al Olson, president of the Minnesota Independent Bankers and a former governor of the state.

Vital as they may be, however, these bank functions do not generate enough earnings to support the nation’s enormous--and very complex--banking structure. Other industrial nations do their banking business with a tiny fraction of 12,000 banks in the American network: There are just 150 commercial banks in Japan, for example, 550 in Britain, 65 in Canada and 900 in Germany.

Simply put, banks are in trouble because American consumers and businesses do not need them as much as they did 20 years ago. Americans can dabble in hundreds of money market funds, pay bills with checks written on a cash management account from a brokerage firm or get a home equity loan from a finance company.

Since 1970, nearly $350 billion in consumer savings has been swept out of the banking system into money market funds, while another $425 billion in corporate borrowing has shifted to new credit markets on Wall Street.

With some of their best customers going elsewhere, bankers have spent much of the last two decades chasing after ever-riskier borrowers--Third World nations, junk-bond kings and commercial real estate speculators--who have been willing to pay the high interest rates that the banks need to satisfy their depositors and still maintain their profits.

America’s banks, like the savings and loan associations before them, now are paying the price for such high-risk investments. In the last four years, banks have been forced to divert $75 billion of their profits to cover the costs of loans that have soured.

Like the S&Ls;, banks bet heavily on real estate, which accounts for 23% of all bank assets, the biggest single category of business.

That over-reliance on volatile real estate is bringing many institutions to their knees.

“There was a feeding frenzy in commercial real estate and everyone got caught up in it,” says John LaWare, a Federal Reserve Board governor. “You seek out business where you can find it, and it was easy to find in real estate development.”

Add to these forces an economic slump and much of the American banking system seems to be collapsing under its own weight. Only 198 banks failed between 1942 and 1980. By contrast, more than 1,200 banks have failed in the last four years--a development that is threatening to wipe out the federal deposit insurance fund that protects depositors.

“The problems in the banking industry are apparent for everyone to see, and have to be faced up to now,” a senior Bush Administration official acknowledges.

To deal with the crisis, however, Washington is making moves that are eerily reminiscent of the early days of the S&L; crisis. At the heart of the Bush Administration’s banking-reform efforts is a campaign to deregulate the banks and give them new chances to make money by selling and underwriting insurance and securities and to move across state lines without restriction. Federal regulators also have been given the word to be more accommodating when reviewing the safety of bank loans.

The argument that new investments will rescue banks was tried as a remedy for the savings and loan woes, and it failed miserably. Freed of regulatory restraints, the S&Ls--especially; in California and Texas--ran wild, going beyond traditional home financing into such new fields as shopping centers, office buildings, restaurants and even horse-breeding farms, often with the help of junk bonds.

Hundreds of S&Ls; collapsed into insolvency, and taxpayers will be bearing the burden for 40 years to dispose of the defunct institutions and to rebuild the S&L; deposit insurance fund.

The savings and loan industry is on a taxpayer-financed life-support system. More than 350 S&Ls; are being run by the federal government.

The same sickness could overcome the banks. If the regulators can’t raise enough money from the healthy banks to keep the insurance fund sound, they will turn once again to the taxpayers.

The wreckage of America’s once-proud thrift and banking industry seems to be a sad--and costly--legacy of the banking policies established during the last financial debacle, in the 1930s.

Before the current crisis, the system served the country well for decades. “What Congress created in 1933 and 1934 was a framework for stability in the financial services industry,” insists Paul Zane Pilzer, a Dallas investment manager, in his book “Other People’s Money.” “That it endured for almost 50 years through recovery from depression, global conflict and steadily rising prosperity is remarkable, if not miraculous.”

In fact, before the introduction of wide-ranging federal regulations in the Great Depression, banking in the United States was periodically plunged into chaos, rising and falling with the exuberant expansions and occasional depressions of the young American economy. States wielded the power to create and regulate banks, and the absence of centralized regulation in Washington, along with a largely agrarian economy, led to the proliferation of thousands of small, independent institutions.

By the end of World War I, the country was dotted with 29,000 banks--more than twice as many as today--most of them single-branch businesses with small deposits. Except for the dominant international bankers of New York, banks were closely linked to their hometowns, and their failure hardly caused a ripple elsewhere.

But the old system died in the Great Depression, when the entire financial infrastructure suffered a meltdown. The stock market crash in 1929 touched off a frenetic cycle of rumors, fears and panic. Anxious depositors stormed banks to withdraw their money, causing a cascade of failures. The banks could not supply the cash, and they closed their doors.

From 1930 to 1933, a staggering 9,096 banks failed, wiping out the savings--and the confidence--of millions of Americans. Deposits plunged 39%, deepening a depression that endured until World War II.

The virtual collapse of the system prompted radical reform. For the first time in American history, the federal government became the guarantor of deposits. The Federal Deposit Insurance Corp. was created in 1933 for the banks, and the Federal Savings and Loan Insurance Corp. in 1934 for the thrifts. The systems initially protected deposits up to $2,500.

Congress thus put the nation’s financial institutions in a gilded cage. Deposits were now insured, relieving the anxieties of bank managers that a whisper of failure could spawn angry crowds clamoring at the doors for their money. But the banks were banned from lucrative businesses, such as underwriting and marketing stocks and bonds. Banks had enjoyed big profits in the 1920s by organizing investment syndicates--early versions of mutual funds--and providing loans for people who wanted to buy these shares.

The New Deal reforms gave banks and thrifts their first extended period of stability. For much of the era after World War II, interest rates held remarkably steady. Mortgages were cheap, and passbook interest rates were modest, but still high enough to placate most Americans in an era of low inflation.

Congress had given the banks and thrifts the power of a cartel, with Uncle Sam keeping away any rivals. Normal price competition was suspended. First National Bank on Main Street could offer no more to woo deposits than Bankers’ Trust on Elm Street.

In this abnormal market, competition took distorted forms. Branches blossomed on virtually every street corner as banks and thrifts sought to make convenience a sales tool. They stayed open longer hours. They gave away television sets, blenders and glassware to depositors.

But none of that was good enough when inflation roared into the economy in the late 1960s and early 1970s. Congress tried to protect banks and thrifts from inflation in the 1960s by imposing new ceilings on the interest rates they could offer, effectively limiting the competition among financial institutions to attract the savings of millions of Americans.

But inflation could not be stopped so easily. People saw the value of their savings shrinking, thanks to the government-imposed limits on rates that banks and S&Ls; could offer, and began to shift their funds to money market accounts and other non-federally insured investments.

The financial revolution accelerated in 1972 when the Massachusetts Supreme Court said that the Consumer Savings Bank of Worcester, Mass., could for the first time offer an interest-bearing checking account, called a negotiated order of withdrawal, or NOW account. The first NOW accounts were opened on June 2, with a minimum deposit of only $10, offering 5.25% interest. By the next year, about 17,000 NOW accounts were in force.

But it was already too late for the banks to keep new competitors out of the market, as consumers began craving new ways to keep up with higher prices.

In 1972, just as NOW accounts were being born, the first money market funds were introduced by investment companies, and they immediately began to bleed deposits from the banks and thrifts to feed the demands of the middle class for better interest rates on their savings.

The rich already enjoyed higher rates--banks could pay more interest for certificates of deposit in excess of $100,000. But the real revolution came in the 1970s, bringing the benefits of sophisticated new investment vehicles within reach of the middle class: Money funds would now pool the dollars of millions of people, and buy high-interest certificates from the banks. Buying shares in a money market fund gave ordinary people access to high returns.

The shift away from banks and thrifts by individual consumers and corporate customers was both sudden and dramatic.

One stark set of numbers offers an example: It took the savings and loan industry 150 years to accumulate assets of $250 billion. Money market funds, created in 1972, reached the same plateau in eight years.

Banks and thrifts complained bitterly about the new funds to regulators, members of Congress and anyone else who would listen. They represented unfair competition, because the money market funds were not insured or supervised, the bankers argued. But suggestions about curbing the funds drew an intense and angry response from the public, especially affluent senior citizens. The message was clear: Leave our money alone.

Inflation turned the world of banking upside-down, forcing bank managers for the first time to scramble desperately to try to make money.

So the careful, precise conservative banker of yesteryear often became a financial gunslinger, a gambler with other people’s money--the billions of dollars worth of deposits that were protected by federal insurance.

More and more of the best customers abandoned banks in favor of institutions such as finance companies and the commercial paper markets, which allowed corporations to borrow directly from investors and from each other.

“Once inflation and interest rates became high enough to catch people’s attention, it was inevitable they would find other ways to invest their money,” says Cynthia Glassman, research director at Furash & Co., a Washington bank consulting firm. “If they couldn’t do it in banks, other opportunities would arise to meet people’s needs.”

Banks were squeezed on both sides of the ledger, with depositors fleeing for higher returns and borrowers disappearing at the same time.

Banks had to fill the gap somehow, so they turned to higher-risk loans, first in agriculture and oil and gas, then to Third World nations, and finally in junk bonds and real estate. Inevitably, many of those loans turned bad because the banks were no longer dealing with the blue-chip corporations who had been their traditional customers. And their balance sheets began filling up with defaulted and overdue loans.

Meanwhile, the legal limits on the amount of interest that banks and savings and loans could offer on deposits were deregulated between 1980 and 1986. That intensified the scramble among banks and thrifts, which offered unrealistically high rates on certificates of deposit in hopes of luring customers back from money market accounts.

The combination of paying high CD rates while taking hits on bad loans was a deadly mix for banks and S&Ls;, made all the more lethal by lax supervision from federal regulators.

Trouble showed up first at the far weaker S&Ls.; Hundreds of thrifts became casualties when they gambled and lost on shopping centers, condominiums, raw land speculation and other ventures far removed from their familiar turf in home mortgage lending.

The result was one of the biggest financial disasters in American history. More than 1,000 of the 4,000 S&Ls; have already disappeared into mergers, government takeovers and bankruptcies.

As usual, innovation ranged ahead of laws and regulation. Not until 1978 did the regulators allow banks to offer the new money market accounts--six-month certificates pegged to Treasury bill rates.

But these modest steps could not disguise the banks’ essential weakness--that they simply could not match the competition. Passbook savings, the traditional time deposits at the heart of banks’ balance sheets, melted away, dropping from $907 billion to $690 billion in just 18 months between January, 1979, and June, 1980.

Running to keep pace with the markets, Congress voted in 1980 for a gradual dismantling of interest-rate restrictions on banks and thrifts. But in the end, that deregulation came back to haunt the banks, and by the 1990s, the forces unleashed by both the market and the government had brought on the current crisis.

“Banks’ costs were going up at the same time that their market was going away,” says Federal Reserve economist Harvey Rosenblum. “They were losing their best corporate customers. They had to take high risks . . . (and) banks got into one disaster after another.” In the financial world of the 1990s, there remain too many banks with too many real estate loans, and too few other ways to make money, the experts say.

“The biggest problem we have is that there are too many banks, and we need to phase them out in an orderly way,” says Allan Meltzer, an economist at Carnegie Mellon University in Pittsburgh, Pa.

Even senior government officials deeply involved with the Administration’s rescue effort concede that the sun may be setting on the nation’s once-proud banking industry.

“The nature of banking is changing, and the role of the traditional commercial bank, the depository institution, is shrinking,” Federal Reserve Board Chairman Alan Greenspan notes.

“The role of banks has clearly declined,” agrees Robert Glauber, undersecretary of the Treasury and one of the chief architects of the Bush Administration’s plan to overhaul the banking system.

Defenders of the banks, however, reject comparisons with the S&L; crisis, and say banks can emerge healthier if they are given new business powers.

The banks have a hefty $200 billion in capital, which is the money contributed to a business by owners and investors. By contrast, the savings and loan industry was virtually broke in 1980 when it embarked on a bizarre odyssey of risky investments. Only some dubious accounting gimmicks enabled regulators to declare that hundreds of crippled S&Ls; were really solvent.

“I don’t think our banking situation is remotely like that of the savings and loan crisis,” says Robert Dederick, executive vice president of Northern Trust Bank of Chicago. However, many bankers themselves admit that new powers will not do any good unless the industry shows better judgment than it did in the 1980s.

“If risk management is not improved, it won’t do any good to be in investment banking or insurance and be spread all across the country,” warns John G. Medlin Jr., chief executive of First Wachovia Corp. in Winston-Salem, N.C. “Expanded opportunities would just provide another chance to make mistakes, over a wider area.”

WHO’S IN CHARGE?

The responsibility for federal banking policy and regulation enforcement rests with three key officials, listed below. At the state level, bank examiners keep an eye on proceedings. * Comptroller of the Currency

Function: Regulates federally chartered banks

Comptroller: Robert L. Clarke

* Federal Reserve Board

Function: Regulates state-chartered banks and bank holding companies.

Chairman: Alan Greenspan

* Federal Deposit Insurance Corp.

Function: Guarantees bank deposits up to $100,000 per depositor

Chairman: L. William Seidman

AMERICA’S TOP 20 BANKS

Assets (billions) Bank Dec. 31, 1990 Citicorp $217.0 Bank of America 110.7 Chase Manhattan 98.1 J. P. Morgan & Co. 93.1 Security Pacific 84.7 Chemical 73.0 Bankers Trust 63.6 NCNB Corp. 61.6 Manufacturers Hanover 61.5 Wells Fargo 56.2 First Interstate 51.4 C&S;/Sovran 51.2 First Chicago 50.8 PNC Financial 45.5 Bank of New York 45.5 First Union 40.8 Sun Trust Banks 33.4 Bank of Boston 32.5 Fleet/Norstar 32.5 Barnett Banks 32.2

Source: Keefe, Bruyette & Woods Inc.

ROSTER OF FAILURE

Bank failures, 1989-90

State 1989 1990 Alaska 2 - Arizona 6 5 Arkansas - 1 California 1 4 Colorado 7 7 Connecticut 1 - District of Columbia - 1 Florida 5 7 Kansas 5 1 Kentucky - 1 Louisiana 21 4 Massachusetts - 2 Minnesota 1 1 Montana 2 - Nebraska 1 - New Jersey - 2 New Mexico - 2 New York 3 2 North Dakota 2 3 Ohio - 1 Oklahoma 12 10 Texas 134 103 West Virginia 1 1

Source: Federal Deposit Insurance Corp.