ATLANTA — As law enforcement agencies and regulators investigate the likes of Goldman Sachs and Morgan Stanley and lawmakers debate legislation to revamp financial regulations, it's become conventional wisdom that big investment and commercial banks caused the crisis and small community banks are paying for the sins of others.
That's not true, however. Georgia leads the nation in bank failures since the crisis began, and all of them have been at small banks, most caused by bad loans to builders.
The reasons that 38 small Georgia banks have failed are varied and in dispute. Some are peculiar to the Peach State, but one lesson Georgia offers the nation is that small community banks have made many of the same mistakes their larger brethren did, and thus exacerbated the national crisis.
"Almost all of the failed banks in recent years have been community banks, i.e., with total assets under $10 billion. Over three-quarters of the failures had less than $1 billion in assets. Most of these banks failed for the classic reason: bad lending, compounded in many cases by excessively rapid growth," said Bert Ely, a banking consultant who rose to prominence during the savings and loan crisis of the 1980s and '90s, when more than 700 thrifts failed.
Nationally, there have been 70 bank failures this year through Friday, according to the Federal Deposit Insurance Corp., which steps in to protect depositors and transfer failed banks' assets to other banks. That's on top of 140 bank failures last year and 25 in 2008, after the recession began in December 2007.
The total is sure to grow, because at the end of last year 702 banks were on the FDIC's "watch list," deemed at risk of failing.
Ely draws a comparison between today's failures and the Great Depression. From 1930 to 1933, more than 9,000 U.S. banks failed, largely because of the severe drop in prices amid the Depression. Congress responded by passing the Glass-Steagall Act in 1933, which erected a firewall between commercial and investment banking, overlooking the cause of most bank failures.
Today, Ely said, lawmakers again are focusing almost exclusively on the problems in big banks and seeking to exempt small ones, even though they're failing at alarming rates because they're overextended in loans to builders.
Big investment banks on Wall Street pooled U.S. mortgages and sold them to investors as bonds and complex securities. Before there was a mortgage to pool and package, however, a house had to be built, and in Georgia, whose economy is driven by the growing metropolis of Atlanta, it's community banks that provided the capital to homebuilders to build and build and build.
Georgia differs from much of the nation in that up until 1996 it restricted banks to operating only in the counties where they were chartered. Georgia has 159 counties, and there are 28 in metro Atlanta alone. That's why Georgia has about four times as many banks as California does, even though California has four times Georgia's population.
"Georgians — businesses and consumers — just had a natural affection for the community-bank model," said Joe Brannen, who heads the Georgia Bankers Association.
Some feared that lifting the geographic restrictions would spell the end of community banking, but since their repeal, 122 new community banks have been chartered in the state.
The fact that Georgia's banks were local meant that homebuilders had local sources of financing. This helped Georgia grow as fast as any state in the nation has for two decades, but it also created a blind spot for bankers and their regulators.
"I'm afraid some of the banks leaned real hard on the growth lever," said Charles Crawford, the CEO of the Private Bank of Buckhead, a community bank in an upscale part of Atlanta that's remained profitable while others have fallen by the wayside, in part because it's limited its lending for residential and commercial construction.
Timing was on Crawford's side, too. His bank opened in December 2006, months before the bottom fell out of the housing market. He didn't ride the elevator up when Georgia led the nation in housing starts for much of the decade from 1995 to 2005, but that saved him from the plunge that sank competitors.
"We're getting more opportunities to . . . cherry-pick the best loan requests out there," said Crawford, adding that many lenders simply lost sight of risk, the same thing that happened to huge commercial banks such as Citigroup and Bank of America.
"Atlanta has no large national builders that dominate the marketplace. I don't think any builder had more than 3 percent of the marketplace," said Mark Vitner, a senior economist in Charlotte, N.C., for the national bank Wells Fargo. "That just lends itself to making it harder for national builders to do business in Atlanta, which really opened the door to smaller banks."
Since no large bank or large builder dominated the Georgia market, the smaller banks' overexposure to risk in lending to builders was camouflaged: Rather than one big bank that bet too heavily on housing, lots of smaller ones did, making it hard to see the big picture.
Community banks enjoyed huge profits during Atlanta's decade-long housing boom, but like large banks, many had too many eggs in one basket.
"The experience in Georgia shows that banks were not innocent bystanders. While there were some small banks that were not at the root of the problem . . . in many cases in Georgia they were," said Vitner, who closely follows economic trends in the Southeast.
Added Ely, "The owners and managers of these mismanaged banks can blame their failure only on themselves."
What lessons do regulators draw from Georgia's bank problems?
"This is obviously something we've spent a lot of time thinking about; it's in our backyard," said W. Brian Bowling, a vice president at the Federal Reserve Bank of Atlanta.
The Atlanta Fed regulates only a small number of Georgia banks, including one large one, SunTrust. Most Georgia bank failures weren't on its watch, but they clearly remain a concern. Bowling is sympathetic to the idea that fragmented banks and builders may have created a distorted view of what was happening in the housing market.
"Smaller banks would not have been doing what they were doing . . . if there was not what appeared to be such demand for housing," he said. "We, like many others, are trying to figure out the extent to which Atlanta's fragmented homebuilding industry is interrelated with other factors. These include a large number of banks in the metro area, a high number of start-ups and a higher number of bank failures than other markets are experiencing."
The FDIC thinks that small Georgia banks were overextended, in part because of national practices that drove mortgage lending.
"I think there was a supply and demand imbalance, but I think that demand was inflated by the nontraditional mortgage activity," said Doreen Eberley, the regional director of the FDIC's New York region, who served as interim regional director in Atlanta last year. "The availability of mortgages drove construction. The Atlanta story wasn't one of speculative construction."
Eberley pointed to the growth in nontraditional mortgages underwritten by entities outside community banking that pooled these loans for sale to investors as complex securities. From 2002 to 2007, subprime mortgages for the riskiest borrowers in the Atlanta area grew in value from $4.6 billion to $15.4 billion, and Alt-A mortgages, given to the next riskiest borrowers, grew from $1.8 billion to $16.6 billion.
For Vitner of Wells Fargo, the lesson for community banks in Georgia remains that too much lending was tied up in residential and commercial real estate.
Even if a lender was prudent, he said, "if a large percentage of your assets are in real estate, it could still drag your (loan) portfolio down."
Brannen, the head of the Georgia Bankers Association, disagreed:
"Our model in Georgia was built on two decades of experience. . . . What Wall Street came up with" — bonds and securities backed by pools of U.S. mortgages — "is fairly new. That has not been the model for the two decades of growth we've had here."
For 20 years, Georgia had a net monthly population growth of 14,000 people, he said, suggesting growing demand for housing, especially in the Atlanta area, which has no natural barriers such as mountains or ocean to limit expansion.
"If we were the only state this was happening in, I would feel very bad . . . but we've got some awfully good company with states that have very different laws," Brannen said.
Vitner expects that Georgia banks will have more company soon.
"The small banks really don't have a lot of avenues to increase lending all that quickly, and a lot of them end up lending in construction and development," he said. "My suspicion is that while Georgia is way out in front . . . we're going to find that other places like Florida, Arizona and Nevada are quickly going to catch up. We're going to find other places are going to have a significant number of failures."
Federal Reserve Chairman Ben Bernanke said in a speech May 6 that the number of regional and community banks considered weak "is still increasing, and their loan losses likely will remain elevated this year. The most significant areas of concern are residential mortgages and commercial real estate loans."
The Fed is trying to get private-equity investors to take stakes in regional and community banks as an alternative to shuttering them.
(Halimah Abdullah contributed to this story.)
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