"…[W]here the preservation of…redwoods is concerned…there is a common sense limit. I mean, if you looked at a hundred thousand acres or so of trees—you know, a tree is a tree, how many more do you need to look at?”
--Ronald Reagan, 1966, during a speech to a wood producers group
He meant it innocently enough at the time he said it. But as with many such innocent quips by public figures, once his opponents hurled it back at him, Ronald Reagan must have regretted ever voicing it.
Daniel Gross over at Yahoo! Finance appears to have made a similarly innocent blunder in an article looking at the toll that 2010 took on America’s small community banks.
Yes, Gross writes, more banks failed in 2010 than in 2009. He calculates that the “average bank that failed in 2010 was about half the size of the average bank that failed in 2009….In other words, as time goes on, banks continue to fail, but the typical bank that fails is getting smaller.”
Gross uses these common sense insights to downplay the impact of small bank failures on the larger economy.
“If a lot of small banks fail, it's bad for their employees and stockholders, and for depositors who have balances greater than the insured maximum,” he writes. He also says: “But the impact to the economy -- and to the system at large -- can be much worse if a few truly massive banks fail. Think about the prospects of restaurant chains failing. The impact of two 3,000-restaurant chains failing would be much larger than that of twenty 80-restaurant chains going under.”
This is good news for President Obama, whose advisors must be dreading the day that a reporter finally gets around to asking POTUS about his plan to slow down the rate of failure among small banks. But Gross’ common sense argument has one fatal flaw – he completely ignores the role that community banks play in the economy.
Small banks are not just miniature versions of larger banks. As economist Fred Mishkin once observed, small banks serve small niches, one of which is small business customers who don't see a problem paying a bit more to a community bank that offers more personalized service.
Do bigger banks wish they could grab this small business niche from the community banks? Not necessarily.
For one thing, because of the big banks’ higher overhead costs, hunting down more money-making opportunities with larger firms makes more economic sense than trying to break into the small business market, especially if you have to start to offer much more personalized service. That makes small business customers expensive to court.
This raises the question of what happens to small business customers of small community banks when those banks fail. Gross’ restaurant analogy is clever, but it doesn’t capture the negative effects of a small bank closing on its local small business customers.
What about the small businesses that cannot get new loans on the same terms from the surviving banks in their town, for example – or who find that big banks won’t lend to them? What about the jobs that don’t get created for local workers as a consequence of those small businesses finding it harder to obtain loans?
Gross’ article is headlined “Bank Failures in 2010: More, but Smaller.” The word “smaller” might be read here to mean “less important banks.”
If you apply some common sense thinking to the role of community banks in fostering economic growth by working with small businesses, then you'll see how those community banks are anything but “less important.”
And the fact that more small banks failed in 2010 than 2009 is hardly proof of an economic recovery.