Bank Failures: Not a Significant Indicator

A bank failure is news. It is clearly negative news. What does this information really mean?

Bank failures are a concurrent indicator of the recession. The rate of failures is bad, but not as bad as the Savings and Loan crisis. Take a look at this chart from featured site Calculated Risk in an article from a year ago. Bank failures are up from good times, but nowhere near the levels of the 80's.

News Information versus Perspective

Several sources are highlighting bank failures, announced each weekend. The information is accurate, but it lacks perspective. The real question is whether the bank failures provide any predictive information about the economy or the market.

CXO Advisory (another featured source) has done the analysis. Readers should check out the entire article to see the typically excellent charts. Here is the key conclusion:

Visual inspection indicates no systematic relationship between the bank intervention rate and stock returns.

and further...

Excluding bank intervention anomalies (1935-1942 and 1982-1993) produces an R-squared of 0.00. These results do not support a belief that the annual FDIC bank intervention rate relates systematically to annual stock market behavior.

and finally....

In summary, evidence from simple tests does not support a belief that there is a systematic relationship between the annual rate of FDIC bank closings and assistance transactions and annual U.S. stock market returns.

Our Take

Bank failures are news. Objective reporting of this news cannot be criticized.

Having said this, investors must learn to distinguish between coincident negative indicators of an acknowledged recession, and data that has a better predictive value. We try to highlight these differences, as we did here.

Comments

[Jim Hawthorne:]

Once again, news is just that.... news!

What is critical to us is not necessarily the news itself, but the only thing to note is the Mother Market's reaction to it! Trying to predict how the market will react has become a very risky business! We see time and time again the market's ability to shrug off news that would have been horrendous enough to cause a crash 24 months ago!!!

May 03 11:03 AM

[Misha:]

“Bank failures are a concurrent indicator of the recession.” “…no systematic relationship between the bank intervention rate and stock returns.” Thus recession has no systematic relationship to stock returns.

Great deductive power you have, Jeff. I bet you were in the top 95% of your class.

May 03 11:40 AM

[@TexasER:]

Since the entire banking system has already failed, any one reported "failure" doesn't mean anything substantive to me.

Seriously, with the Fed programs and accounting changes designed to hide bank insolvency, it just doesn't mean anything anymore.

The Enron folks went to jail for this same monkey business. Wonder when treasury-gate will break?

May 03 12:07 PM

[altaman:]

Just as number of foreclosures being offer for sale does not accurately reflect how bad things are in real estate, as banks are holding masses of foreclosures off the market, the bank failure rate does not accurately reflect how bad things are in banking as the government is failing to close and/or propping up numerous insolvent banks. In both cases the motivation is the same - to prevent the markets from accurately reflecting the true state of things. A newly supine news media has no desire to get out the truth at the risk of being pushed from the bandwagon.

May 03 03:36 PM

[Steven Hansen:]

"In summary, evidence from simple tests does not support a belief that there is a systematic relationship between the annual rate of FDIC bank closings and assistance transactions and annual U.S. stock market returns."

the weekly banking closures are just small fish in the market. the big ones are too big to fail. as one of the contributors who bring up the closures, i do so to remind people of the destructive wrath of this recession.

it is never one indicator which defines our economy. we need to look at all of them, and try to put what is going on in perspective. the bank failures pale in significance to the decline in jobs, the rising debt, and shortly the competition for private money which will set off another economic crisis.

May 03 11:52 PM

[Jeff Miller:]

Steven -- I am trying to do something pretty simple here -- distinguishing concurrent from leading indicators. CXO has good research showing this is not a leading indicator. You do not really reply to that.

We both look to the ECRI, which has a strong leading indicator.

How do you -- other than general opinions -- discover leading indicators?

Just wondering.....

Jeff


On May 03 11:52 PM Steven Hansen wrote:

> "In summary, evidence from simple tests does not support a belief
> that there is a systematic relationship between the annual rate of
> FDIC bank closings and assistance transactions and annual U.S. stock
> market returns."
>
> the weekly banking closures are just small fish in the market. the
> big ones are too big to fail. as one of the contributors who bring
> up the closures, i do so to remind people of the destructive wrath
> of this recession.
>
> it is never one indicator which defines our economy. we need to
> look at all of them, and try to put what is going on in perspective.
> the bank failures pale in significance to the decline in jobs, the
> rising debt, and shortly the competition for private money which
> will set off another economic crisis.

May 04 12:35 AM

[PainfullyAware:]

The FDIC does not have the resources to close the amount of banks that are currently in the Zombie State.

Why Else Would The Government Initiate Such Drastic Plans As We Have Seen?

The plan as stands is - Feed Them Money And Hope Their Revenues Can Compensate To Keep Them Alive.

Bank Closings are not an indicator because of this fact.

Things In The "Real World" Are Worse Than They Appear.

May 04 08:02 PM

[donzelion:]

Two observations. First, the wave of bank failures in the 80s was driven by bad debts accrued in the 70s (and a desire by banks, S&Ls, and others not to kick farmers off their land). Many regional banks had been on life support for 3-10 years. Mega-banks swept in partially to fill the gap these banks left.

Second: while predictive value of bank failures is probably minimal in the broad economy, they may be helpful to predict regional performance. I can't learn much from watching one gambler lose his shirt, but I can learn a great deal if I know that more gamblers lose their shirt in one casino than another.

May 10 04:55 AM