Bank Failures: Not a Significant Indicator

May. 3.09 | About: SPDR S&P (KBE)

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.