Reply #9: New banks: No better than old banks Felix Salmon Tags: banking

[Demeter]

http://blogs.reuters.com/felix-salmon/2009/06/22/new-banks-no-better-than-old-banks/

When the TARP was being unrolled last fall, a simple question was often asked: rather than pouring good money after bad into banks which clearly had inadequate risk controls, why not just use that cash to start up fresh new banks unencumbered by toxic assets?

Well, for one thing, the banks needed to be saved, to protect the economy from the systemic consequences of them failing. But more to the point, no one had any particular reason to believe that fresh new banks would be any better at banking than the old ones were. And Daniel Massey has a great example: Herald National Bank, which opened up last fall with an impressive $62 million of initial capital.

In its first full quarter of operation, its return on average assets was negative. Which might be predictable, for a startup. But it wasn’t just negative, it was -27%. Which is insane. Oh, and despite the fact that the bank has only been operating for a few months, it has already started laying people off, including nine managing directors.

And that’s not all:

The loss of Executive Chairman Daniel Healy, an industry veteran who is believed to have attracted many of the bank’s initial investors, may loom even larger than the one on the balance sheet. Mr. Healy had been the chief financial officer at North Fork Bancorp. for 14 years before it was sold to Capital One Financial Corp. He resigned his post at Herald on May 19, leaving for “personal reasons,” according to a regulatory filing.

Mr. Healy did not return several calls seeking comment.

In general, scrapping failed old firms and replacing them with something new is something which is often very attractive in theory, but which can be highly problematic in practice. During the airline rescue after 9/11, for instance, there was a strong case made that the lumbering old legacy airlines should be allowed to fail: small nimble upstarts would surely take their place and be much more successful. But the history of, say, JetBlue since then has hardly been particularly glorious.

The fact is that most startups fail. As a result, placing one’s hope in startups to replace large and established institutions is generally foolish. They can help drive change at the margins, but it’s rare indeed for the mammals to overthrow the dinosaurs entirely, and it’s a bad idea to enshrine such an overthrow as part of public policy.