Will Bank Closings Sink US Economy?

FEDERAL Reserve Board chairman Alan Greenspan told Congress Wednesday he sees "very subtle signs" of economic improvement.

Subtle indeed, says Paul Kasriel. The Northern Trust Company economist figures the economy will remain "sluggish" and could even turn down again in six months.

What has Mr. Kasriel so concerned is the prospect of further closings of banks and savings and loan associations by the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation (RTC) in the months ahead. Such action, he argues, takes money out of the economy. And it is money which makes the wheels of commerce go round.

Kasriel reckons that a surge of closings in the second and third quarters of last year ($60 billion in the third quarter alone) produced the slowest growth in broad measures of money in at least 30 years (comparable numbers go back no further) and that slow growth resulted in the current renewed slump in the economy. National output, according to the first estimate of the Commerce Department, grew at a minimal 0.3 percent annual rate in the fourth quarter of 1991.

Some months ago, Kasriel and Robert Laurent, senior economist at the Federal Reserve Bank of Chicago, prepared a paper outlining their thesis that the contractionary effect of bank and thrift closings explains the slowdown in money growth. It was critiqued by Fed economists in Washington. They disagreed with the mechanism for this phenomenon suggested by Kasriel and Mr. Laurent. But they agreed that the closings did restrain money growth - a distinction that does not change the policy implications, accor ding to Laurent.

In earlier Congressional testimony, Greenspan said that with interest rates at their lowest level in a generation, that should be enough "by any historical standards" to get the economy moving again. Kasriel concedes that he doesn't know whether that easing is adequate or not. But he mentions the Fed's worst "gaffe" of all - when it allowed the bank closings of the 1930s to shrink the nation's money supply and cause the Great Depression.

There is no doubt that the Fed has been trying to get the money supply and the economy growing again. The Fed funds rate, the interest rate that banks charge each other on overnight loans, has been cut 15 times since the recession began in July 1990. It now stands at 4 percent. The Fed cut the discount rate by an exceptionally large 1 percent on Dec. 20.

But to Kasriel and Laurent, if money (M2) doesn't start growing more rapidly soon, the Fed should cut rates again. "The Fed is in charge of the money supply," says Kasriel. "It has the tools to get the job done. But they may have to be more aggressive."

Kasriel doesn't regard the Fed's explanation that a credit crunch in bank lending produced slow money growth as adequate. If necessary to get money growing, he says, the Fed should reduce the interest rate to zero.

At the hearing Wednesday, Greenspan did refer to the money problem arising from bank closings. But he also said that no further easing in monetary policy was needed now, prompting bond and stock prices to turn sharply down within minutes. He indicated the Fed would move again if necessary.

Because of a lack of funds, the FDIC and the RTC paused in closing banks and thrifts in the fourth quarter. The money supply began growing again - at a 2.8 percent annual rate in the last three months. However, Congress voted another $95 billion for these institutions just before it recessed at Thanksgiving. That money is now available for them to start closing financially impaired banks and thrifts again. In fact, $1.2 billion was spent to close a New York savings bank a week ago.

Should more banks and thrifts be closed in coming months, will the Fed offset the impact on the money supply? If it doesn't and the economy slips again into recession, this could endanger the Fed's survival as an institution, warns Laurent. "A triple dip would be disastrous."

Congress will be looking at tax and spending measures to revive the economy in the next few months. Most economists regard these measures as primarily political, with little impact on the business cycle. They count on the Fed to rescue the economy.