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'Hot Money' Prompts Small Bank Collapses

Deposits from brokers, used to ignite growth, fueled risky loans

By Rob Quinn, Newser Staff

Posted Jul 4, 2009 5:49 AM CDT

(Newser) – A boom-time reliance on something known as "hot money" to boost growth has left many of America's small and regional banks with their fingers badly burnt, the New York Times reports. Brokers provided billions in deposits to ambitious banks seeking to grow fast, but the high interest rates needed to secure the cash prompted the banks to make riskier loans, leaving them high and dry when the economy soured.

In extreme cases, some banks used these brokered deposits to loan hundreds of millions of dollars, despite having no branches or traditional deposit accounts. The 79 banks that failed over the last 2 years had a brokered-deposit rate four times the national average, and hundreds more currently struggling to survive are at twice the hot-money average. Federal regulators, who acknowledge they missed the warning signs, are seeking to restrict the practice, but they are meeting stiff opposition from the banking industry.

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The wave of bank failures in the last 18 months has cost the Federal Deposit Insurance Corporation $7.7 billion. (AP Photo/J. Scott Applewhite)

The 371 banks on the Federal Deposit Insurance Corporation's "watch list" have brokered-deposit rates that are twice the national average. (AP Photo/Seth Perlman)

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We went through this golden age of banking and I just think that everybody lost their compass. - Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation.

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'Hot Money' Prompts Small Bank Collapses