The ugly underbelly

In these uncertain times, we get a rare glimpse of things taken for granted that help make possible the certain times. NPR’s Planet Money recently documented one of these things – the FDIC process of taking over a failed bank and restoring its solvency. It begins on a Friday evening:

At 5:01 p.m., a small team enters the Bank of Clark County. They’re a casual group, just two Federal Deposit Insurance Corporation (FDIC) agents and a Washington state regulator, and they head straight for the CEO’s office. And this is when it happens: They deliver the news. They tell him his bank is undercapitalized and has failed.

At 5:03 p.m., an agent positioned by the CEO’s office door, types the news into a BlackBerry. It is received by everyone on the FDIC takeover team, including the FDIC’s manager on location, Ron Hodges.

“At 5:04, we receive the notification that the bank had been declared failed,” Hodges says. “It’s that simple.”

The whole ordeal is short and sweet; the FDIC does not permanently take the bank over but rather has pre-identified another, solvent, and usually nearby bank that will ultimately take the reigns in only a few days. It’s a quiet, smooth process; and much like other elements of the rule of law such as bankruptcy procedures, it’s hardly given thought until it’s absolutely necessary. Few wish to think of such things.

The bank’s officers describe it as like watching an autopsy, as FDIC agents aided by bank employees work hard throughout the weekend so that the bank can re-open under new ownership by the next business day, but without the bad assets or loans that threaten a run on the bank. It happens so fast that it’s quite excusable not to think about the process; but for those who wish to tap into the power of entrepreneurship in developing markets, it’s absolutely central.

Entrepreneurs can’t take on all the risk they need to without a formal system to deal with what happens when the risk does not pay off. Bankruptcy procedures, contract litigation procedures, debt collection, and bank failure procedures are the ugly underbelly of rule of law that provide entrepreneurs a safe environment in which to innovate, thrive, and sometimes fail.

Without a failure process prescribed by law and administered by government, entreprenuers risk finding themselves at the hands of hired outlaws collecting debts. As long as failure to repay creditors comes with threats of violence, entrepreneurs are handcuffed; and on the other side of the table, lax rule of law deters investors, who worry about collecting debts. The mafia doesn’t work for everyone.