Sheila Bair, chairwoman of the Federal Deposit Insurance Corporation, released the latest information on “problem” banks on Wednesday. The list now includes 305 institutions, up from 252 at the end of 2008. We have had 36 bank failures this year and if no more than a quarter of the “problem” institutions fail, we will be over 110 bank failures for the year. This is nowhere near a record and the cumulative number of failures since the beginning of the recession in December 2007 is minimal compared with what happened in the 1988 to 1991 period.

This raises a question about how many more financial institutions are going to merge or close in the next two to three years. If the historical record is any indication, one could argue that a minimum of 100 banks or thrift institutions will close each year for the next two years. Bank closures are not a leading indicator of economic health and can continue for some time even after the economy begins to recover.

The basic scenario that we are looking at for the next two to three years or so is a stagnant economy for much of the time. Economic growth is supposed to be tepid for an extended period of time. Mohamed El-Erian of the bond fund PIMCO stated the other day that PIMCO was expecting the United States economy to grow by no more than 2% or less in the near term. Given that potential real GDP will only be growing at a crawl during this time, unemployment will stay around 8% or above, something similar to the period from January 1975 through to February 1977 where the unemployment rate was at 7.5% or above and the period from October 1981 through to January 1984 where the unemployment rate was above 8.0%. Thus, from January 1975 through to January 1984, unemployment averaged more than 8%.

Within such an environment, foreclosures and bankruptcies will continue to increase and more and more personal loans and mortgages will have to be charged off bank balance sheets. Furthermore, this environment will not be a good one for non-financial business and many more businesses will close their doors. The restructuring of industry will continue as businesses attempt to align themselves with the markets and technologies of the future. This will impact commercial and industrial loans and more of these will have to be charged off going forward.

There is great concern in the F. D. I. C. and beyond about the adequacy of current loan loss reserves in financial institutions. The underlying fear is that a lot of banks have not sufficiently reserved for the loan losses they will be facing in the near future. Bankers have a tendency to be slow in accepting the fact that so much of their loan portfolio is severely challenged. It is a historical fact that reserving for loan losses tends to lag behind the need to build up bank coffers for future charge offs. The present time is not an exception.

This is not a scenario that contains a lot of enthusiasm for producing loan growth. For one, the focus of the bankers should be upon cleaning up their balance sheets. Therefore, they should not be looking for new loans or new sources of loans. These bankers should be focused internally on what they already have on their books. They need to be focused on the performance of existing loans, on working out existing loans, and on charging off loans that are no longer performing.

As many analysts have stated, we still are anticipating increasing charge offs connected with credit cards, consumer loans and commercial real estate. Furthermore, we still have not reached the end of the problems connected with residential mortgages. And then there are the business loans to keep small and medium sized businesses going. The point of all this is that “we are not out of the words yet” in the banking sector.

Secondly, there is not going to be a lot of acceptable loan demand coming into the banks. Credit standards are higher now than they have been for a long time. Bankers are getting back to the idea that you don’t deserve a loan from them unless you are so well off that you don’t really need a loan from them. This has recently been referred to as “boring” banking. Boring, yes, but also prudent.

Some analysts are arguing that the trouble in the smaller banks is not as big a problem as that for the larger banks. Stuart Plesser, a banking analyst at Standard & Poor’s in New York has been quoted as saying that smaller banks were more vulnerable to a souring economy than larger institutions because they were more specialized or focused on a particular region. “But,” he continued, “the repercussions of the failures among the smaller institutions were not as severe for the overall economy as they would be if a larger bank stumbled because the big banks are more important to the economy. It’s not as big a hit if the small fail.”

This may be true in terms of the “systemic” risk in the banking system, but it is not true in terms of the impact of bank failures on “Main Street.” Because the small and medium sized banks are “more specialized or focused on a particular region,” their failure can contribute to the weakness in the local or regional areas they serve and, hence, can slow down any turnaround or recovery that might take place there.

For the past year or so, we have been focusing on big banks and the problem of systemic risk. Now we need to turn our attention to the rest of the banking sector for there is still much work to be done there. Bank failures are going to rise and remain at a relatively high level for an extended period of time. This is an adjustment process that the economic and financial system must go through. It will be a painful process, but there is little that the government could or should do to accelerate the restructuring.

One comment on recent discussions of the government’s P-PIP. Enthusiasm for this program is waning. As I have written, the problem with the toxic bank assets the government has been worrying about is not a “liquidity” problem. The problem is not that certain “legacy” loans or securities cannot be sold within a reasonable period of time. The problem has been that the value of the loans and securities has been in question because of the quality of the assets. The government has been trying to “force” a sale of these assets. But, this is not the problem. The problem is one of working out the value of the assets and the solvency of the banks themselves. An effort to “force” the sale of bank assets is only a program to “socialize” bank losses so that the government can transfer the losses from the banks to the tax payer and does not resolve the ultimate problem. As the banks are attempting to re-capitalize the solvency issue becomes less pressing and so the interest in the program drops off. Except in the case where the government allows the banking system to make a risk-free re-purchase of their own assets at a profit!