11/12/2010 02:19 pm ET | Updated May 25, 2011

George Bailey, the Dark Side

More than two years have passed since the financial system almost went up in flames, but a big question remains: What should we do about the banks? Nationalize them? Break 'em up? Turn them into utilities? Bring back Glass-Steagall? These are tough issues, filled with endless complexities. But for a certain segment of the punditocracy, the answer is simple: When it comes to banks, small is beautiful.

Arianna Huffington, for one, wants us all to withdraw our money from big, corrupt, bailed-out banks and put it instead into "America's Main Street community banks." Not only are we likely to get a better deal, she argues, but we'll be sticking it to bankers who acted recklessly while rewarding those who didn't. Elizabeth Warren, meanwhile, sees community banks as victims of big banks and their "phantom prices" that ripped off consumers. In an op-ed on Politico, she vows to help these banks "by streamlining regulations and eliminating outdated or ineffective rules."

Then there's Simon Johnson, who continues to argue that big banks must be broken up. Writing in The New Republic, Johnson calls J.P. Morgan's global expansion plans "the ultimate poison pill under the new regulatory regime." In his view, going abroad is a "brilliant" and "terrifying" loophole being exploited by big banks looking to get around U.S. resolution authority. Johnson's sidekick, James Kwak, meanwhile, recently told the website The Straddler that Bank of America "would be trivially easy to break up" and that "there's no particular reason why a bank has to have branches in every state of the country."

Well, if that's your view, there's "no particular reason" why any business should operate in every state; maybe we should limit bailed-out General Motors to selling cars only in Michigan.

To be sure, breaking up the banks would certainly solve our mammoth too-big-to-fail problem. But it could also touch off a liquidity crisis and wreak economic havoc. And a breakup is hardly trivial. But no matter. That small banks are better, more virtuous and capable of providing us with all the services we'll ever need is now taken on faith. Small banks have become the proverbial little guy -- a George Bailey-esque figure worthy of reverence and protection.

Is that reverence warranted? Are all small banks forces for good, and are those that fail simply victims (like the rest of us) of greedy big banks?

Time magazine decided to investigate. It went down to Cornelia, Ga., to chronicle the failure of its hometown bank, Community Bank & Trust, which for years was the picture of Bailey-esque benevolence. Not only did it support local schools and sports arenas, but "its hardheaded bankers personally inspected the local businesses they underwrote."

That all changed when the land boom hit and CBT's longtime president died. "Headquarters stopped checking the loans its officers were peddling," Time reported. The bank "renewed interest-only commercial loans every year, leading borrowers to believe the underlying debts would never come due." CBT "kept terrible records, classifying home loans as business loans and vice versa." Worse, some of the bank's officers began lending money to "favored friends," with at least one receiving kickbacks for fraudulent loans. Amazingly, this all went undetected by regulators until the Lehman Brothers failure forced them to become more diligent. By late 2009, CBT was on the brink of failure.

In the end, the Federal Deposit Insurance Corp. stepped in and sold CBT to South Carolina Bank and Trust, a recipient of TARP funds. SCBT fired 120 CBT employees, foreclosed on 224 of its loans and classified 1,500 more as particularly troubled. It's now being blamed for sending Cornelia down the tubes. "[SCBT's] really killing the town, and I blame the FDIC," Donald Anderson, the city manager, told Time. "They're giving them incentives to foreclose on properties."

Time notes, however, that SCBT has foreclosed on just 2.14% of CBT's business loans and 1.75% of its residential mortgages, and that it's not incentivized by the FDIC to do so. But Cornelians remain reluctant to badmouth their beloved CBT. "It's like finding out an old friend has done something you don't want to believe until the facts just smack you in the face," Sally Yates, the U.S. attorney for the Northern District of Georgia, told Time.

Yes, facts. That's what Time supplied by going down to Georgia, rather than to simply opine on the virtues of small banks. CBT's woes are by no means representative of all small banks. But they are worth remembering the next time a pundit starts muttering the "small banks are beautiful" meme.

Yvette Kantrow is executive editor of The Deal magazine.