ARC's 1st Law: As a "progressive" online discussion grows longer, the probability of a nefarious reference to Karl Rove approaches one

Monday, March 31, 2008

A Trip Down Memory Lane - The Continental Illinois Bank Failure of 1984 - "Too Big to Fail"

As it it is kind of quiet around here, I will take this opportunity to again harp on one of my pet issues, the risk of a major bank failure. This notion is fueled by the collapse of Bear Stearns.

The media's attention is focused on such thing's as Hilary's veracity challenged campaign, Obama's psycho pastor, McCain's slip of the tongue regarding al Qaeda and Iran and other irrelevancies. While these matters draw huge attention, the erosion of our financial institutions goes by with scant attention and a profound lack of understanding by either the media or any the candidates. I find that unnerving.

In 1984 the 7th largest bank in the country failed. It was insolvent due to bad loans. There was a run on the bank when the facts became known. The FDIC rode to the rescue and the Federal government became the owner of the bank until it was finally sold to the megabank, Bank of America, in recent times.

The FDIC analysis of the collapse of Continental Illinois can be found here.

The bank was deemed too large to be allowed to fail.


Continental Illinois was a gnat compared to BA and CitiBank. Further, it was just a bank. These days the mega-banks are now into all sorts of other exposures such as investment banking, brokering and insurance. These were prohibited lines of business for banks until recent deregulation.

If CI was "too big to fail," what are these other banks?

Maybe this issue is not as much fun as Pastor Wright and Hilary's combat record, but for me it is a lot more important, and in view of recent events, more pressing.

Your Co-Conspirator,
ARC: MontereyJohn

Comments (10)
Brian said...

Strange, a bank failed and the entire banking system didn't collapse? We didn't have to bring wheelbarrows of money to buy bread?

That's your position is it not? That the banks have made bad subprime loans, and that this will cause the entire downfall of the US economy, bringing us into the next Great Depression

Is there evidence that BofA is going to "collapse" (not its share price, but the entire bank". Citibank?

Me thinks you are projecting a scenario that doesn't exist.

St Wendeler said...

The moral hazard that the BSC bailout creates is a concern. Frankly, I wish the Feds would've let BSC fail, although I'd say that the "bailout" that the Fed arranged with JPMC is tantamount to a failure.

Why is it that taxpayers have to be on the hook for $30b of BSC's garbage?

John - This WSJ OpEd mentions the Continental bailout and compares it to the current situation.

Monterey John said...

No, that is not my position, Brian.

I am TRYING to point out an exposure here, and it is a real one that needs to be addressed. Wishful thinking will not solve the problem nor prevent similar problems in the future.

Frankly, I do not know if the subprime loans are the only issue. They for sure are the ones in the headlights just now, but not necessarily the only ones. The entire system needs a serious academic look. I would like to see something from The Heritage Foundation or some similar group.

Why folks like you seem to want to deal with this with sarcasm rather than debate and reasoned argument concerns me. I expect a more open mind from a fellow conservative. This is serious stuff.

I think the FDIC analysis I linked to ( is a good starting point.

The exposure is there. It needs to be assessed as any insurable risk is measured and rated. We do not have the information we need to know if we are on a sound footing or not. If someone like me thinks that, believe me there are serious money people out there who are asking similar questions.

Is there any evidence that BoA etc are about to collapse? Not that I know of. Was there evidence that Bear Stearns was about to collapse before it did?

I hate surprises like that, don't you?

Brian said...

BSC is not the banking industry!

And after the $2/share "bailout" people took a look at their books and realized that whoah, $2 is a pretty cheap price.. Maybe $10 is more in line...

We do not have a banking crisis here. We have a credit confidence crisis. A luqidity crisis. Nobody wants to lend money, because nobody knows if they are going to get paid back.

This is why the fed lowering the rates was SOO important. Lower rates leads to more lending, which relieves the appearance of a credit crises.

A vast majority (all but 5%? 3%? 1%?) of mortgages curently held are secured by property that is worth more than the mortgage. On paper there is no "loss".

The only thing that will cause a true calamity is if people start mailing in their keys instead of paying their obligations. Just like if everybody went to the bank and withdrew all their money for their mattress.

So your, "the sky is falling" mantra is precisely the wrong prescription. It causes people to not pay their mortgages. Default, etc. Which makes the mortgage holders worry that they will have to sell a lot of property (which takes money in the short term) instead of receiving the payments they are owed.

As I've said before, the questionable lending practices (no doc, etc) that were prevalent in the past decade are horrible practices, and banks will fail, but that is a self regulating phenonemom.

Congress (see Barney Frank) is right now trying to come up with new regulations that will "save us" from this mess. They will just make things worse.

If the Dem's banking proposals go through, you won't be able to get a loan for anything without your local political beaurocrat stamping his ok.

And Todd, the BSC "bailout" wasn't much of a bailout. As I understand it the Fed promised to open the discount window to JPM for additional funding, which JPM was going to use to gaurantee BSC's liabilities. They still have to pay the fed back (unless they fail). That fed lending was required to make JPM do the deal in the first place.

Hillary's proposal (for example), i.e. no foreclosures, will just instill MORE panic on the part of the lender as they will feel they can't cut their losses.

Monterey John said...

Could not agree more that War Hero Hilary's "no foreclosures" is ridiculous. The market needs to be allowed to right itself. To do as she suggests would do just the opposite.

Now as for me, once again, I am NOT saying "the sky is falling." I AM saying that IF there is more to this story, I want to know about it. The lack of knowledge is what I am protesting.

It seems the Treasury Department is coming to the same conclusion. The overhaul of the regulation of the financial system in the news today that is being proposed is pretty radical from what little I understand about it. I have not had time to review what all is being proposed, but knowing the discussion is getting underway is somewhat reassuring.

If memory serves, there was a time not so long ago the CitiBank got in some very serious trouble. Again, if my memory is correct, that was inspired by some Brazilian land speculation under Robert Rubin's (yes that Robert Rubin) tutelage. It nearly drove the bank under.

Would it not have been nice for the bank regulators to have known about that BEFORE they were called upon to bail out the largest bank in the world at that time? I do not remember how they dodged that bullet. I do know it was a near thing.

My point, BSC and CI are not aberrations. These things happen with alarming regularity with potentially devastating consequences. As pointed out by the FDIC, the consolidation of banking over the last 10-15 years has greatly increased the risk and need for transparency.

That's all I'm saying, Brian.

So enough with the Chicken Little comparisons, OK?

St Wendeler said...

Brian, if the Fed is underwriting 30b of BSC's liabilities in order for JPMC to do the deal, that smells like a bailout to me. (The left-wing WSJ would seem to agree with me on the point.)

I am also fearful of anything that Congress (or the Treasury Sec'y) will do in the midst of the crisis. The SarBox reaction to Enron was overkill and recent regulations on finance only made London the Financial Capital of the world.

I frankly would've preferred to see BSC get wiped out instead of being lead by the hand into the arms of JPMC in a taxpayer-financed deal.

When it all comes down to it, let the market work. It may cause tumult & tremendous pain in the short term, but it's the quickest way to a recovery.

A new "New Deal" will only prolong the misery.

Monterey John said...

Saint's cautionary words are well taken.

Transparency is one thing and the Feds running the show is quite another!

However, the banks are taking risks in part because they know the Feds are going to ride to the rescue if things turn to crap, such as in covering insured deposits and even deposits that are not insured "to stabilize the system."

Insurance companies, in this case the tax payers, insist, or should insist, on audits (transparency) of exactly what it is they are insuring. Buying a pig in a poke is never a great idea, especially in view of the enormity of the exposure. SOMETHING has to be done in this regard. BSC was a warning shot, fortunately not a huge one. Let's have no more of that.

Either that, or the Feds should get out of insuring these banks altogether, which I guess is what Saint is aiming at. Now THAT would be a radical change. We have been down that road before. Massive deflation as money vanished from the market place. We called it The Depression.

Had BSC been allowed to fail, that would have been one hell of a warning shot over the bow of the banking industry. It might have inspired them to clean up their act knowing no one was there to back stop their stupid business decisions. It is worth a thought.

But so long as we are in the business of insuring these banks, we need to know what is going on.

Jason said...

Bear Stearns traded at 170 a year ago, 30 the weekend before JPMorgan took it over and $2/share is considered a bailout? What motivation do shareholders have to repeat that? The only people that made money were shorters. Even at $10/share, that's 1/3 of what Wall Street thought it was worth on Friday. The $29/30 billion in lending by the Fed isn't completely different from the other programs like TAF, TSLF, etc.

"However, the banks are taking risks in part because they know the Feds are going to ride to the rescue if things turn to crap," BSC was not able to borrow from the discount window -- this put them at a disadvantage compared to commercial banks (more leftover regulation). You're overplaying the moral hazard here. I'd much rather have the Fed lending to JPMorgan than anyone in Congress doing anything. Please, keep Congress away at any cost. That should be your top fear. Any recession will be over with in 6 months, the regulations will likely outlive us all.

And let's put this in persepctive. BSC, at its peak, had a $20B market cap. "Was there evidence that Bear Stearns was about to collapse before it did?" Perhaps Cramer didn't think so, but yes, that's why the stock went from 170 to 30. In addition, its own hedge funds had failed a year earlier.

Brian said...

Now as for me, once again, I am NOT saying "the sky is falling." I AM saying that IF there is more to this story, I want to know about it. The lack of knowledge is what I am protesting.

Agreed. Transparency is good, except for private companies obviously...

I still don't understand the Fed's 30bn in loans as a bailout (the WSJ non-withstanding). JPM can borrow from the fed as a member bank. They secured financing for a buyout of BSC. The fed was essentially a last-resort lender simply because noone else is lending money!

Why? Because nobody wants to be first in the pool (nobody wants to be last in the pool either)...

The taxpayers aren't going to need to spend 1 penny of that 30billion.

Unless of course, if JPM fails. And if JPM failed simply because they took on BSC's liabilities (at no cost!) then something is seriously wrong not just with our economy, but with the entire worldwide banking system....

Monterey John said...

And the beat goes on...

You lose your right to privacy when you ask someone else to insure your risks. Banking is not "private" in that respect. To the extent they are looking to be backstopped by whatever agency of the government, then they must disclose what risks are abd be subject to examination. Either that, or do without the insurance.

'Taint rocket science.