The biggest sense of relief that President Reagan probably felt after his latest news conference is that no reporter asked him about the government’s biggest business bailout ever for the sinking Continental Illinois National Bank and Trust Company.
As the nation’s eighth largest bank, Continental Illinois presented Mr. Reagan with the challenge that it was too big to be allowed to fail. Not one to let his vaunted free enterprise philosophy stand in the way of becoming Uncle Sugar to mismanaged giant companies, Mr. Reagan went along with his banking agencies’ vast rescue package.
The Federal Deposit Insurance Corporation (FDIC) agreed to pour $1 billion of new capital into Continental and assume $3.5 billion in delinquent loans. The Illinois Bank had loaned money to many oil ventures in the southwest which more conservative bankers believed were wildly imprudent. In a phrase, the Bank went on a speculative lending drunk in the late Seventies and the chickens were coming home to roost.
In return for this government welfare payout, shareholders of Continental Illinois will lose virtually all their stock values and the FDIC will control 80% of Continental’s shares. FDIC secured the services of a new top management team, led by former AMOCO Chairman, John Swearingen, to run the government controlled bank.
Wall Street breathed a collective sigh of relief at avoiding a dominoes effect throughout the shaky financial community, but the embarrassment was also apparent. Where does this government bailout policy — Lockheed, Chrysler and now the far larger and riskier bailout of Continental Illinois — end? What does this “too big to fail” doctrine do to the legitimacy of the tree market which presupposes the acceptance of both profits and loss?
There were few if any defenders of Continental Illinois’ performance. The experts quoted in the press over a week’s period agreed that bad management, bad lending practices and an unbridled growth mentality led to the big Bank’s downfall. Virtually all of these observers also agreed that something had to be done to avert a total collapse which would likely bring down some major New York banks and possibly the whole financial kit and caboodle.
One observer, Professor George A. Benston from the University of Rochester, urged that federal deposit insurance protect only small depositors, prevent bank runs and let “market discipline” be employed by large depositors (including institutional pension and trust funds) who he says can better assess risk.
A former vice-president of Citibank for strategic planning, Eugene J. Laka, argues that the go-go growth mania of banks is incompatible with the banks’ “primary responsibility as a fiduciary.” This fast growth strategy he sees as the root cause of the imprudent lending and loose practices.
Mr. Laka reminds us that the Federal Reserve Act of 113 allowed American banks to establish branches in foreign countries for one main purpose “the furtherance of the foreign commerce of the United Nonetheless the major American banks, including Continental Illinois went on a lending binge to foreign governments who now cannot pay the high interest rates. Every one of the top nine American banks lent money to many governments, tour of which, Brazil, Mexico, Argentina and Venezuela, owe these banks more than 100 percent of the banks’ shareholders’ equity.
The large banks fully expected any default to be backed up by Uncle Sam, according to a recent study commissioned by the Federal Reserve Bank of New York.
Small banks are properly upset with the unfairness of this implied U.S. government guarantee of the large banks, not to mention the dubious authority to do so without explicit Congressional authority. These smaller institutions believe that depositors will turn away from them because, being small, they are riot given the same guaranteed treatment. More banks failed this year than any year since the nineteen thirties and none of them were large banks. More banks. banks will merge into fewer banks as long as this double standard is permitted by President Reagan and his successors.
Clearly, some modest reforms are in order. Since the federal government is foolishly moving toward nearly total de-regulation, then shareholders of banks should be given more power to watchdog and head off reckless bank management. Depositors should be given easier class action rights and remedies. Banks should be required to make public more information about their activities, such as the quality of their loan portfolio, to alert earlier the shareholders and depositors. Bank directors and officers should be subject to personal sanctions beyond merely losing their positions after they have run “other peoples’ money” (in Justice Brandeis’ words) toward ruin.
But as long as the verdict of the marketplace applies only to the smaller banks and a camouflaged corporate socialism is granted by Mr. Reagan’s government to the larger and reckless banks, you can say goodbye to any remaining pretense for the free enterprise system in the financial industry.