52 THE CREATURE FROM JEKYLL ISLAND
phenomenal growth through loans from another bank, Chase
Manhattan in New York. When Commonwealth went belly up,
largely due to securities speculation and self dealing on the part of its management, Chase seized 39% of its common stock and
actually took control of the bank in an attempt to find a way to get its money back. FDIC director Sprague describes the inevitable sequel:
Chase officers ... suggested that Commonwealth was a public interest problem that the government agencies should resolve. That unsubtle hint was the way Chase phrased its request for a bailout by the government.... Their proposal would come down to bailing out the shareholders, the largest of which was Chase.1
The bankers argued that Commonwealth must not be allowed
to fold because it provided 'essential' banking services to the community. That was justified on two counts: (1) it served many minority neighborhoods and, (2) there were not enough other banks in the city to absorb its operation without creating an unhealthy concentration of banking power in the hands of a few. It was unclear what the minority issue had to do with it inasmuch as every neighborhood in which Commonwealth had a branch was served by other banks as well. Furthermore, if Commonwealth were to be liquidated, many of those branches undoubtedly would have been purchased by competitors, and service to the communities would have continued. Judging by the absence of attention given to this issue during discussions, it is apparent that it was merely thrown in for good measure, and no one took it very seriously.
In any event, the FDIC did not want to be accused of being indifferent to the needs of Detroit's minorities and it certainly did not want to be a destroyer of free-enterprise competition. So, on January 17,1972, Commonwealth was bailed out with a $60 million loan plus numerous federal guarantees. Chase absorbed some losses, primarily as a result of Commonwealth's weak bond portfolio, but those were minor compared to what would have been lost without FDIC intervention.
Since continuation of the bank was necessary to prevent
concentration of financial power, FDIC engineered its sale to the First Arabian Corporation, a Luxembourg firm funded by Saudi 1. Sprague, p. 68.
PROTECTORS OF THE PUBLIC
53
princes. Better to have financial power concentrated in Saudi Arabia than in Detroit. The bank continued to flounder and, in 1983, what was left of it was resold to the former Detroit Bank & Trust Company, now called Comerica. Thus the dreaded concentration of local power was realized after all, but not until Chase Manhattan was able to walk away from the deal with most of its losses covered.
FIRST PENNSYLVANIA BANK
The 1980 bailout of the First Pennsylvania Bank of Philadelphia was next. First Penn was the nation's twenty- third largest bank with assets in excess of $9 billion. It was six times the size of Commonwealth; nine hundred times larger than Unity. It was also the nation's oldest bank, dating back to the Bank of North America which was created by the Continental Congress in 1781.
The bank had experienced rapid growth and handsome profits largely due to the aggressive leadership of its chief executive officer, John Bunting, who had previously been an economist with the Federal Reserve Bank of Philadelphia. Bunting was the epitome of the era's go-go bankers. He vastly increased earnings ratios by reducing safety margins, taking on risky loans, and speculating in the bond market. As long as the economy expanded, these gambles were profitable, and the stockholders loved him dearly. When his gamble in the bond market turned sour, however, the bank
plunged into a negative cash flow. By 1979, First Penn was forced to sell off several of its profitable subsidiaries in order to obtain operating funds, and it was carrying $328 million in questionable loans. That was $16 million more than the entire stockholder investment. The bank was insolvent, and the time had arrived to hit up the taxpayer for the loss.
The bankers went to Washington and presented their case.
They were joined by spokesmen from the nation's top three: Bank of America, Citibank, and of course the ever-present Chase Manhattan. They argued that, not only was the bailout of First Penn essential' for the continuation of banking services in Philadelphia, it was also critical to the preservation of
The bank was so large, they said, if it were allowed to fall, it would act as the first domino leading to an international financial crisis. At first, the directors of the FDIC resisted that theory and earned the angry impatience of the Federal Reserve. Sprague recalls: 54 THE CREATURE FROM JEKYLL ISLAND
We were far from a decision on how to proceed. There was strong pressure from the beginning not to let the bank fail. Besides hearing from the bank itself, the other large banks, and the comptroller, we heard frequently from the Fed. I recall at one session, Fred Schultz, the Fed deputy chairman, argued in an ever rising voice, that there were no alternatives—we had to save the bank. He said, 'Quit wasting time talking about anything else!'...
The Fed's role as lender of last resort first generated contention between the Fed and FDIC during this period. The Fed was lending heavily to First Pennsylvania, fully secured, and Fed Chairman Paul Volcker said he planned to continue funding indefinitely until we could work out a merger or a bailout to save the bank.
The directors of the FDIC did not want to cross swords with the Federal Reserve System, and they most assuredly did not want to be blamed for tumbling the entire world economic system by allowing the first domino to fall. 'The theory had never been tested,' said Sprague. 'I was not sure I wanted it to be just then.'2
