So, in due course, a bailout package was put together which featured a $325 million loan from FDIC, interest free for the first year and at a subsidized rate thereafter; about half the market rate.
Several other banks which were financially tied to First Penn, and which would have suffered great losses if it had folded, loaned an additional $175 million and offered a $1 billion line of credit. FDIC
insisted on this move to demonstrate that the banking industry itself was helping and that it had faith in the venture. To bolster that faith, the Federal Reserve opened its Discount Window offering low-interest funds for that purpose.
The outcome of this particular bailout was somewhat happier than with the others, at least as far as the bank is concerned. At the end of the five-year taxpayer subsidy, the FDIC loan was fully repaid. The bank has remained on shaky ground, however, and the final page of this episode has not yet been written.
CONTINENTAL ILLINOIS
Everything up to this point was but mere practice for the big event which was yet to come. In the early 1980s, Chicago's Continental Illinois was the nation's seventh largest bank. With assets of $42 billion and with 12,000 employees working in offices 1. Sprague, pp. 88-89.
2.
PROTECTORS OF THE PUBLIC
55
in almost every major country in the world, its loan portfolio had undergone spectacular growth. Its net income on loans had literally doubled in just five years and by 1981 had rocketed to an annual figure of $254 million. It had become the darling of the market analysts and even had been named by
The gaudy fabric began to unravel during the Fourth of July weekend of 1982 with the failure of the Penn Square Bank in Oklahoma. That was the notorious shopping-center bank that had booked a billion dollars in oil and gas loans and resold them to Continental just before the collapse of the energy market. Other loans also began to sour at the same time. The Mexican and Argentine debt crisis was coming to a head, and a series of major corporate bankruptcies were receiving almost daily headlines.
Continental had placed large chunks of its easy money with all of them. When these events caused the bank's credit rating to drop, cautious depositors began to withdraw their funds, and new funding dwindled to a trickle. The bank became desperate for cash to meet its daily expenses. In an effort to attract new money, it began to offer unrealistically high rates of interest on its CDs. Loan officers were sent to scour the European and Japanese markets and to conduct a public relations campaign aimed at convincing market managers that the bank was calm and steady. David Taylor, the hank's chairman at that time, said: 'We had the Continental Illinois Reassurance Brigade and we fanned out all over the world.'1
In the fantasy land of modern finance, glitter is often more important than substance, image more valuable than reality. The bank paid the usual quarterly dividend in August, in spite of the fact that this intensified its cash crunch. As with the Penn Central Railroad twelve years earlier, that move was calculated to project an image of business-as-usual prosperity. And the ploy worked—
Quoted by Chernow, p. 657.
56 THE CREATURE FROM JEKYLL ISLAND
for a while, at least. By November, the public's confidence had been restored, and the bank's stock recovered to its pre-Penn Square level. By March of 1983, it had risen even higher. But the worst was yet to come.
By the end of 1983, the bank's burden of non-performing loans had reached unbearable proportions and was growing at an
alarming rate. By 1984, it was $2.7 billion. That same year, the bank sold off its profitable credit-card operation to make up for the loss of income and to obtain money for paying stockholders their expected quarterly dividend. The internal structure was near collapse, but the external facade continued to look like business as usual.
The first crack in that facade appeared at 11:39 A.M. On
Tuesday, May 8, Reuters, the British news agency, moved a story on its wire service stating that banks in the Netherlands, West Germany, Switzerland, and Japan had increased their interest rate on loans to Continental and that some of them had begun to withdraw their funds. The story also quoted the bank's official statement that rumors of pending bankruptcy were 'totally preposterous.' Within hours, another wire, the Commodity News Service, reported a second rumor: that a Japanese bank was interested in buying Continental.
WORLD'S FIRST ELECTRONIC BANK RUN
As the sun rose the following morning, foreign investors began to withdraw their deposits. A billion dollars in Asian money moved out that first day. The next day—a little more than twenty-four hours following Continental's assurance that bankruptcy was totally preposterous, its long-standing customer, the Board of Trade Clearing Corporation, located just down the street—withdrew $50 million. Word of the defection spread through the financial wire services, and the panic was on. It became the world's first global electronic bank run.
By Friday, the bank had been forced to borrow $3.6 billion from the Federal Reserve in order to cover its escaping deposits. A consortium of sixteen banks, lead by Morgan Guaranty, offered a generous thirty-day line of credit, but all of this was far short of the need. Within seven more days, the outflow surged to over
$6 billion.
PROTECTORS OF THE PUBLIC
57
In the beginning, almost all of this action was at the institutional level: other banks and professionally managed funds which closely monitor every minuscule detail of the financial markets. The general public had no inkling of the catastrophe, even as it unfolded. Chernow says: 'The Continental run was like some modernistic fantasy: there were no throngs of hysterical depositors, just cool nightmare flashes on computer screens.'1 Sprague writes:
