Download One of two largest Chicago banks in 1900s. Generally, a

ECO 473 – Money & Banking – Dr. D. Foster


Maintaining depository institution
liquidity.
Assuring bank solvency by
limiting failures.

Promoting an efficient financial system.

Protecting consumers.

The Banking Act of 1933 (Glass-Steagall Act):
◦ Created the Federal Deposit Insurance Corporation
(FDIC).
◦ Placed interest rate ceilings on checking deposits of
commercial banks.
◦ Separated commercial and
investment banking.
◦ Branching restrictions.
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Disintermediation in the 1970s.
1980 - Depository Institutions Deregulation and
Monetary Control Act (DIDMCA):
◦ Six-year phaseout of interest rate ceilings.
◦ Permitted NOW accounts.
◦ Increased FDIC coverage to $100,000.

The Garn–St. Germain Act of 1982:
◦ Authorized money market deposit accounts.
◦ Increase the DIDMCA limit on consumer loans and
commercial paper.
◦ Authorized savings institutions to make commercial real
estate loans.
◦ Gave these institutions the power to purchase
“unsecured loans,” including low-rated, “junk” bonds.
◦ Gave the FDIC power to permit troubled financial
institutions to merge with healthier partners.

1989 - Financial Institutions Reform, Recovery &
Enforcement Act (FIRREA):
◦ Authorized taxpayer funds to cover cost of liquidating
failed thrifts.
--Insurance wasn’t enough!
◦ Abolished current thrift regulatory structure.
--Created Office of Thrift Supervision.
--Created the Resolution Trust Corp. to liquidate thrifts.
◦ Moved thrift insurance (FSLIC) into FDIC.
◦ Required insurance fund = 1.25% of insured deposits.
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The moral-hazard problem of deposit
insurance:
◦ S&L crisis.

Too-big-to-fail policy:
◦ Continental Illinois.
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The FDIC Improvement Act Of 1991
-- Allowed for earlier intervention by the FDIC.
-- Let FDIC set/change premiums to boost fund.
-- Mandated risk-based premium structure.
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Origins to the Civil War …
-- The Commercial National Bank.
-- Mergers in 1910 and in 1929.
-- Name change in 1932.
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$50 million loan to survive the Great
Depression
-- Reconstruction Finance Corp. (gov’t.)
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One of two largest Chicago banks in 1900s.
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Generally, a conservative bank …
-- Until the 1970s and its focus on commercial
lending.

By 1981, CINB was 7th largest
bank in the U.S.
-- Total assets = $45 billion.
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Largest provider of commercial loans.
-- $14 billion.
-- Citibank was next, at $12.5 billion.
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Great average ROE from 1977-1981.
-- 14.35% (2nd highest among top 10 banks).
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Stock price high and rising.
-- 1974 - $13; 1979 - $27; 1981 -
1/25/1982
Morgan Stanley $42.
CINB stock is an
“attractive” buy.
Current price = $38.
The Continental Illinois Story
• Problems:
-- Loan/Assets = 69% in 1981 (58% in 1977)
-- ROA falling to .51% in 1981.
- Rolling over loans at lower interest rates.
-- Large corporate customers going bankrupt.
- Nucorp, Int’l Harvester had $250 mill. in loans.
-- Penn Square Bank fails in July, 1982
- Large portfolio of speculative oil & gas loans.
- CINB owns $1 billion in Penn participations.
(About half Penn’s total; Penn had $500 mill. in assets).
-- Core deposits constant from 1977-1981.
- Falling from 30% to 20% of total deposits.
-- Expensive, long-term CDs double; up to 30% of dep.
-- Stock price down to $16.
The Continental Illinois Story
• It gets worse:
-- By early 1984, non-performing loans …
$2.3 billion
Over half from troubled Latin America
-- Major shareholders dump CINB
- U.S. Steel & Carnegie pensions completely divest
themselves.
- Stock had been recovering was back down to $14.
“The only difference between Continental and the Titanic
is that the Titanic had a band.”
--A.F. Ehrbar, Fortune magazine, 2/7/1983
-- In early May 1984, the bank run begins.
The Continental Illinois Story
• The bank run:
-- By May 11, CINB borrows $3.6 bill. from Fed’l Reserve
-- Correspondent banks withdraw deposits.
-- CINB creates $5.4 billion loan package w/16 banks.
-- FDIC provides $2 billion in assistance.
-- A group of 24 banks puts together a $5.3 billion deal.
-- FDIC promises to protect all deposits, even if
over the $100,000 maximum!
-- In July, as $ continue to flow out, FDIC “buys” $4.5 billion in bad
loans from CINB.
-- By September, all of top management & board of directors are
replaced and a permanent plan is in place.
-- In 1994, merged into Bank of America.
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The moral-hazard problem of deposit
insurance.
Too-big-to-fail policy.
Was their strategy bad, or was it
something else?
Depository
Institution
Assets
($ Billions)
Failure
Date
Resolution
Cost
($ Billions)
$33.5
15.7
33.6
4.8
4.8
July 1988
February 1989
May 1984
July 1989
April 1988
$3.9
2.8
1.1
1.1
1.1
21.8
January 1991
8.7
May 1988
3.4
March 1982
1.1 September 1999
0.9
0.8
0.8
0.8
First Republic Bank (Dallas)
MCorp (Dallas)
Continental Illinois (Chicago)
Texas American (Fort Worth)
First City Bancorp (Houston)
Bank of New England (Boston)
Goldome FSB (Buffalo)
New York Bank for Savings (NYC)
1st National Bank of Keystone (WV)
Crossland Savings Bank (Brooklyn)
Superior Bank (Illinois)
7.3
2.3
January 1992
July 2001
0.7
0.6
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Capital requirements:
◦ Minimum equity capital standards.

Risk-based capital requirements:
◦ Risk factors that distinguish different depository
institutions. [Degree of capitalization.]

Risk-adjusted assets:
◦ A weighted average of bank assets to account for risk
differences across types of assets. [Type of
capitalization.]

Act removes Glass-Steagall restrictions
and permits:
◦ Securities firms and insurance companies to own
commercial banks.
◦ Banks to underwrite insurance and
securities, including shares of stock.

Off-balance-sheet banking:
◦ Loan commitment; credit default swaps.

Asset valuation:
◦ Historical cost vs. market value

Derivatives:
◦ Replacement cost exposure.
◦ Credit/market/operating risks.

New wave of regulation:
◦ SOX; Dodd-Frank
ECO 473 – Money & Banking – Dr. D. Foster