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World's First Electronic Bank Run- charged to the taxpayer - 5th of series

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As the sun rose the following morning, foreign investors began to withdraw their deposits. A billion dollars in Asian money moved out the 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, 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 escaping deposits. A consortium of sixteen banks, led 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. 


Peter Palms
(image by Peter Palms)


Peter Palms
(image by Peter Palms)

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." Sprague writes: "Inside the bank, all was calm, the teller lines moved as always, and bank officials recall no visible sign of trouble--except in the wire room. Here the employees knew what was happening as withdrawal order after order moved on the wire, bleeding Continental to death. Some cried." 2

1.    Chernow, p. 658.

2.    Sprague, p. 153.


From the beginning, there was only one serious question: how to justify fleecing the taxpayer to save the bank. The rules of the game require that the scam must be described as a heroic effort to protect the public. In the case of Continental, the sheer size of the numbers made the ploy relatively easy. There were so many depositors involved, so many billions at risk, so many other banks interlocked, it could be claimed that the economic fabric of the entire nation--of the world itself--was at stake. And who could say that it was not so. Sprague argues the case in familiar terms: 


Peter Palms
(image by Peter Palms)


This was the golden moment for which the Federal Reserve and the FDIC were created. Without government intervention, Continental would have collapsed, its stockholders would have been wiped out, depositors would have been badly damaged, and the financial world would have learned that banks, not only have to talk about prudent management, they actually have to do it. Future banking practices would have been severely altered, and the long-term economic benefit to the nation (and world) would have been enormous. But with government intervention, the discipline of a free market is suspended, and the cost of failure and fraud is passed to the taxpayers. Depositors continue to live in a dream world of false security, and banks can operate recklessly and fraudulently with the knowledge that their political partners will come to their rescue when they get into trouble.

THE FINAL BAILOUT PACKAGE

At the May 15 meeting, Treasury Secretary Regan spoke eloquently about the value of a free market and the necessity of having the banks mount their own rescue plan, at least for a part of the money. To work out that plan, a summit meeting was arranged the next morning among the chairmen of the seven largest banks:

1. Ibid., pp. 154-55,183.


Morgan Guaranty, Chase Manhattan, Citibank, Bank of America, Chemical Bank, Bankers Trust, and Manufacturers Hanover. The meeting was perfunctory at best. The bankers knew full well that the Reagan Administration would not risk the political embarrassment of a major bank failure. That would make the President and the Congress look bad at re-election time. But, still, some kind of tokenism was called for to preserve the Administration's conservative image. So, with urging from the Fed and the Treasury, the consortium agreed to put up the sum of $500 million--an average of only $71 million for each, far short of the actual need. Chernow describes the plan as "make-believe" and says "they pretended to mount a rescue."

Sprague supplies the details:

The bankers said they wanted to be in on any deal, but they did not want to lose any money. They kept asking for guarantees. They wanted it to look as though they were putting money in but, at the same time, wanted to be absolutely sure they were not risking anything.... By 7:30 A.M. we had made little progress. We were certain the situation would be totally out of control in a few hours. Continental would soon be exposing itself to a new business day, and the stock market would open at ten o'clock . Isaac [another FDIC director] and I held a hallway conversation. We agreed to go ahead without the banks. We told Conover [the third FDIC director] the plan and he concurred....

[Later], we got word from Bernie McKeon, our regional director in New York , that the bankers had agreed to be at risk. Actually, the risk was remote since our announcement had promised 100 percent insurance.

The final bailout package was a whopper. Basically, the government took over Continental Illinois and assumed all of its losses. The FDIC took $4.5 billion in bad loans and paid Continental $3.5 billion for them. The difference was made up by the infusion of $1 billion in fresh capital in the form of stock purchase. The bank, therefore, now had the government as a stockholder controlling 80 per cent of its shares, and its bad loans had been dumped onto the taxpayer. In effect, even though Continental retained the appearance of a private institution, it had been nationalized.

By 1984, the Federal Reserve and the Treasury had given Continental the staggering sum of $8 billion. By early 1986, the figure had climbed to $9.24 billion and was still rising. While explaining this fleecing of the taxpayer to the Senate Banking Committee, Fed Chairman Paul Volcker said: "The operation is the most basic function of the Federal Reserve. It was why it was founded." With those words, he has confirmed one of the more controversial assertions of this book.

1. Chernow, P. 659

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... by Peter Palms on Wednesday, Mar 19, 2014 at 1:28:05 PM
It's so strange that a supposedly monetarily sover... by Scott Baker on Wednesday, Mar 19, 2014 at 1:32:41 PM
#price Stability #destroy United States #Lusita... by Peter Palms on Wednesday, Mar 19, 2014 at 2:08:08 PM
#price Stability #destroy United States #Lusita... by Peter Palms on Wednesday, Mar 19, 2014 at 5:45:34 PM