Creature From Jekyll Island by G. Edward

Those in excess of $100,000 and those held outside the United States. Which banks hold the vast majority of such deposits? The large ones, of course, particularly those with extensive overseas operations.2 The bottom line is that the large banks get a whopping free ride when they are bailed out. Their uninsured accounts are paid by FDIC, and the cost of that benefit is passed to the smaller banks and to the taxpayer. This is not an oversight. Part of the plan at Jekyll Island was to give a competitive edge to the large banks.

UNITY BANK

The first application of the FDIC essentiality rule was, in fact, an exception. In 1971, Unity Bank and Trust Company in the Roxbury section of Boston found itself hopelessly insolvent, and the federal agency moved in. This is what was found: Unity's capital was depleted; most of its loans were bad; its loan collection practices were weak; and its personnel represented the worst of two worlds: overstaffing and inexperience. The examiners reported that there were two persons for every job, and neither one had been taught the job.

With only $11.4 million on its books, the bank was small by current standards. Normally, the depositors would have been paid back, and the stockholders—like the owners of any other failed 1. Sprague, pp. 27-29.

2. The Bank of America is the exception. Despite its size, it has not acquired foreign deposits to the same degree as its competitors.

PROTECTORS OF THE PUBLIC

51

business venture—would have lost their investment. As Sprague, himself, admitted: "If market discipline means anything, stockholders should be wiped out when a bank fails. Our assistance would have the side effect ... of keeping the stockholders alive at g o v e r n m e n t expense."1 But Unity Bank was different. It was located in a black neighborhood and was minority owned. As is often the case when government agencies are given discretionary powers, decisions are determined more by political pressures than by logic or merit, and Unity was a perfect example. In 1971, the specter of rioting in black communities still haunted the halls of Congress. Would the FDIC allow this bank to fail and assume the awesome responsibility for new riots and bloodshed? Sprague answers:

Neither Wille [another director] nor I had any trouble viewing theproblem in its broader social context. We were willing to look for acreative solution.... My vote to make the "essentiality" finding andthus save the little bank was probably foreordained, an inevitablelegacy of Watts.... The Watts riots ultimately triggered the essentialitydoctrine.2

On July 22, 1971, the FDIC declared that the continued operation of Unity Bank was, indeed, essential and authorized a direct infusion of $1.5 million. Although appearing on the agency's ledger as a loan, no one really expected repayment. In 1976, in spite of the FDIC's own staff report that the bank's operations continued "as slipshod and haphazard as ever," the agency rolled over the "loan"

for another five years. Operations did not improve and, on June 30, 1982, the Massachusetts Banking Commissioner finally revoked Unity's charter. There were no riots in the streets, and the FDIC

quietly wrote off the sum of $4,463,000 as the final cost of the bailout.

COMMONWEALTH BANK OF DETROIT

The bailout of the Unity Bank of Boston was the exception to the rule that small banks are dispensable while the giants must be saved at all costs. From that point forward, however, the FDIC

game plan was strictly according to Hoyle. The next bailout occurred in 1972 involving the $1.5 billion Bank of the Common-Wealth of Detroit. Commonwealth had funded most of its

Sprague, pp. 41-42.

2- Ibid., p. 48.

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: