Creature From Jekyll Island by G. Edward

We were far from a decision on how to proceed. There was strongpressure from the beginning not to let the bank fail. Besides hearingfrom the bank itself, the other large banks, and the comptroller, weheard frequently from the Fed. I recall at one session, Fred Schultz, theFed deputy chairman, argued in an ever rising voice, that there wereno alternatives—we had to save the bank. He said, "Quit wasting timetalking about anything else!"...

The Fed's role as lender of last resort first generated contentionbetween the Fed and FDIC during this period. The Fed was lendingheavily to First Pennsylvania, fully secured, and Fed Chairman PaulVolcker said he planned to continue funding indefinitely until wecould 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

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. Ibid., p. 89.

PROTECTORS OF THE PUBLIC

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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 Dun's Review as one of the five best managed companies in the country. These opinion leaders failed to perceive that the spectacular performance was due, not to an expertise in banking or investment, but to the financing of shaky business enterprises and foreign governments which could not obtain loans anywhere else. But the public didn't know that and wanted in on the action. For awhile, the bank's common stock actually sold at a premium over others which were more prudently managed.

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.