Bailout: An Insider's Account of Bank Failures and Rescues

The engrossing story of how the Federal Deposit Insurance Corporation handled four bank failures.

Category: Banking & Finance

Of Interest:

American Commercial Banking: A History

Full Faith and Credit: The Great S & L Debacle and Other Washington Sagas

The Failure of the Franklin National Bank: Challenge to the International Banking System

The Rise and Decline of the Medici Bank: 1397-1494

The Story of Bank of America: Biography of a Bank

The Tumultuous History of the Bank of America

Thrifts Under Siege: Restoring Order to American Banking

During the high interest times of the 1970s and 1980s, banks and savings and loan associations were under heavy financial pressure. Hundreds of them failed. The Home Loan Bank Board permitted the savings and loan associations to treat goodwill as capital, thereby allowing them to remain open and to build up enormous losses that eventually cost the taxpayers billions of dollars. The Federal Deposit Insurance Corporation took a different approach. It closed the banks or sold them, all at no cost to taxpayers. Bailout is the engrossing story of how the FDIC handled four of these failures.

No one is more qualified to write a work on this subject of bank bailouts. Holding the positions of chairman or director of the Federal Deposit Insurance Corporation (FDIC) during the 1970s and 1980s, one of Sprague's most important tasks was to close down banks that were failing before they could cause wider damage. The decades of the 1970s and '80s were times of high interest rates for both depositors and borrowers. Rates for depositors at many banks approached ten percent, with rates for loans higher than that. The fierce competition in the banking industry to offer the highest rates to attract and keep depositors caused severe financial stress to an unusually high number of banks. Having to pay out so much in interest to stay competitive without taking in much greater deposits was straining the cash and other assets of many banks. The unprecedented high interest rates also had the effect of reducing the number of loans banks were giving out. There were not so many borrowers willing to take on loans with the high interest rates. With the disruptions in the their interrelated deposits and loans, many banks began to engage in unprecedented and unfamiliar financial activities, including investing in risky business ventures. As well as having harmful effects on local economies, the widely-reported troubles of a number of well-known and well-respected banks were having a harmful effect on the public's confidence in the entire banking industry .

Sprague along with other government and private-sector leaders in the banking and financial field realized the problems with banks of all sizes in all parts of the country had to be dealt with decisively. Action had to be taken to restore public confidence, as well as prevent widespread and long-lasting damage to the U. S. economy. Sprague's task was one of damage control largely on the blind. The banking industry, the financial community, and the government and the public had never faced such a large number of bank failures at one time. The Home Loan Bank Board for the savings-and-loans associations had allowed these institutions to treat goodwill as an asset in an effort to shore up their deteriorating financial situations with disastrous results for their depositors and U. S. taxpayers. Such a desperate stratagem only made the problems with the savings-and-loans worse. The banks covered by the FDIC headed by Sprague were different from these institutions. But the problems with their basic business of deposits and loans were more or less the same. And the cause of the problem was precisely the same: the high interest rates.

Faced with so many bank failures, Sprague and the government officials, Congresspersons, and leaders he worked with realized they could not deal effectively with every bank failure. So one of their first tasks was to devise criteria for which failures they would deal with. Their criteria formed what came to be known as the "essentiality doctrine." This was crucial for guidance in dealing with the banking crisis, as well as for explanation and justification to the public for the government agency's decisions and actions. Sprague's tale is mainly a "chronicle [of] the evolution of the essentiality doctrine, which derives from the statutory authority for bank bailouts." The doctrine was first used in the bailout of the small Unity Bank of Boston and refined in the bailouts of the Bank of the Commonwealth and First Pennsylvania Bank. It then came into use for the multi-billion dollar bailout of the Continental Illinois National Bank and Trust Company in the early 1980s. Continental's failure came about almost overnight by the "lightening-fast removal of large deposits from around the world by electronic transfer." This was another of the unprecedented causes for the bank failures Sprague had to deal with in the new, high-interest, world of banking in the '70s and '80s. The main part of the book is how the essentiality doctrine was applied in the case of each of these four banks, with the especially high-stakes bailout of Continental having a section of its own.
Although stability and reliability have returned to the banking industry with the return of modest and low interest rates in following decades, Sprague's recounting of the momentous activities for damage control of bank failures for whatever reasons still holds lessons for today. For bank failures inevitably occur in any economic conditions; and in dealing with these promptly and effectively in the ways pioneered by Sprague, the unfavorable economic effects will be contained, and public confidence in the banking system maintained.

As chairman or director of the FDIC for more than 11 years, Irvine H. Sprague handled 374 bank failures. He was a special assistant to President Johnson, and has worked on economic issues with other high government officials.

From P.D. Nigro - Choice The book is timely, given current public concern with the effects of banking failures on the economic and social scene. Also, the bank-failure plot makes for fine drama. Academics, surprisingly, have little factual knowledge ofthe interpersonal play between insider and regulator during the bailout period--Sprague's book fills this void. In appendix form is a tabulation listing the 100 largest banks receiving FDIC assistance, along with the year and form of assistance. End-of-text notes indicate sources of information by chapter. Appropriate readership will include business and banking professionals and faculty, undergraduates and graduate students of money and banking and the general public.

From Michael M. Thomas - The New York Times Book Review {This} is an immensely important book despite two shortcomings: it is written in a style halfway between a doctoral dissertation and a bureaucratic report, and it is essentially nonjudgmental about individuals. Mr. Sprague concentrates his firepower and his recollection on banks; had he done half so much with bankers, readers would have been doubly in his debt. As it is, when he sets his case studies before us, the human element is not at the center of affairs.

Sprague was formerly chairman and board member of the Federal Deposit Insurance Corporation, authorized by Congress to rescue banks deemed 'essential' to the economy. His book examines . . . the largest bank bailouts of the early 1980s, including the First Pennsylvania Bank of Philadelphia and Continental Illinois. He died February 2004.