Too Big To Fail, Redux

For the last couple of years there has been a great deal of ink and paper devoted to the subject of financial institutions deemed to big to fail and thus beneficiaries of Federal largess, taxpayer money, to prevent their failure regardless of the cause of their economic distress.  We know the litany of the listings: AIG, Fannie, Freddie, GM, Chrysler, and virtually the entire top ten of the banking clique.  Saving these giants has cost us hundreds of billions to date and the ultimate outcome of the bailouts is not yet known although if we know our history many of us have seen the story before.

A companion issue has been the soundness of sovereign or national debt of various nations around the world.  Payment of foreign loans has been a concern for millenia and certainly off and on for the last couple of centuries.   Governments in times past, up to around the Napoleonic age, would mostly borrow their needed funds from individuals or private bankers.  That tradition goes back to the Medici and the great banking houses of Venice, Paris, Genoa and Amsterdam.  By mid -19th century the countries started borrowing from banks as we know them or from the public.  It had happened before but by then was becoming fairly common.  The JP Morgan company was started by an American in London specialized in making loans to government or brokering their borrowings to other by selling bonds which is merely a fancy term for an IOU from the government to an individual.  Over the years there have been many defaults of the various government bonds issued.   JP Morgan became a super rich man by gambling on some bonds to France they used to finance the Franco-Prussian War.  The bonds were sold when things looked bad for France and they sold only for fifty cents on the dollar and then the Frogs lost the war and the value dropped even more.   Morgan predicted rightly as it turned out that Germany would withdraw after the war and that France would indeed pay on the war bonds and he bought many of them at about 20 cents on the dollar at their low point.  He was right in the end and France paid them in full and he reaped a fortune.

In the late ’70’s and early ’80’s a lot of the major US banks decided to make large loans to South American countries.  It was easier and cheaper to make one large loan rather than work so hard to make 50,000.0 car loans and the returns were good.  The banks would form syndicates to fund the loans.  So Brazil borrowed billions from American banks.  One of the major lead banks was Continental Illinois.   Many smaller banks felt like they had been pressured to participate but they went along and the regulators were good with the concept.  This was different than all the sovereign borrowing during the ’20’s when almost all the borrowings were made by selling bonds of the foreign countries to individuals.  JP Morgan represented over 200,000 bondholders in its negotiations with Mexico during the ’20’s and ’30’s.  

Continental Ill was one of the top 3 or 4 banks in the US at the time. It was a big deal and a major player.  It ran into trouble with some real estate and oil loans it had participated in with a relatively small bank in Oklahoma called Penn Square in 1982. This was the opening salvo in what became the great real estate collapse of the Savings and Loan debacle of the ’80’s and the closure of hundreds of banks and S and L’s during the ’80’s and early ’90’s.  At the same time there was already a steady drum beat of bad news from Brazil.  The Carnival crowd was making very loud noises about not paying the foreign loans on time or in full or some of both.  None of that was good news.  Cont. Ill was heavily invested into that loan and now had this extra burden from the Oil Patch.  The regulators couldn’t ignore the situation.   Nervous investors and depositors was beginning to smell blood in the water.  

As always with these situations things are known but then accelerate dramatically at some pint with lightening speed.  The FDIC tried at the last minute to get a couple of the major New York banks to buy and take over Cont. Ill. but to know avail. It was too late and too much risk for them since they would be buying a pig in a poke.  The money was flowing out of Cont. ILL at such a rate that a true bank run was ripe.  There was worry this would spread to other banks and institutions like a contagion.  This would be like Wells Fargo or Citibank going under today.  At the last moment the FDIC stepped in a bought 80% of the bank and guaranteed all the deposits on hand regardless of amount. This was a clear violation of the law that limited deposit insurance to $50,000.00.  But, but but the FDIC declared that under exigent circumstances to avoid systemic risks it could take extraordinary measures to protect the banking system. The Federal Reserve was involved in all these decisions as was the New York Fed and the Secretary of the Treasury.    Cont. Ill was deemed too big to fail because it would possible cause a wide-spread run and collapse of the banking system.   Have you heard some of those terms lately?  Heard similar arguments made by technocrats?   It cost billions to save the depositors of Cont. Ill because it was busted because of the bad loans.  The Brazilians weren’t good for the money except in inflated reals down the road.  But the public has a very short memory.   Now Brazil is considered a rising star in the world economy.   Maybe it is, maybe not.  Heard that story before.   ‘Today’s headlines could have been lifted straight out of those from ’82 with only minor changes in proper names.  If you don’t know your history you can’t learn from it.”

Saudi Arabia in an effort to comply with the Koran prohibition against charging interest created SAMA, Saudi Arabian monetary Agency.  It didn’t charge interest but it required a “return on investment” .  Ah, a rose by any other name…


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