The stability of the US banking system is maintained by means of supervision and regulation, inspections, deposit insurance, and loans to troubled banks. For over 50 years, these precautions have pred banking panics. However, there have been some close calls. The collapse of Continental Illinois Bank & Trusted Company of Chicago in 1984 did not bring down the banking system, but it certainly rattled some windows.
In the late 1970s, Continental soared to a leadership position among Midwestern banks. Parts of its growth strategy were risky, however. It made many loans in the energy field, including one billion dollars that it took over from Penn Square Band of Oklahoma City. To obtain the funds it needed to make these loans, Continental relied heavily on short-term borrowing from other banks and large 30-day certificates of deposit—"hot money", in banking jargon. At least one Continental officer saw er signs and wrote a warning memo to her superiors, but the memo went unheeded. Although the Comptroller of the Currency inspected Continental on a regular basis, it failed to see how serious its problems were going to be.
Penn Square Bank was closed by regulators in July 1982. When energy prices began to slip, most of the billion in loans that Continental had taken over from the smaller banks turned out to be bad. Other loans to troubled companies such as Chrysler, International Harvester, and Braniff looked questionable. Seeing these problem, "hot money" owners began to pull their funds out of Continental.
By the spring of 1984, a run on Continental had begun. In May, the bank had to borrow 5 billion from the Fed to replace overnight funds it bad lost. But this was not enough. To try to stem the outflow of deposits from Continental, the FDIC agreed to guarantee not just the first 1,000 of each depositor’s money but all of it. Nevertheless, the run continued.
Federal regulators tried hard to find a sound bank that could take over Continental—common way of rescuing failing banks. But Continental was just too big for anyone to buy. By July, all hope of a private sector rescue was dashed. Regulators faced a stark choice: let Continental collapse, or take it over themselves.
Letting the bank fail seemed too risky. It was estimated that more than 100 other banks had placed enough funds in Continental to put them at risk if Continental failed. Thus, on a rainy
Thursday at the end of July, the FDIC in effect nationalized Continental Illinois at a cost of 5 billion dollars. This kept the bank’s doors open and pred a chain reaction. However, in all but a technical sense, Continental had become the biggest bank failure in US history.
By July, all hope of a private sector rescue was______