1 FDIC, Failed Bank Cost Analysis 19861994 (1995), 12, 32. 2 At year-end 1984, only 24 commercial banks had more than $10 billion in assets; by year-end 1994, the number was 64.

During the same ten-year period, total assets at such banks had risen from $865 billion to $1.94 trillion.

Chapter 7

Continental Illinois and Continental Illinois and

Too Big to F oo Big to Fail

Introduction

One of the most notable features on the landscape of the banking crises of the 1980s

was the crisis involving Continental Illinois National Bank and Trust Company (CINB) in

May 1984, which was and still is the largest bank resolution in U.S. history. Although it

took place before the banking crises of the decade gathered strength, the Continental

episode is noteworthy because it focused attention on important banking policy issues of

the period. Among the most significant of these was the effectiveness of supervision: in the

wake of the banks difficulties, some members of Congress questioned whether bank regulators (in this case, the Office of the Comptroller of the Currency in particular) could adequately assess risk within an institution. The economic dislocation such a large bank failure

might bring also engendered increased scrutiny of the supervisory process. In addition,

Continental was a particularly telling example of the problem that bank regulators faced

when attempting to deal with safety-and-soundness issues in an institution that had already

been identified as taking excessive risks but whose performance had not yet been seriously

compromised.

Continentals size alone made it consequential. Large-bank failures in the 1980s and

early 1990s would prove to have serious consequences for the Bank Insurance Fund (BIF).

For example, although only 1 percent of failed institutions from 1986 to 1994 had more

than $5 billion in assets, those banks made up 37 percent of the total assets of failed institutions and accounted for 23 percent of BIF losses during that period.1 Moreover, continuing industry consolidation can only serve to make the issues involved in the handling of

large-bank failures more significant.2
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236 History of the EightiesLessons for the Future

3 L. William Seidman, Full Faith and Credit: The Great S&L Debacle and Other Washington Sagas (1993), 7576. 4 See Irvine Sprague, Bailout: An Insiders Account of Bank Failures and Rescues (1986), pt. 4; James P. McCollum, The

Continental Affair: The Rise and Fall of the Continental Illinois Bank (1987); and William Greider, Secrets of the Temple:

How the Federal Reserve Runs the Country (1987), chaps. 14 and 17. The discussion here also owes much to FDIC, Report on Continental Illinois (unpublished paper), 1985.

5 U.S. House Committee on Banking, Finance and Urban Affairs, Subcommittee on Financial Institutions Supervision, Regulation and Insurance, Inquiry into Continental Illinois Corp. and Continental Illinois National Bank: Hearings, 98th

Cong., 2d sess., 1984, 39; and Continental Illinois Sails into a Calm, Business Week (May 14, 1979): 114.

As the nations seventh-largest bank, Continental forced regulators to recognize not

only that very large institutions could fail but also that bank regulators needed to find satisfactory ways to cope with such failures. The methods adopted in the resolution of Continental gave rise to a great deal of controversy, with the debate centering on whether large

banks like Continental had to be treated differently from smaller institutions (the policy of

differential treatment was soon given the rather inaccurate sobriquet of too big to fail

[TBTF]). In fully covering all deposits in Continental, the FDIC used a method that contrasted sharply with its continuing use of deposit payoffs in some smaller resolutions. Perceptions of inequity in the treatment of banks depending on their size were brought into

even greater relief by the fact that the Continental assistance package was put together soon

after the FDIC had implemented a pilot program of modified payoffs in which only a proportion of the amount owed to uninsured depositors and other creditors was paid, based on

the estimated recovery value of the institutions assets. The FDIC, seeking to encourage depositor discipline, had hoped to expand the modified payoff to all banks regardless of size.

However, the Continental assistance package effectively ended the program. At the Senate

hearings for his confirmation as FDIC chairman in September 1985, L. William Seidman

testified that it was important not to have bank size lead to differential treatmentbut he

would later write that regulators were largely unsuccessful in remedying the problem.3 The

Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) took significant steps toward dealing with TBTF, but since then no very large bank has failed, so the

laws effect on how regulators would respond to such a failure has not yet been tested.

Continentals Growth through 1981

The story of Continental Illinois is now well known, but before 1982 few observers

would have nominated it as the institution that would become emblematic of TBTF.

4 The

bank had long been conservative, but in the mid-1970s its management began to implement

a growth strategy focused on commercial lending, explicitly setting out to become one of

the nations largest commercial lenders.5 By 1981, management had accomplished this and

more: Continental was the largest commercial and industrial (C&I) lender in the United

States. CINBs emphasis on C&I lending can be seen clearly when it is compared with

other money-center banks. Between 1976 and 1981, CINBs C&I lending jumped from ap-
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 237

Table 7.1 

Growth in Assets and Domestic C&I Lending at the Ten Largest U.S. Banks,

19761981 

($Billions)

1976 1981 19761981

Domestic Domestic

Total Domestic C&I as % Total Domestic C&I as % Asset Domestic

Bank Assets C&I of Assets Assets C&I of Assets Growth C&I Growth

Bank of America $72.94 $7.06 9.67 $118.54 $12.10 10.21 62.52% 71.51%

Citibank 61.50 7.71 12.54 104.80 12.54 11.97 70.40 62.57

Chase Manhattan 44.75 9.24 20.66 76.84 10.05 13.07 71.69 8.67

Manufacturers Hanover 30.10 4.43 14.73 54.91 9.46 17.22 82.44 113.39

Morgan Guaranty 28.49 3.07 10.79 53.72 5.61 10.44 88.57 82.43

Chemical Bank 26.08 4.65 17.82 45.11 10.82 23.98 72.94 132.74

Bankers Trust 21.76 3.06 14.04 33.00 5.23 15.84 51.66 71.08

Continental Illinois 21.44 5.09 23.74 45.15 14.27 31.61 110.56 180.42

First National Bank of Chicago 18.68 4.04 21.61 32.55 5.59 17.16 74.25 38.42

Security Pacific 16.15 2.49 15.43 30.46 5.91 19.38 88.59 136.98

6 Here Comes Continental, Duns Review 112, no. 6 (1978): 4244; and Banker of the Year, Euromoney (October 1981):

134.

proximately $5 billion to more than $14 billion (180 percent), while its total assets grew

from $21.5 billion to $45 billion (110 percent). During the same period, Citibanks C&I

lending rose from $7.7 billion to $12.5 billion (62.5 percent), while its total assets rose from

$61.5 billion to $105 billion (70 percent). Growth at Continental Illinois substantially outstripped that at institutions such as Chemical Bank, Morgan Guaranty, and its Chicago competitor, the First National Bank of Chicago. (See table 7.1.)

Continentals management, the banks aggressive growth strategy, and its returns

were lauded both by the market and by industry analysts. A 1978 article in Duns Review

pronounced the bank one of the top five companies in the nation; an analyst at First Boston

Corp. praised Continental, noting that it had superior management at the top, and its management is very deep; in 1981, a Salomon Brothers analyst echoed this sentiment, calling

Continental one of the finest money-center banks going.6 Continentals share price reflected the high opinions of and performance by the bank. In 1979, an article noted that

while the stocks of other big banking companies have hardly budged,  . . . Continentals . . .

has doubled in pricerising from about $13 to $27 . . . since the end of 1974, compared
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238 History of the EightiesLessons for the Future

Figure 7.1

Continental Illinois Corporation:

Average Weekly Share Price, 1981–1984

Source: Dow Jones News/Retrieval.

1981 1982 1983 1984

0

10

20

30

40

Dollars

7 Continental Illinois Sails into a Calm, Business Week (May 14, 1979): 114. 8 See, for example, Wall Street Transcript (January 25, 1982), where a Morgan Stanley analyst described Continental as attractive, and Keefe Nationwide Bankscan (March 15, 1982), where market dissatisfaction with Continental was viewed as

a gross overreaction to the year-end increase in the banks nonperforming assets. Two weeks after this comment, an analyst at the Bank of New York raised his rating on Continental from hold to buy (Wall Street Transcript [March 29, 1982]).

All of these are cited in FDIC, Report on Continental Illinois.

with a 10% gain for the average money-center bank.7 And even as its share price was deteriorating during late 1981 and early 1982 (see figure 7.1), many stock analysts continued

to recommend purchase of Continental shares.8

It is not surprising that few observers recognized the problems inherent in Continentals rapid growth; most indicators of the banks financial condition were good, and some

were outstanding. For example, for the five-year period from 1977 to 1981, the banks average return on equity was 14.35 percent, which was second only to Morgan Guaranty (14.83

percent) among other large commercial banks. Over the same period Citibanks average was

13.46 percent, and Continentals cross-town rival First Chicago had an average of only 9.43

percent. Continentals return on average assets was also acceptable, exceeded only by the returns of Security Pacific, Morgan Guaranty, and Citibank (see table 7.2). Continental did

have one of the lower equity levels of the large banks, with its average of 3.78 percent putting
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 239

it seventh out of ten; however, only three banks had ratios significantly over 4 percent.

Moreover, asset and loan growth at Continental was at least matched by growth in the banks

equity ratio, which rose from 3.55 percent at year-end 1976 to 4.31 percent at year-end 1982.

If there were signs of trouble, that was not obvious from Continentals earnings.

There were, however, two aspects of Continentals financial profile that, with the benefit of hindsight, were indicators of the increased risk the bank took on during its growth period. First, Continentals loans-to-assets ratio increased dramaticallyfrom 57.9 percent in

1977 to 68.8 percent (see appendix, table 7-A.3) by year-end 1981, when it was the highest

of the ten banks. This alone suggests that the bank was riskier; the greater the proportion of

its portfolio a bank holds in loans, the more exposed the firm is to default risk. Second, although Continentals return on assets was adequate over this period, it hovered at around

.51 percent; with a higher percentage of assets in loans, the average loan had to have been

earning less at the end of the period than it had been at the beginning, implying that over

time, Continental was originating loans with lower interest rates than those on the books in

1978. Given the large increase in interest rates over this same period, such a scenario indicates the bank might have adopted a below-market pricing strategy, a possibility some observers noted at the time.

As this suggests, intimations that Continentals lending style might be overly aggressive had not been altogether lacking. The banks growth was attributed partly to its zeal for

occasional transactions that carry more than the average amount of risk. One bank officer

Table 7.2 

Average Returns and Equity Ratios at the Ten Largest U.S. Banks, 19771981

Average Average Average Equity/

Bank ROA* ROE Assets Ratio

Bank of America 0.50% 13.91% 3.57%

Bankers Trust 0.42 10.84 3.92

Chase Manhattan 0.44 11.04 4.01

Chemical Bank 0.38 10.96 3.52

Citibank 0.59 13.46 4.40

Continental Illinois 0.54 14.35 3.78

First National Bank of Chicago 0.38 9.43 3.99

Manufacturers Hanover 0.45 12.92 3.53

Morgan Guaranty 0.65 14.85 4.37

Security Pacific 0.66 14.31 4.60

*Return on assets is year-end net income divided by year-end assets.

Return on equity is year-end net income divided by year-end equity.
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240 History of the EightiesLessons for the Future

9 Both of these citations are from Continental Sails, 114. 10 On the Offensive, The Wall Street Journal (October 15, 1981), 1. 11 See Sanford Rose, A Well-Heeled Gamblers Half-Hearted Reformation, American Banker (August 18, 1981), 4; and

Laurel Sorenson, In the Highflying Field of Energy Finance, Continental Illinois Bank Is Striking It Rich, The Wall Street

Journal (September 18, 1981), 33. 12 Neil Osborn, Continental Illinois Shakes Up the Competition, Institutional Investor 14, no. 10 (1980): 17879. 13 On the Offensive, 1. 14 Sorenson, Highflying Field, 33. 15 Banker of the Year, 135; and Sanford Rose, Will Success Spoil Continental Illinois? American Banker (August 25,

1981), 4. 16 Sorenson, Highflying Field, 33. 17 Greider, Secrets, 522; and The Wall Street Journal (June 1, 1982), 1.

stated, We hear that Continental is willing to do just about anything to make a deal.9 Another observer noted that Continental had sold the hell out of the corporate market by taking more than the average risks in selected areas.10 One of the most significant of those

areas was the energy sector, where Continental had a long history and the bank could claim

a great deal of expertise.11 Continentals growth was also perceived to stem from aggressive pricing. A published news report stated that when Continental wanted to do business

with a corporation badly enough, the bank would offer a cheap deal . . . the financial officer cant refuse.12 A Chicago competitor noted in 1981 that even with a 20% prime they

were doing 16% fixed rate loans. I dont know how they do it.13 But while some were suggesting that the banks aggressive lending style might be too risky, few thought so before

1982, and Continentals management dismissed such views.14

Late in 1981, however, problems were beginning to surface. The banks secondquarter earnings fell 12 percent, a drop that CEO Roger Anderson explained was largely the

result of backing interest rates the wrong way. (It was reported that the fall would have

been much greater had the bank not taken some extraordinary gains during the quarter.)15

In September 1981, Continentals senior vice president in charge of oil and gas dismissed

the 1981 drop in oil priceswhich would in fact continue steadily as just a little blip.16

In addition, some of Continentals corporate customers began to have severe problems. For

example, in the first six months of 1982, Nucorp Energy lost more than $40 million, and

Continental held a large portion of the companys debt. Continental had also lent $200 million to the near-bankrupt International Harvester, and one bank analyst suggested that Continental had taken some bad credit gambles that arent paying off . . . and it is costing them

now.17 After peaking at approximately 42 in June 1981, Continentals share price declined

almost 37 percent during the next year. Many stock analysts believed the reaction was

overdone and the downturn in stock price more psychological than fundamental; nevertheless, the increasing volume of nonperforming loans was viewed as at least a short-term
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 241

18 Dow Jones New Service: The Wall Street Journal combined stories (April 20, 1982). Moodys Investors Service had downgraded Continentals debt rating from AAA to AA in March. 19 For the story of Penn Squares failure, see Chapter 9; and Phillip L. Zweig, Belly Up: The Collapse of the Penn Square

Bank (1985). 20 See Sprague, Bailout; and Greider, Secrets, 497500. 21 Penn Square had $390 million in deposits and $436 million in assets. In 1992, there was a deposit payoff of the Independence Bank of Los Angeles ($548 million in deposits and $536 million in assets). Data are for the quarter before failure. 22 For example, within a month of Penn Squares failure, revised positions were taken by analysts at Keefe, Bruyette and

Woods; Smith Barney Harris Upham and Co.; and Donaldson, Lufkin, Jenrette (FDIC, Report on Continental Illinois). 23 See Chapter 5 for a discussion of the LDC debt crisis. 24 See, for example, The Stain from Penn Square Keeps Spreading,  Business Week (August 2, 1982), available: LEXIS, Library: NEWS, File: BUSWK; Forgetting the Rules, Newsweek (August 2, 1982), available: LEXIS, Library: NEWS,

File: NWEEK; and Continental IllinoisMost Embarrassing Year, Business Week (October 11, 1982), available: LEXIS,

Library: NEWS, File: BUSWK.

problem. Yet in March 1982, when Fitchs Investors Service Inc. downgraded six large

banks ratings, Continental retained its AAA rating.18

After Penn Square

Optimism about Continentals condition ended abruptly in July 1982, when Penn

Square Bank, N.A., in Oklahoma failed.19 Penn Square had generated billions of dollars in

extremely speculative oil and gas exploration loans, many of which were nearly worthless,

and Continental had purchased a monumental $1 billion in participations from Penn

Square. While Continental and the other upstream banks pressed regulators to find a way

to prevent a deposit payoff of Penn Square, a course that would also have been preferred by

both the Federal Reserve and the OCC, the larger banks involved refused either to inject

money into Penn Square or to waive their claims on the bank. The refusal to waive their

claims meant that the contingent liabilities the FDIC would have incurred militated against

every course except a deposit payoff.20 Penn Square became the largest bank payoff in the

history of the FDIC, and remained so until 1992.21

News of Continentals relationship with Penn Square caused great anxiety among investors, and many stock analysts quickly halved earnings estimates and downgraded their

opinions on the company.

22 During July the share price had dropped to nearly 16, a 62 percent decline from a year before. The major rating agencies swiftly downgraded the banks

credit and debt ratings. Continentals lending involvement with three of the largest corporate bankruptcies of 1982 helped turn perceptions of the bank increasingly negative. Such

perceptions were reinforced by the advent of the less-developed-country (LDC) debt crisis

brought on by Mexicos default in August 1982; Continental had significant LDC exposure.23 The aggressiveness and loan policies that had met with so much praise during the

go-go years were now seen in a far more critical light. The financial press began to write

about faults in the banks management, internal controls, and loan pricing.24 CEO Ander-
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242 History of the EightiesLessons for the Future

25 McCollum, Continental Affair, 248. 26 Concerning federal law, see the discussion in Chapter 2 on the Riegle-Neal Interstate Banking and Branching Efficiency

Act of 1994. Until after the Continental open-bank assistance, Illinois law prohibited branching, only permitting one facility within 1,500 feet and another within 3,500 yards of the main banking premises (Conference of State Bank Supervisors, A Profile of State-Chartered Banking [1977], 98; and ibid. [1986], 86). 27 FDIC, Report on Continental Illinois, 712. 28 A. F. Ehrbar, Toil and Trouble and Continental Illinois, Fortune (February 7, 1983), available: LEXIS, Library: BUSFIN,

File: FORTUN.

son, while admitting that Continentals system had broken down, defended the banks lending policies and stated that the bank had no intention of pulling in its horns.25

Analysts reactions to Continentals statements about its condition were mixed, but

during 1983 the stock price did gradually recover into the mid-20s. While Continental furnished an image of a sober institution dealing with its problems, the banks mistakes had

meant a loss of credibility in the domestic money markets. This was particularly significant

because Continental had little retail banking business and therefore relatively small

amounts of core deposits. The banks ability to generate retail business was severely circumscribed by the combination of federal banking laws restricting geographic expansion

and Illinois law strictly requiring unit banking in the state.26 In 1977 core deposits made up

30 percent of total deposits; by 1981 they had declined to just under 20 percent. (See appendix, table 7-A.1.) Instead, the bank relied on fed funds and large CDs. In addition, management favored issuing shorter-term, more volatile but less-expensive instruments rather

than longer-term ones that were both more stable and more expensive. Continental therefore continually needed to roll over large volumes of deposits and search for new sources of

funds, but the loss of confidence due to Penn Square meant the bank had to pay substantially higher rates on its CDs. Within three weeks of Penn Squares failure, Continental removed itself from the list of top-graded banks whose CDs traded interchangeably in the

secondary markets. Unable to fund its domestic operations adequately from domestic markets, Continental increasingly turned to foreign money markets (at higher rates). Its dependence on these funds would figure significantly in the banks crisis in 1984.27

During the first half of 1983 Continentals situation appeared to have stabilized somewhat, but the banks recovery was far from certain. Although the bank apparently had made

efforts to tighten its internal controls and lending procedures, its nonperforming loans continued to mount. Earnings were bolstered by a series of extraordinary gains, while operating earnings declined. One reporter noted an example of gallows humor among bank

employees: [The only] difference between Continental and the Titanic is that the Titanic

had a band.28 Many institutional investors were deserting the ship, including major shareholders such as U.S. Steel & Carnegie Pensions and Mathers & Co. (a Chicago-based
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 243

29 Lynn Brenner, Chicago Giants Top Holder Isnt Fazed: Batterymarch Financial Management Still Owns 2 Million

Shares, American Banker (May 23, 1984), 3. 30 The Wall Street Journal (May 2, 1984), 41. 31 See Jeff Bailey and Jeffrey Zaslow, Continental Illinois Securities Plummet amid Rumors Firms Plight Is Worsening,

The Wall Street Journal (May 11, 1984), 3; Robert A Bennett, Continental Fighting Rumors, The New York Times (May

11, 1984), sec. 4, p. 1; and Sprague, Bailout, 15253. 32 For the text of the OCC press release, see U.S. House, Inquiry, 285. It was noted that the last time the government had

made such a statement had been in 1974, ten years earlier; the bank was Franklin National, and it later failed (The Wall

Street Journal [May 21, 1984], 3). 33  Smart Money Bank: What Went Wrong, The New York Times (May 18, 1984), sec. 4, p. 15.

money management firm), both of which sold their entire stock positions.29 The firstquarter 1984 results confirmed Continentals troubles: nonperforming loans increased

$400 million to a record $2.3 billion, with more than half the increase coming from Latin

American loans; if not for the sale of its profitable credit card business to Chemical for $157

million, Continental would have reported a loss for the quarter. This news prompted

Moodys to announce yet another review of its debt ratings on Continental.30 By the end of

April, Continentals share price had sunk from a postPenn Square high of 26 in September

1983 to less than 14.

The Bank Run and Government Assistance

The deterioration in Continentals condition and earnings, coupled with its reliance on

the Eurodollar market for funding, helped make the bank vulnerable to the high-speed electronic bank run that took place in May 1984. Among the factors that caused the run to start

and made stopping it difficult, rumor was prominent. On May 9, Reuters asked Continental to comment on rumors that the bank was on the road to bankruptcy; the bank condemned

the story as totally preposterous. In addition, stories circulated that a Japanese bank was

interested in acquiring Continental, or that the OCC had asked other banks and securities

firms to assist Continental.31 Anxious overseas depositors began to shift their deposits

away from Continental, and it was reported that Chicagos Board of Trade Clearing House

had done the same. In an effort to calm the situation, the Comptroller of the Currency, departing from the OCCs policy of not commenting on individual banks, took the extraordinary step of issuing a statement denying the agency had sought assistance for Continental

and noting that the OCC was unaware of any significant changes in the banks operations,

as reflected in its published financial statements, that would serve as the basis for rumors

about Continental.32 The run, however, continued, and by Friday May 11, Continental had

had to borrow $3.6 billion at the Federal Reserves discount window to make up for its lost

deposits.33 During the following weekend Continental attempted to solve its problems by
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244 History of the EightiesLessons for the Future

34 See OCC, FDIC and FRB, Joint News Release (May 17, 1984). 35 Placing the capital in the holding company was controversial because holding company bondholders were protected, but

no other avenue to effect the resolution could be found. See John Riley, Inside the Bailout: Continental Leaves a Wide

Wake, National Law Journal (October 22, 1984): 29. Continentals shareholders were substantially wiped out, though

they did have the prospect of some return, depending on the losses the FDIC incurred under the agreement.

creating a $4.5 billion loan package provided by 16 banks, but this proved insufficient to

stop the run; Continentals domestic correspondent banks also began to withdraw funds

from the bank.

As the situation continued to deteriorate, bank regulators were faced with a potential

crisis that might envelop the entire banking system. The run had to be stopped, and so the

three bank regulatory agencies decided to provide a $2 billion assistance package to Continental: the FDIC provided $1.5 billion, and participated an additional $500 million to a

group of commercial banks. The capital infusion was in the form of interest-bearing subordinated notes at a variable rate 100 basis points higher than that on one-year Treasury

bills. The Federal Reserve stated that it would meet any liquidity needs Continental might

have, and a group of 24 major U.S. banks agreed to provide more than $5.3 billion in funding on an unsecured basis while a permanent solution was sought. In what was perhaps the

most controversial move by the regulators, the FDIC promised to protect all of Continentals depositors and other general creditors, regardless of the $100,000 limit on deposit insurance. The assistance package was to remain in place while the regulators searched for a

permanent solution to Continentals problems.34

The regulators spent two months searching for a suitable and willing merger partner

for Continental, but none could be found. Moreover, the temporary assistance package had

not ended deposit outflows from Continental. In July the bank regulators agreed on a complex and controversial resolution. The plan consisted of the FDICs purchase from the bank

of $4.5 billion in bad loans. These troubled loans would then be managed for the FDIC by

the bank under a servicing contract. The structure of the loan transfer involved a charge-off

to the bank of $1 billion, but the permanent assistance plan also infused $1 billion in capital into the bank through the FDICs acquisition of preferred stock in Continental Illinois

Corporation (CIC), which the holding company was required to downstream to the bank as

equity. The FDIC wanted to place the new capital directly into the bank but was prevented

from doing so by outstanding indenture agreements with the holding company.

35 The bank

also continued to receive liquidity support from the Federal Reserve, and the funding facility that had been provided by a group of U.S. commercial banks remained in place. Finally,

the permanent assistance plan removed Continentals top management and board of direc-
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 245

36 See OCC, FDIC, FRB, Permanent Assistance Program for Continental Illinois National Bank and Trust Company, PR87-84 (July 26, 1984). 37 As of 1997, the estimated cost to the FDIC of resolving Continental is approximately $1.1 billion. At this writing, a small

number of assets are still to be disposed of, but are not expected to change the final cost significantly. Although many criticized the Continental resolution, the FDICs estimated cost was considerably smaller than the costs for First Republicbank

Corp. ($3.77 billion) and MCorp-Dallas ($2.85 billion). Moreover, if one considers estimated losses as a percentage of assets, Continental (3.27 percent) ranks behind Texas American Bancshares (22.67 percent), MCorp (18.12 percent), First

Republic (11.69 percent), First City Bancorporation [its 1988 failure] (9.55 percent), New Hampshire Savings Bank (9.55

percent), Goldome Federal Savings Bank (9.24 percent), CrossLand Federal Savings (7.50 percent), and Bank of New

England Corp. (3.40 percent). These percentages are calculated using asset size either at the time of closure or at the time

of the assistance transaction, whichever is applicable.

tors and put John Swearingen and William Ogden in place as executive officers of CIC and

CINB, respectively.

36 In September Continentals shareholders approved the plan.37

Policy Implications: Supervision

Continental continued in existence, though as a substantially different entity, but both

the need for intervention as well as the character of the intervention highlighted several important policy debates. Even if one did not take issue with the regulators permanent solution (and many did), the effectiveness of the OCCs supervisory activities before the

Continental assistance plan remained open to question. There was little doubt that the

banks management had embarked on a growth strategy built on decentralized credit evaluation unconstrained by any adequate system of internal controls and that the bank had relied on volatile funds. But how well had the responsible bank regulators assessed

Continentals situation, and should they have been more assertive in requiring the bank to

change its lending and other high-risk practices? 

A staff report of the House Banking Subcommittee in 1985 expressed reservations

about both the OCCs and the Federal Reserves supervision of Continental. Among its criticisms, the report found that the OCC failed to take decisive action to slow the banks

growth or increase its equity-to-assets ratio before 1983 and failed to require Continental to

remedy known problems in its loan management system before 1982. The report also held

that despite the OCCs awareness of Continentals growing concentrations in oil and gas,

the agency did not consistently and forcefully point out potential dangers to management,

and that OCC examination reports in general were too ambiguous to provide a clear message to the bank about its problems. The OCCs sampling technique for loan evaluation

was also thought to be insufficient in the case of Continental because it relied too much on

the banks own internal controls, which in this case were themselves woefully deficient.

The report criticized the Federal Reserve on the grounds that although its supervision of the

holding company identified potential risks from the reliance on volatile funding, the agency

did not communicate these warnings consistently over time. The report also noted that the
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246 History of the EightiesLessons for the Future

38 U.S. House Committee on Banking, Finance and Urban Affairs, Subcommittee on Financial Institutions Supervision, Regulation and Insurance, Continental Illinois National Bank: Report of an Inquiry into Its Federal Supervision and Assistance, Staff Report, 99th Cong., 1st sess., 1985, 710. 39 U.S. House, Inquiry, 21213. 40 Cited in Greider, Secrets, 52425. 41 The CAMEL rating system refers to capital, assets, management, earnings, and liquidity. In addition to a rating for each of

these individual or component categories, an overall or composite rating is given for the condition of the bank. Banks

are assigned ratings between 1 and 5, with 5 being the worst rating a bank can receive. See Chapter 12 for a detailed explanation of CAMEL ratings.

Federal Reserves continuing approval of the holding companys applications to expand its

activitiesdespite numerous examinations containing critiques of the banks capitalization, asset quality, and fundingmay have conveyed to CIC and the public that the Federal Reserve basically approved of the operating and financial characteristics of both the

holding company and the bank.38

C. T. Conover, the Comptroller of the Currency, noted in his testimony before Congress in 1984 that the OCC had considered whether the agency ought to have taken action

as early as 1976 to stop Continental from implementing its growth strategy. Conover said

he believed that this would have been inappropriate but that the OCC could have placed

more emphasis on . . . evaluation and criticism of Continentals overall management

processes.39 This issue touches on a central quandary that bank regulators faced. On the

one hand, as Federal Reserve Board General Counsel Michael Bradfield noted, The real

failure of supervision [was that] . . . nobody did anything about Continental in the late seventies and early eighties, but on the other hand, as Federal Reserve Board Governor

Charles Partee pointed out, To impose prudential restraints is meddlesome and it restricts

profits. If the banking system is expanding rapidly, if they can show theyre making good

money by the new business, for us to try to be too tough with them, to hold them back, is

just not going to be acceptable.40

A different situation obtained, however, after Penn Square had made Continentals

shortcomings obvious. Conover noted that in 1983, at the OCCs direction, Continental had

entered into a formal agreement with the agency requiring the bank to deal with problems

in asset and liability management, loan administration, and funding. Continentals plan

called for a reduction in assets and a more conservative lending policy. The OCC believed

that management and organizational changes to help recovery were being implemented but

that economic conditions, such as rising interest rates and a continuing decline in the energy

sector, made the plans goals unachievable. This further deterioration was noted in the 1983

OCC examination of Continental, when the banks composite CAMEL rating slipped to 

a 4.41 The banks decline continued, and Conover stated that at that point there was little the

regulators could have done to increase market confidence in the bank in a manner that

would have changed the outcome in May 1984. 
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 247

42 U.S. House, Inquiry, 211. 43 Greider, Secrets, 52225. William Isaac noted that what should have been done right away was the board of directors

should have fired the management, brought in strong management from outside, taken a huge loan write-off and eliminated

its dividend to stockholders. They might have failed anyway, but . . . there was a substantial chance they could [have] survive[d] (Greider, Secrets, 522).

The Comptroller noted that removing the banks top management following Penn

Square was viewed as unnecessarymanagement was perceived as capable and had put a

program in place to correct problems within the bank; moreover, the officers directly responsible for Continentals Penn Square difficulties had been removed. Forcing Continental to cease dividend payments was another option, but the banks management and board

of directors felt the dividend was crucial to regaining market confidence, and in any case

the amount of money involved would not have added appreciably to the banks capital.

Conover stated that after mid-1982 there was nothing more that we could have done to

speed Continentals recovery.42

A later account by William Greider, however, suggests that the regulators did informally attempt to do more after Penn Square but believed it inadvisable to impose a formal action, such as a cease-and-desist order. According to Greider, in 1982 Federal Reserve Board

Chairman Paul Volcker advised Continentals directors to make changes in both management

and lending policy, but the directors refused. FDIC Chairman William Isaac remembered

that when Volcker and Conover presented their recommendations to the Continental Illinois

directors, . . . the directors said to them: Well, this will be the end of the bank and you will

be to blame.  Isaac noted that it would have been difficult for a regulator to proceed in the

face of the directorsrefusal. It takes real gumption for a regulator to sit there and say, Ill

take the responsibility. . . Were talking about one of the biggest banks in the world. No one

knows what will happen. Michael Bradfield made the same point about any Federal Reserve attempt to deny a bank access to the discount window as a way of forcing its hand, noting that the consequences of refusing to supply liquidity support to a bank are too severe.

It appears, therefore, that in 1982 regulators believed more should have been done but were

unwilling openly to require the removal of Continentals top management or take other formal actions, such as demanding a dividend cut. However, it also seems likely that, as Bradfield noted, by the time Penn Square failed, the damage had already been done.43

Policy Implications: Too Big to Fail

Just as Continentals supervision had raised fundamental questions about regulatory

policy, so did the banks resolution. Some critics objected simply to the notion of a government agencys acquiring 80 percent ownership in a bankthe word nationalization
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248 History of the EightiesLessons for the Future

44 Bank analyst David Cates, however, noted at the time that the fact that the FDIC shares would have voting rights only after they were sold indicated the FDIC wanted to return the bank to the private sector as soon as possible, so nationalization

was not the most accurate term to describe the assistance package (All Debits, No Credits: A Hard Look at the Governments Takeover of Continental Illinois, Barrons [July 30, 1984]: 6). 45 There was a correlation between bank size and resolution method. During the period 198691, for example, the average

asset size of institutions that were resolved by insured-deposit payoff and liquidation was approximately $65 million,

whereas the average asset size of institutions that were resolved through either acquisition or open-bank assistance, both of

which meant uninsured depositors were protected, was about $200 million (FDIC, Failed Bank Cost Analysis 19861995

[1996], 11). 46 See §13(c)(1) of the Federal Deposit Insurance (FDI) Act, 12 U.S. Code §1823(c)(1). When this change was made to the

law, the FDIC noted that it was the intent of the Corporation to exercise this authority sparingly (FDIC, Annual Report

[1950], 6); and indeed, it was not invoked until 1970, and since then has been used relatively infrequently. 47 See the FDI Act, §13(c). For a discussion of the history of the essentiality issue, see Henry Cohen, Federal Deposit Insurance Corporation Assistance to an Insured Bank on the Ground That the Bank Is Essential in Its Community, Congressional Research Service, Library of Congress (October 1984), 8. Cohen notes that before Continental, essentiality had

been used five times, all of them between 1971 and 1980: Unity Bank and Trust (Boston, MA 1971), the Bank of the Commonwealth (Detroit, MI 1972), the American Bank and Trust Company (Orangeburg, SC 1974), the Farmers Bank of the

State of Delaware (Wilmington, DE 1976), and First Pennsylvania Bank, NA (Philadelphia, PA 1980).

was often invoked to describe the assistance package.44 Others objected to the methods

adopted in this case: the combination of the FDIC guarantee of protection to all depositors

and creditors, the apparent possibility that Continental shareholders might retain some of

their investment, and the protection of CICs bondholders. Overarching all of these issues

and far outlasting the immediate aftermath was the question of whether certain banks were

too big to fail. If they were, then the obvious corollary was that most banks were not, and

this pointed up what many believed to be a significant inequity in the deposit insurance system.45

Until 1950, the FDIC had basically had two options in dealing with failed and failing

banks: close the institution and pay off the insured depositors, or arrange for the banks acquisition. After 1950, a third option was available if the FDIC Board of Directors deemed

a bank essential to its community: keep a failing bank open through direct infusion of

funds (as was done with Continental).46 Also after 1950, and until the passage of the Federal Deposit Insurance Corporation Improvement Act of 1991, the FDIC operated under a

cost test for determining which method to use: it was required to estimate the cost of a payoff and liquidation as the standard of comparison, and could adopt an alternative resolution

if the alternative was expected to be less costly than the standard. But the FDIC was also

allowed to use an alternative method under the essentiality provision, and the statutory language was sufficiently general to provide the FDIC with discretion to extend essentiality

beyond local economic dislocation (as was done with Continental).47 When essentiality

was invoked, cost considerations could be ignored. In practice, most larger bank failures

were handled by purchase-and-assumption (P&A) transactions rather than payoffs, and the
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 249

48 In a P&A, all deposits and other nonsubordinated liabilities of the failed bank are assumed by another institution. Even

without the too-big-to-fail policy, it is likely that large banks would have been resolved more often through P&As than

through deposit payoffs because they had greater franchise value and marketability. The latter may have stemmed from

large banks(1) greater flexibility in seeking new markets and offering new product lines, (2) location in states where the

absence of restrictions on geographic expansion meant a greater number of qualified bidders, and (3) earlier resolution action (to the extent that disclosure requirements applicable to publicly traded companies alerted regulators to problems at an

earlier stage). 49 FDIC, Systemic Risk (Too Big to Fail) (unpublished paper), 1995. 50 E. Gerald Corrigan, A Perspective on Recent Financial Disruptions, Federal Reserve Bank of New York Quarterly Review 14, no. 4 (winter 198990): 12. 51 Statement of John P. LaWare, U.S. House Committee on Banking, Finance and Urban Affairs, Subcommittee on Economic

Stabilization, Economic Implications of the Too Big to Fail Policy: Hearing, 102d Cong., 1st sess., 1991, 113. Cited in

Charles Moyer and Robert E. Lamy, Too big to fail: Rationale, Consequences and Alternatives, Business Economics

27, no. 3 (1992): 21. 52 Ibid. For other discussions of TBTF, see Walker F. Todd, An Insiders View of the Political Economy of the Too Big to

Fail Doctrine, working paper 9017, Federal Reserve Bank of Cleveland, 1990; and Robert L. Hetzel, Too Big to Fail:

Origins, Consequences, and Outlook, Federal Reserve Bank of Richmond Economic Review 77, no. 6 (November/December 1991): 6ff.

uninsured depositors were protected.48 The FDIC recognized the inequities of its practice,

but also desired to minimize local economic disruptions. Thus it often selected a resolution

method that protected all deposits even with smaller banks if allowed under the cost test.49

Overall, the FDIC weighed the particular circumstances in deciding on failure-resolution

methods, and for the most part this meant that when uninsured depositors suffered losses, it

was in smaller institutionsa practice that created incentives for depositors to place large

deposits in larger banks, and that fueled concern over TBTF.

As has been noted, however, TBTF was an inaccurate term: too big to liquidate

would have been more appropriate. Large banks did fail during the period, with shareholders losing their investments and managements being removed. In significant ways, Continental failed. But as one regulator observed, the banking agencies were reluctant to

tolerate the sudden and uncontrolled failure of large institutions and therefore generally

opt[ed] for managed shrinkage, merger, or recapitalization.50 There were several reasons

for adopting such an attitude, the most important of which was systemic risk. This rubric

covered potential spillover effects leading to widespread depositor runs, impairment of

public confidence in the broader financial system, or serious disruptions in domestic and international payment and settlement systems.51 In addition to systemic risk, the logistical

difficulties and potential expense of liquidating a large bank also contributed to regulatory

reluctance to close such a bank and pay off insured depositors. Moreover, liquidation

would mean tying up uninsured depositors funds during the lengthy proceedings, a situation that could have a very disruptive effect on a banks community.

52 For all these reasons

combined, the larger the bank, the more likely it was that bank regulators would look for alternatives to closing the bank and paying off the insured depositors. 
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250 History of the EightiesLessons for the Future

53 FDIC, Deposit Insurance in a Changing Environment (1983), III-4-5. See also William Isaac, address before the Management Conference of the National Council of Savings Institutions (FDIC PR-92-83, December 6, 1983). 54 See Eugenie D. Short, FDIC Settlement Practices and the Size of Failed Banks, Federal Reserve Bank of Dallas Economic Review (March 1985): 19. 55 FDIC, Mandate for Change: Restructuring the Banking Industry (1987), 112. For the reaction of a depositor (after the

Continental assistance package) at a bank resolved through the modified payoff, see Pam Belluck, Continental Illinois

Rescue May Doom FDIC Plan to Share the Insurance Risk, National Journal (August 11, 1984), available: LEXIS, Library: BANKING, File: NTLJNL. 56 Federal Register 50 (May 6, 1985): 19088.

Regulators had another concern besides inequity and local economic disruption. They

and industry observers worried that the perception of de facto 100 percent deposit insurance

for many banks led depositors to believe they needed to devote little if any attention to

where they placed their money, a situation that could induce some banks to take excessive

risks. But some commentators thought moves to increase depositor discipline flew in the

face of too big to fail; the issue of depositor discipline therefore became attached to the

TBTF debate. During the early 1980s, the FDIC did seek ways to increase market discipline as a means of controlling inordinate risk taking. A solution proposed in 1983 was the

creation of the so-called modified payoff. In such a resolution, insured depositors claims

would be settled as they always had been. Rather than being made whole, however, other

claimants would receive a proportion of their money based on an estimate of the total value

of bank assets that would have been recovered in a liquidation. The agency expected that

both the insured-deposit settlement and the advance could be handled by transfer to an

operating institution.53 The FDIC began to experiment with the method in 1983 and used it

in 13 resolutions in 198384, most of which took place in March and April 1984, just before the Continental assistance package was put in place.54 The experiments had been

viewed as possibly leading to regular use of the method, but the Continental assistance

package effectively ended the modified payoff as a means to instill market discipline.55 Almost a year after Continental, the FDIC sought public comment on the possible use of modified payoffs in all resolutions, but it did not pursue the policy at that time.56

With regard to Continental Illinois, the regulators greatest concern was systemic risk,

and therefore handling Continental through a payoff and liquidation was simply not considered a viable option. Continental had an extensive network of correspondent banks, almost 2,300 of which had funds invested in Continental; more than 42 percent of those

banks had invested funds in excess of $100,000, with a total investment of almost $6 billion. The FDIC determined that 66 of these banks, with total assets of almost $5 billion, had

more than 100 percent of their equity capital invested in Continental and that an additional

113 banks with total assets of more than $12 billion had between 50 and 100 percent of their

equity capital invested. 
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 251

57 U.S. House, Inquiry, 43536, 44445, 47173. 58 Greider, Secrets, 62627, 63233. 59 For FDIC memos on FDI Act §13(c)(2) assistance under the essentiality provision, see U.S. House, Inquiry, 52225. Stanley C. Silverberg notes that another factor militated against a deposit payoff in the case of Continental: that the FDIC did

not have the system and capability to pay off Continentals depositors in a reasonable time period and without looking incompetent. See volume 2 of this study. 60 While noting that he would have preferred it to be otherwise, Conover admitted there was then no mechanism for treating

large and small banks in a consistent way that is fair to them, and he essentially agreed that the regulators could not allow any of the money-center banks to be liquidated in a payoff as they might allow smaller institutions to be (U.S. House,

Inquiry, 299300). 61 See Chapter 6.

The House Banking Committee staff found that this analysisinasmuch as it did not

take into account either the $100,000 payment on insured deposits or the banks likely recovery from the disposition of Continentals assetsoverstated the true exposure of the

creditor institutions and thus the numbers of correspondent banks that fell into the abovementioned categories. In reply, FDIC Chairman William Isaac noted that the FDIC had

never suggested that all these banks would fail but that these small banks would probably

have lost more than $1 billion and that such losses would have led to a number of failures.

In addition, the assets involved would have been frozen while the bank was liquidated, and

liquidation is a protracted process.57

The potential impact on the correspondent banks was not the only problem. Regulators were afraid of ripple effects on other large institutions that were perceived to be in vulnerable financial condition, banks such as First Chicago, Manufacturers Hanover, and Bank

of America. The financial markets worry about such banks was amply demonstrated just a

week after the Continental assistance package was announced, when rumors about funding

difficulties at Manufacturers Hanover caused its share price to drop 11 percent in one day,

with other major banks shares falling as a result.58 Regulators feared that if Continental

were allowed to close, a series of large institutions might be next; given this perception,

open-bank assistance under the essentiality clause was viewed as the only viable option.59

The Continental assistance package sharpened the publics focus on TBTF, and not

only because the banks size ensured notoriety. C. T. Conovers statement before Congress

that regulators would be unable to do a deposit payoff of the 11 largest banks seemed an explicit confirmation that large banks were inherently treated differently from smaller ones.60

Even if this appeared to codify TBTF, it should be noted that many of the characteristics of

Continentals resolution most relevant to TBTF were not unique to Continental. The FDIC

had assisted a large bank before: only four years earlier, it had provided assistance in the

form of a $325 million loan to First Pennsylvania, a $9 billion institution. Nor was the controversial guarantee that all depositors would be protected a novelty: the FDIC had made

the same promise in the case of Greenwich Savings Bank in 1982.61 Except for the FDICs
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252 History of the EightiesLessons for the Future

62 TBTF, specifically defined as the invocation of the essentiality clause with regard to an institution, was actually used only

three times between the resolutions of Continental and BNEC. The other cases were First National Bank and Trust Company of Oklahoma City ($1.6 billion in assets) in 1986, First Republicbank of Dallas ($32.2 billion in assets) in 1988, and

MCorp of Houston ($15.7 billion) in 1989 (assets are as of time of failure). See U.S. House, Economic Implications, 83.

For a discussion of BNEC, see Chapter 10. 63 See BNAs Banking Report, 56, no. 18 (May 6, 1991): 853ff., and no. 19 (May 13, 1991): 910ff. See also statements by 

L. William Seidman, Robert Clarke, and John LaWare, U.S. House, Economic Implications. 64 Congressional Quarterly (May 11, 1991): 1174. 65 For a discussion of the post-FDICIA period, see Larry D. Wall, Too-big-to-fail after FDICIA, Federal Reserve Bank of

Atlanta Economic Review 78, no. 1 (January/February 1993): 114.

involvement as primary shareholder in the resurrected bank, the steps taken in the Continental assistance package were not really unprecedented. 

TBTF after Continental

Despite reservations on the part of both regulators and industry about whether TBTF

should be used, it remained in place into the 1990s, when its most famous exemplar was the

resolution of three banking subsidiaries of the Bank of New England Corporation (BNEC),

with total assets (at the time of failure) of $21.9 billion, in January 1991.62 Although questions about unfairness and depositor discipline remained, the increasingly parlous state of

the Bank Insurance Fund and the attendant increases in deposit insurance premiums made

the issue more urgent, and attempts to restrict the policy formed an important part of the debate over FDICIA. Some members of Congress wanted to prohibit the government from

protecting uninsured depositors altogether, but most regulators as well as many legislators,

though wanting to limit the application of TBTF, favored retaining regulatory flexibility to

deal with the relatively rare problem of systemic risk.63 All depositors in some large banks

would need to be protected, Federal Reserve Board Chairman Alan Greenspan noted, in

the interests of macroeconomic stability, but there would also be circumstances in which

large banks fail with losses to uninsured depositors but without undue disruption to financial markets.64

FDICIA as enacted essentially took this road, attempting to place limits on regulatory

activities associated with TBTF but still leaving regulators the ability to invoke it under certain circumstances.65 FDIC resolutions were now required to proceed according to a leastcost test, which would mean that uninsured depositors would often have to bear losses.

The FDIC was prohibited from protecting any uninsured deposits or nondeposit bank debts

in cases in which such action would increase losses to the insurance fund. One important

effect of the least-cost provision was that the FDIC would not be able to grant open-bank

assistance unless that course would be less costly than a closed-bank resolution; thus FDICIA limited the discretion the agency had exercised under the old cost test and essentiality

provisions of the FDI Act. These changes have had a significant effect on the protection of
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 253

66 FDIC, Failed Bank Cost Analysis (1996), 1011. 67 If the systemic-risk exception is invoked, the FDIC must expeditiously recover the loss to the appropriate insurance fund

through one or more special assessments on the members of the insurance fund of which the relevant institution is a member. (The assessment is to be equal to the product of an assessment rate established by the FDIC and the amount of each

members average total assets during the semiannual period, minus the sum of the amount of the members average total

tangible equity and the amount of the members average total subordinated debt.) See Public Law 102-242, §141(a). 68 Wall, Too-big-to-fail after FDICIA, 11.

uninsured depositors. From 1986 through 1991, 19 percent of bank failure and assistance

transactions resulted in the nonprotection of uninsured depositors. From 1992 through

1994, the figure rose to 62 percent. On the basis of total assets, the average percentage of

uninsured depositors suffering a loss was 12.3 percent from 1986 through 1991, but from

1992 through 1994 it increased to 65 percent.66

The law made an exception to the least-cost requirement in cases of systemic risk, but

provided for a specific decision-making process to increase governmental accountability

and limit the application of the exception. At least two-thirds of both the FDIC Board of

Directors and the Board of Governors of the Federal Reserve must recommend that an exception be made, and this recommendation must then be acted upon by the secretary of the

treasury in consultation with the president.67 The General Accounting Office then reviews

any such actions taken and reports its findings to Congress. In addition, FDICIA establishes a relationship between a banks capitalization and the Federal Reserves ability to

provide assistance through the discount window: for critically undercapitalized banks, the

Federal Reserve has to demand repayment within no more than five days, and if that limit

is violated the Federal Reserve is liable for increased costs to the FDIC. As one economist

who has recently examined FDICIA notes, the law clearly moves toward the elimination of

TBTF as an operating principle and it gives the accountable agencies political incentives to

avoid resorting to the systemic-risk exception. He concludes by observing that although

FDICIA does not ban the too-big-to-fail doctrine, it has substantially reduced the likelihood

of future large bank bailouts.68

Conclusion

The crisis at Continental Illinois highlighted concerns about both large-bank supervision and large-bank failure and resolution. Given the regulators anxiety about Continentals correspondent banks and their worries about overall systemic risk, it was very unlikely

they would have pursued a course different from the one taken in 1984. Regulatory options

were further limited by Continentals peculiar characteristics: although very large, it had

proportionately few core deposits, no retail branches, and little franchise value. The Continental assistance package brought debate over TBTF to the fore, and although regulators

would have preferred otherwise (a preference that did not mean regulators had a solution to
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254 History of the EightiesLessons for the Future

69 One effort to try to get beyond TBTF was described by Seidman, who noted that E. Gerald Corrigan, president of the Federal Reserve Bank of New York, proposed that regulators use a policy of constructive ambiguity to prevent any institution or its depositors from being certain they would be protected under TBTF. Seidman stated that although regulators

agreed to follow such a course, the markets knew that the largest institutions would always be known as too big to fail

(Seidman, Full Faith and Credit, 150). 70 See the section on CEBA in Chapter 2. 71 Seidman, Full Faith and Credit, 14354.

put in its place), TBTF essentially remained in place until addressed by law in 1991.69 Nevertheless, after Continental there were some significant changes as the banking agencies acquired greater experience with large-bank failures. For example, regulators were given

more flexibility, which allowed them to deal with large-bank failures more efficiently. The

most important addition to the regulatory arsenal was the bridge-bank authority granted by

Congress in 1987.70 Moreover, without addressing TBTF directly, by the late 1980s regulators were no longer, in L. William Seidmans words,  as solicitous of the interests of the

banks owners and bondholders as they had been in the case of Continental. This changed

policy had partly evolved by the time of the First City Bancorporation assistance in 1988,

and was clearly evident in the case of First Republic, also in 1988, when FDIC money was

channeled directly into the banking subsidiaries and not into the holding company.

71 By the

early 1990s, many of the issues surrounding TBTF had been addressed under FDICIA, but

the problem of systemic risk remains, as does the question of how regulators would respond

today to a dilemma similar to the one they confronted in May 1984.
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 255

Appendix

Table 7-A.1

Continental Illinois National Bank and Trust:

Consolidated Statement of Condition, 19771983

($Millions)

1977 1978 1979 1980 1981 1982 1983

ASSETS

Interest-Bearing Deposits $ 3906 $ 738 $ 3883 $ 4016 $ 4992 $ 1819 $ 3483

Securities 2759 2635 2896 2817 2482 3009 2175

Loans and Leases 14462 17489 21871 25725 31071 32185 30103

Selected Loan Categories

Commercial Loans 5618 7120 9339 10980 14272 16183 14350

Real Estate Loans 555 869 1645 1926 2584 3092 3284

Foreign Office Loans 3672 4376 5502 7310 8337 7287 6640

LESS: Reserve for Loan Losses 154 173 191 225 265 364 368

Fed Funds and Reverse Repos 183 362 308 416 494 434 665

Total Earning Assets 21157 24050 28769 32749 38774 37083 36059

Cash and Due from Banks 2740 3904 3337 4359 2512 2189 2559

Other Assets 1078 1984 2188 3179 3860 2028 2052

Total Assets 24975 29938 34294 40287 45156 41300 40670

LIABILITIES

Core Deposits 5581 6009 6254 6242 5822 6404 6595

Large Time Deposits 4525 6117 6260 7371 9174 6234 6836

Foreign Office Deposits 8337 8767 11222 13497 14884 15741 16442

Fed Funds and Repos 4403 5152 5914 7257 7886 5893 4811

Other Borrowings 256 1151 1247 1475 1917 3340 2041

Other Liabilities 772 1516 1997 3901 3685 1652 1905

Total Liabilities 23874 28712 32934 38743 43370 39521 38839

Total Equity Capital 1102 1226 1360 1544 1776 1779 1831

Total Liabilities and Capital 24975 29938 34294 40287 45146 41300 40670

Average Total Assets $22892 $26359 $32035 $37846 $42320 $44084 $39020
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256 History of the EightiesLessons for the Future

Table 7-A.2

Continental Illinois National Bank and Trust:

Consolidated Statement of Income, 19771983

($Millions)

1977 1978 1979 1980 1981 1982 1983

INTEREST INCOME

Interest on Deposits $ 217 $ 293 $ 430 $ 615 $ 722 $ 487 $ 209

Securities Income 162 165 199 253 253 223 183

Interest and Fees on Loans and Leases 1012 1469 2346 3315 4661 4585 3404

Interest on Fed Funds and Reverse Repos 12 39 62 66 81 46 28

Total Interest Income 1402 1967 3036 4248 5716 5342 3825

INTEREST EXPENSE

Interest on Large Time Deposits 183 335 495 692 1138 880 324

Interest on Other Deposits (incl. Foreign) 495 703 1233 1668 2178 2323 1932

Interest on Fed Funds and Repos 255 398 676 1041 1390 1054 508

Interest on Other Borrowings 17 28 72 132 224 229 234

Total Interest Expense 951 1465 2475 3532 4929 4485 2998

NET INTEREST INCOME 451 502 561 716 787 856 827

OPERATING INCOME

Non-Interest Income 115 149 188 234 284 306 359

Overhead Expense 310 374 451 539 605 648 691

Provision for Loan Losses 52 57 65 91 114 477 359

Pre-Tax Operating Income 205 221 233 320 352 38 137

Income Taxes (Credit) 64 62 51 101 116 (34) 34

NET OPERATING INCOME 141 159 182 218 236 72 103

Securities Gains (Losses) (2) (1) 2 1 (5) (2) 1

NET INCOME 139 158 184 219 231 70 104

Dividends Upstreamed 50 34 50 30 0 62 50
Chapter 7 Continental Illinois and Too Big to Fail

History of the EightiesLessons for the Future 257

Table 7-A.3. 

Continental Illinois National Bank and Trust:

Financial Ratios, 19771983

1977 1978 1979 1980 1981 1982 1983

Ratio to Total Assets of:

ASSETS

Interest-Bearing Deposits 15.64 12.49 11.32 9.97 11.06 4.40 8.56

Securities 11.05 8.80 8.44 6.99 5.50 7.29 5.35

Loans and Leases 57.91 58.42 63.78 63.85 68.81 77.93 74.02

Selected Loan Categories

Commercial Loans 22.49 23.78 27.23 27.25 31.61 39.18 35.28

Real Estate Loans 2.22 2.90 4.80 4.78 5.72 7.49 8.07

Foreign Office Loans 14.70 14.62 16.04 18.14 18.46 17.64 16.33

LESS: Reserve for Loan Losses 0.62 0.58 0.56 0.56 0.59 0.88 0.90

Fed Funds and Reverse Repos 0.73 1.21 0.90 1.03 1.09 1.05 1.64

LIABILITIES

Core Deposits 22.35 20.07 18.24 15.49 12.89 15.51 16.22

Large Time Deposits 18.12 20.43 18.25 18.30 20.32 15.09 16.81

Foreign Office Deposits 33.38 29.28 32.72 33.50 32.96 38.11 40.43

Fed Funds and Repos 17.63 17.21 17.24 18.01 17.46 14.27 11.83

Other Borrowings 1.03 3.84 3.64 3.66 4.25 8.09 5.02

Other Liabilities 3.09 5.06 5.82 9.68 8.16 4.00 4.68

Total Liabilities 95.59 95.90 96.03 96.17 96.04 95.69 95.50

Total Equity Capital 4.41 4.10 3.97 3.83 3.93 4.31 4.50

Ratio to Total Average Assets of:

INTEREST INCOME

Interest on Deposits 0.95 1.11 1.34 1.63 1.71 1.10 0.54

Securities Income 0.71 0.63 0.62 0.67 0.60 0.51 0.47

Interest and Fees on Loans and Leases 4.42 5.57 7.32 8.76 11.01 10.40 8.72

Interest on Fed Funds and Reverse Repos 0.05 0.15 0.19 0.17 0.19 0.10 0.07

Total Interest Income 6.12 7.46 9.48 11.22 13.51 12.12 9.80

INTEREST EXPENSE

Interest on Large Time Deposits 0.80 1.27 1.55 1.83 2.69 2.00 0.83

Interest on Other Deposits (incl. Foreign) 2.16 2.67 3.85 4.41 5.15 5.27 4.95

Interest on Fed Funds and Repos 1.11 1.51 2.11 2.75 3.28 2.39 1.30

Interest on Other Borrowings 0.07 0.11 0.22 0.35 0.53 0.52 0.60

Total Interest Expense 4.15 5.56 7.73 9.33 11.65 10.17 7.68

NET INTEREST INCOME (NIM) 1.97 1.90 1.75 1.89 1.86 1.94 2.12

OPERATING INCOME

Non-Interest Income 0.50 0.57 0.59 0.62 0.67 0.69 0.92

Overhead Expense 1.35 1.42 1.41 1.42 1.43 1.47 1.77

Provision for Loan Losses 0.23 0.22 0.20 0.24 0.27 1.08 0.92

Pre-Tax Operating Income 0.90 0.84 0.73 0.85 0.83 0.09 0.35

Income Taxes (Credit) 0.28 0.24 0.16 0.27 0.27 -0.08 0.09

NET OPERATING INCOME 0.62 0.60 0.57 0.58 0.56 0.16 0.26

Return on Assets (ROA) 0.61 0.60 0.57 0.58 0.55 0.16 0.27

Return on Equity (ROE) 12.61 12.89 13.53 14.18 13.01 3.93 5.68