When the banks went off the rails
Isbell, Harold
WHEN THE BANKS WENT HAROLD ISBELL OFF THE RAILS A WAR MEMOIR FROM THE EIGHTIES it new administration is...
...Already The borrower, meanwhile, will almost certainly never know they were so far I could no longer feel them...
...of $100,000 was made at 8 percent and due in a year...
...Such a denial might be based of our banking system...
...Most commonly these transactions specified a administration began a radical restructuring of the banking sysrate of interest as well as a duration of time over which the tem...
...Thrifts comSecond, the banking business was also divided between monly sold their loans to such investors while retaining-for commercial banks and savings and loan associations...
...nothing so opulent...
...By discounting the loan, the seller offers the investor a payoff that equals 12 percent on the $98,113.45 investment...
...Nor did I want too great a haste as it was one of marketability or liquidity for the loan itself...
...banking system came with inflation and steadiprimarily in shorter term loans while the S&Ls, also known as ly rising interest rates in the midseventies after the Arab oil emthrifts, were specifically chartered for the purpose of extend- bargo...
...ited the depositors' ability to move deposits rapidly...
...She tried to wake me, shouting, retailers who discount less desirable goods to move Why don't you bring them back...
...The loans a fee paid by the investor-the obligation to collect payments that could be made and the deposits that could be accepted by and monitor the health of the loan...
...Savings Simply put, the loans carried a fixed rate of return and the money accounts, or time deposits, also carried a provision that, unlike market was demanding a higher rate...
...From the earliest days bankers lent their own funds...
...As time passed the banker became the source of funds for borrowers as well as a refuge or a place of safekeeping for the excess funds of others...
...their depositors suddenly, and en masse, demanded the reA bank is not a complex phenomenon...
...How could there have been such massive fail- require more time for repayment while simultaneously deures of both savings and loans and commercial banks in the positors would be demanding their funds of the banker...
...Two inFor many years this system served the country very well, es- terest payments of $4,000, the first due at the end of 180 days pecially as the Depression gave way first to World War II and and the second at maturity, are required...
...Such a situation could neither a bank nor a thrift invoked this privilege unless it was be accommodated only by decreasing or marking down the value on the brink of failure...
...terested in buying long-term mortgage loans...
...No investor would buy a checking or "demand" account, a withdrawal order could be an older mortgage paying 8 percent when he or she might buy delayed for a period up to thirty days...
...vide assurance that the money received at the end of the loan Commercial banks were allowed to offer both savings ac- will retain the purchasing power those funds had at the begincounts and checking accounts, although the former could not ning of the loan...
...We find ourselves with a financier's rule of thumb: when interest rates are The doctor wanted to tie them down...
...Commonweal 26 February 1993: 11 ple insolvencies, the fund, as an agency of the federal govern- inated...
...should regulation take to help make sure this doesn't happen During the Great Depression many banks failed because again...
...This last decade...
...First, depositors' funds could remain on loan...
...My wife screamed and screamed at me as the feet Such an investment strategy is not unlike that of drifted beyond her...
...Treasury to pay off By the 1970s, a market had grown for outside investors indepositors...
...But I despised them, and I didn't trouble about it...
...Restricting checking privileges lim- ing in value, and not because they were likely to be defaulted...
...In ity than is found when one person borrows money from an- the event of a major underwriting disaster triggered by multiother or when one person guarantees the obligation of another...
...by doling them, interest rates are declining the value of existing loans rises...
...Since most of any bank's resources are ly referred to the bench or counter on which a money chang- invested in its loan portfolio, the banks were often unable to er conducted his business...
...Let's begin at the beginning...
...Thrifts were permitted to accept only 1975 to compensate for inflation, lenders found their loans plung"time" or savings deposits...
...This chain of the place where a person needing ready cash could borrow events is known as a "run on the bank" (remember Jimmy money under certain conditions or could secure a letter of Stewart in It's a Wonderful Life...
...Moritz amount, will receive in six months $104,000 from the original Untreated Condition borrower...
...in my falling apart, no bitter spectacular decay: Bankers found their position even more complicated as depositors came to expect higher interest on their time deposits...
...However, the come due at the end of twelve months, the borrower would have system was dismantled by legislation in 1980 and 1982 when to hand over $104,000...
...credit in which the banker substituted his credit for that of Confronted with such widespread insolvencies, the Roosevelt his customer...
...But I'm getting ahead of myself...
...But let's suppose that after six months the distinction based on loans and deposits was virtually elim- the lender suddenly needs the face amount of the note...
...Worse, the institution which set out to sell an older, less desirable portfolio confronted immediate losses because these lower yielding assets were sharply discounted in value when put up for sale to outside investors...
...A solution is for the bank to discount the selling price of the note to $98,113.45 so that the new buyer, after investing that A.F...
...As a matter of practice a more recent loan yielding 12 percent...
...12: 26 February 1993 Commonweal...
...Thus a working definition: A bank is an intermediary between those with excess and those with deficient liquidity, liquidity being the ability readily to convert assets into cash...
...He wanted rising the value of existing loans declines and when to save them by cutting pieces off...
...Commercial banks were expected to deal trouble in the U.S...
...ing long-term mortgages to home buyers...
...And he was right, no doubt...
...When interest rates suddenly began rising after be accessed by checks...
...And finally, what direction ing relationship: creditworthiness and liquidity...
...Let's say an ordinary commercial loan the maximum rates of interest they could pay on deposits...
...His books include Ovid: Heroides (Penguin...
...Later, when the banker might well be lending a mix of his own funds and the funds of others, he would be expected to maintain the same level of care and attention...
...Although current on a variety of reasons, most obvious of which was the fear banking news tends to the upbeat, we are that the borrower could fail and the loan would not be restill living with the consequences of a paid...
...bite by bite, to the ground, he thought he could delay Consequently, at the outset the banking crisis was not so much their disappearing...
...loan portfolio...
...When the loan would then to the spectacular postwar economic boom...
...Just something small, even The interest payments an institution was making to depositors despised: to be, unknown to myself, each day could well exceed the interest income being earned from its a little faster, without wanting it, dying out...
...ment, would have ready access to the U.S...
...But a more common fear was that the borrower would major debacle...
...The term original- turn of their deposits...
...them out of inventory...
...Not too many decades ago a standard negative reply to a loan HAROLD ISBELL, a graduate of the University of Michigan Graduate School of Bank Management, was an officer and director of The Continental Bank & Trust Company in Salt Lake City...
...My feet were floating away from me...
...How was the cost of that fiscal disaster visited shows the two elements essential to a mutually beneficial bankupon the country's taxpayers...
...Shut that door...
...Restructuring took a number of forms...
...The first hints of serious each were distinct...
...The lending institution's problem is that in those six months the prevailing interest rate has gone from 8 percent to 12 percent and of course nobody wants to buy the 8 percent loan from the bank...
...dinary savings accounts in both banks and thrifts had limits on But let me explain...
...Consequently there was every incentive to ensure that the funds would be returned...
...Before too long, that bench became meet such extreme and unexpected demands...
...that all of this happened...
...In addition, and most significantly, or- of the older, lower yielding loan...
...WHEN THE BANKS WENT HAROLD ISBELL OFF THE RAILS A WAR MEMOIR FROM THE EIGHTIES it new administration is in place and one of request was: "I'm sorry, but I cannot commit my depositors' its nagging problems will be the condition funds to this particular venture...
...confidence was restored by providing a system of deposit inAt its simplest a bank functioned with little more formal- surance funded by regular assessments on all insured banks...
...they were excluded Interest rates for loans rise during inflationary periods to profrom other kinds of lending...
...one of creditworthiness on the part of the existing borrowers But I didn't want it...
Vol. 120 • February 1993 • No. 4
