History of Government Bailouts in the U.S.

History of Government Bailouts in the U.S.

Bank failures are fairly common. Since 1934, a US bank has failed each year except 2005 and 2006. High levels of attention are given when a prominent and well-known institution fails and when several failures occur at the same time. The bank failures of the 1920s and 1930s were due to the Great Depression. The Federal Deposit Insurance Corporation (FDIC) was created in 1933 as a response to the crisis and to assure depositors that their investments were safe. Government intervention is often a technique used to solve first time problems or to address a concern that historically would have been, or has been, successfully handled by government involvement.

In the 1970s and 1980s, the economic landscape featured high interest rates and oil prices, deregulation, industry consolidation, and an increase in bank failures. In the 1970s, banks had restrictions on their ability to open new branches and expand across state lines. This changed with the 1980 passage of the Depository Institutions Deregulation and Monetary Control Act, which allowed larger banks to acquire smaller ones and diversify the products they offered. With this increased freedom, banks created investment instruments that involved a higher level of risk. In 1984, the largest failure and bank bailout occurred with Continental Illinois National Bank and Trust. The bank had over $40 billion in assets and was the largest bailout since the Great Depression.

I.R. Sprague, in his book, Bailout: An Insider's Account of Bank Failures and Rescues, notes 200 bank failures in 1984-1985, which accounted for more than all the failures in a forty-year period from World War II to the 1980s. Sprague also recounts eight high profile government bailouts in the 1970s and 1980s, four of which were of banks. Four "congressionally approved [corporate] bailouts" included Chrysler, Lockheed Corporation, New York City, and Conrail. The banks included Unity Bank and Trust of Boston in 1971, Bank of the Commonwealth of Detroit in 1972, First Pennsylvania Bank in 1980, and Continental in 1984. Bailouts are controversial because not all banks will be saved—large banks are generally saved before smaller ones—and there is no single criteria determining which banks are worthy of saving.

The savings and loan crisis of the 1980s saw hundreds of savings and loans associations bailed out by the government to the tune of over $160 billion. The Federal Savings and Loan Insurance Corporation (FSLIC), a government agency charged with insuring the savings and loan deposits, went bankrupt largely because it had charged the same premium to all institutions regardless of risk (Ely, 2008). Savings and Loans were at risk as the result of heavy investments in real estate, restrictions on interest rates, and by high inflation. The deregulation of savings and loans and improper supervision allowed risky investments leading to failure.

The Financial Services Modernization Act of 1999 was passed in a joint effort between the Clinton administration and Congress to remove the distinctions between banks, insurance companies, and other financial institutions. This action allowed financial institutions to crossover into other lines of business; for instance, an insurance company could sell financial investments to their customers and securities firms could sell insurance. It also meant that these organizations could become affiliated with each other, with the Federal Reserve Board exercising oversight, and with other regulatory agencies regulating specific aspects of business. As with other efforts in deregulation, this act allowed many organizations to grow dramatically, and some blame this action for the complex financial problems of today.

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