intervention does not fail and go out of business through revocation of an operat-ing charter and placement into FDIC re-ceivership (commercial banks) or bank-ruptcy (noncommercial banks), but re-mains a going concern, thus benefitingcreditors, shareholders, or counterpartiesof the financial institution.
In the absence of a bailout, the financialinstitution would either be forced to gothrough receivership or bankruptcy inthe prescribed legal form, or have its rolein financial intermediation disrupted.Based on this definition, recent examples of financial-institution bailouts would include theFederal Deposit Insurance Corporation’s bail-out of Continental Illinois in 1984 and Citi-group in 2008; the Federal Reserve’s bailout of Bear Stearns and American International Group;and the Treasury’s Troubled Asset Relief Pro-gram and bailouts of Fannie Mae and FreddieMac. Under this definition, transactions thatwould not be considered bailouts would be theFDIC’s purchase-and-assumption or payoff transactions, in which a troubled institutiondoes not remain a going concern. Additionally,the exercise of the Federal Reserve’s lender-of-last-resort powers would not be considered a bailout as these loans are traditionally fully col-lateralized.
Interestingly enough, the so-called“savings and loan bailout” of the 1980s and1990s, which involved the creation of theResolution Trust Corporation, would not be a financial-institution bailout under this defini-tion, as the transactions were structured to elim-inate the institutions as going concerns.
Historical Analysisof Structure of Bailouts,Great Depression to 2007
A historical review of the major financialcrises during the past 80 years is vital to anunderstanding of how the system is current-ly structured, as the influence of these crisesmolded the mandated responses to the chal-lenges of contagion, access to credit, resolu-tion of troubled institutions, and financialinstability.
Depression-era Banking Crisis
The Depression and the changes thatflowed from it brought us our modern bankingsystem. The number of banks in the UnitedStates grew rapidly from 1887 to 1921, increas-ing from about 5,000 to 30,000—an environ-ment most observers of the sector would de-scribe as overbanked.
Throughout the 1920s,the number of failures began to rise. By 1930,what followed was a series of crises involvingbank failures that brought the number of banks rapidly down to 15,000 by 1934. No lessa pair of observers than Nobel-prize-winnerMilton Friedman and Anna Jacobson Schwartzof the National Bureau of Economic Researchdescribed the first crisis in 1930 as:[a] contagion of fear spread amongdepositors, starting from the agricultur-al areas, which had experienced theheaviest impact of bank failures in thetwenties. But such contagion knows nogeographical limits. The failure of 256banks with $180 million of deposits inNovember 1930 was followed by thefailure of 352 with over $370 million of deposits in December, . . . the most dra-matic being the failure on December 11of the Bank of United States with over$200 million of deposits. That failurewas of especial importance. The Bank of United States was the largest commer-cial bank, as measured by volume of deposits, ever to have failed to that timein U.S. history.
The term “contagion” refers to a state inthe financial industry whereby a seemingly irrational negative cascading effect causesfinancial institution failures regardless of theinstitution’s actual condition. As SenatorCarter Glass explained during the delibera-tions on deposit insurance in 1933, “whenweak banks begin to topple there takes place a disastrous psychology in the whole country that precipitates runs on strong banks that
The term“contagion”refers to a statein the financialindustry whereby a seemingly irrationalnegativecascading effectcauses financialinstitutionfailuresregardless of theinstitution’sactual condition.