Stephen Bush is a business consulting and commercial banking expert. He is the CEO and Founder of AEX Commercial Financing Group.
We Need to Remember Bank Bailout History
The history of bank bailouts is a sad one because it vividly illustrates the common wisdom by George Santayana that "Those who cannot remember the past are condemned to repeat it." Whenever looking for a striking example of failure to learn from mistakes, it seems like bank bailout history is a leading candidate because of three recurring events:
- Banks keep on making similar mistakes that necessitate a bailout.
- The U.S. Government, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) continue to bail out the guilty banks.
- Despite multiple perspectives that often indicate criminal activity might have taken place, legal prosecution is extremely rare.
Below you will find a concise overview of modern bank bailout history in the United States—since 1970. As you will see, one of the most timely and relevant books about this topic is aptly titled "The Best Way to Rob a Bank Is to Own One."
It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.
— Henry Ford
Modern U.S. History of Bank Bailouts – 1970 Was an Important Year
The modern history of bank bailouts started with the bankruptcy of Penn Central Railroad in 1970. The highlights of the period from 1970 to the present are summarized below.
Banks that issued commercial paper to Penn Central Railroad were bailed out by the Federal Reserve Board when Penn Central declared bankruptcy in 1970.
Corruption and poor business practices forced the FDIC to take over Franklin National Bank. Some of the bank executives were eventually convicted.
Continental Illinois National Bank (eighth-largest bank in the United States at the time) incurred excessive losses due to energy loans purchased from Penn Square Bank in Oklahoma. The Federal Reserve and FDIC combined efforts to rescue the bank. BankAmerica eventually purchased the bank.
There were numerous failed savings and loans (S&Ls). This was a taxpayer bailout of about $200 billion via the Financial Institutions Reform Recovery and Enforcement Act. In general, the S&Ls failed in large numbers because they took excessive risks and took advantage of changes in laws covering financial institutions. This should sound familiar to those recently exposed to banks incurring excessive risks and taking advantage of reduced banking restrictions. The 2008 financial crisis had its origins in 1989 and earlier. The most visible S&L executive was Charles Keating of Lincoln Savings and Loan. He eventually served less than five years in prison.
This was the year of the perfect financial storm that brought down Bear Stearns, Fannie Mae, Freddie Mac, and Citigroup. In January 2009, Bank of America was given additional assistance. The Emergency Economic Stabilization Act was passed by Congress in October 2008 (Troubled Asset Relief Program or TARP).
In the Beginning: Mortgages and No Money Down
For most of us, mortgages have been a routine fixture in our entire financial life. By most accounts, the “patient zero” for a home loan was sometime during the 1930s. Contrary to what you might think, banks were not the first mortgage lenders. Insurance companies were looking around for a sound place to invest some of the money that an insurance company often has on hand after it has received premium payments from their customers. As the story is now told, the insurance industry was not interested in making real estate loans out of the goodness of their heart but rather because they saw what they thought was a unique opportunity to make sizable profits when borrowers defaulted on their loans. Given that the Great Depression was a major negative economic force until World War II created a financial stimulus, the insurance companies truly thought that they had found a winning investment strategy.
In the first mortgages, it was not unusual for the borrower to routinely make a “down payment” of 80 percent or more. In today’s real estate market, an 80 percent mortgage might refer to borrowing 80 percent of the purchase price. In the beginning of mortgage financing, however, an 80 percent mortgage meant that a homeowner was paying 80 percent of the purchase price and borrowing 20 percent. If a homeowner did default on their real estate loan and lost the property, they were losing a substantial equity ownership position.
Fast-forward to the end of the war, the federal government wanted to help returning veterans adapt quickly to a different economy. The G.I. Bill (officially the Servicemen’s Readjustment Act of 1944) was a law that helped veterans to attend college or vocational schools, buy a business, receive unemployment compensation and to buy a house with a low-cost mortgage that did not require a down payment. This was the beginning of no money down for buying a home.
The “official” G.I. Bill continued to provide financial benefits to veterans until 1956. There was additional legislation that provided similar assistance in the following decades, and these government programs are still usually referred to as the G.I. Bill.
Explanation of a Bank Bailout
What are bank bailouts? Here is a great explanation.
How can banks be bailed out by governments?
A Poll – For or Against?
No Down Payments for Mortgage Loans in the 21st Century
In the early 21st century banks had an oversupply of money to lend and a shortage of consumers to borrow it. The banks’ financial solution to this unusual dilemma was to create new home loan standards in which it would be easier for individuals to borrow more money and use less money for a down payment. In some situations, mortgage loans were available for even more than 100 percent of the purchase price so that closing costs and other loan fees could be covered by the financing agreements.
The way that banks must have looked at this golden opportunity was that with one swipe of their pen they could increase their loan interest income by 10 percent to 25 percent simply by lending more money on a safe investment asset that seemed to increase in value every year. Even if investors started with no equity (or negative equity in the case of loans over 100 percent of value), the highly leveraged borrowers would quickly build up their equity ownership within a short period of time.
The federal government helped this creative financing mentality by offering to guarantee part or all of some real estate loans. This kind of “insurance policy” in the background in turn probably encouraged the mortgage bankers to get sloppy with their loan underwriting practices. For several years the banks and mortgage companies had bumper crops of new and refinanced home loans. But the “dry years” were looming in the future for those who were paying attention.
In the meantime, though, life was good. What could go wrong? There were prominent banking and economic experts who were warning that the banks were on a lending path that could lead to serious problems. Foremost among these—Sheila Bair, head of the Federal Deposit Insurance Corporation (FDIC).
Unfortunately for all of us, Sheila Bair was ignored and a massive banking bailout was required in 2008 to keep the financial system afloat. Should the banks have been saved by taxpayer funding? According to Sheila Bair, “The banks should have been let go.”
Video Featuring William Black – Author of "The Best Way to Rob a Bank Is to Own One"
The Best Way to Rob a Bank Is to Own One was published in 2005 and focuses on the collapse and subsequent bailout of the savings and loans (circa 1989). Charles Keating was one of the few bankers criminally prosecuted, and William Black connects the dots between Keating's actions and corporate financial fraud during the period after 2000.
Are Today's Banks the New Robber Barons?
Do you know what a "Robber Baron" is (was)? The term "robber baron" has been around for parts of at least two centuries. I haven't seen it used much recently but couldn't help thinking immediately of modern-day banks when I came across this definition of "Robber Baron": "It combines the sense of criminal ('robber') and illegitimate aristocracy ('baron'). The term was typically applied to businessmen who were viewed as having used questionable practices to amass their wealth. Allegedly, their 'questionable practices' usually included selling the product at extremely low prices (and paying their workers very poorly in order to do so), buying out the competitors that couldn't keep up, and once there was no competition, they would hike prices far above the original level." This perspective is consistent with William Black's viewpoint in The Best Way to Rob a Bank Is to Own One.
Neil Barofsky Discusses Ongoing Bank Bailouts – Taxpayers Paid for This?
"Banking establishments are more dangerous than standing armies."
— Thomas Jefferson – Third President of the U.S.
Are We Learning from History? What Did the Banks Learn?
Another way to answer these questions is to look at what would happen differently if the recent banking crisis flares up again. In our last episode, the biggest banks got much bigger so "Too Big to Fail" certainly appears to still be a substantial and real risk. Bankers have continued their losing ways since the bailout by continuing risky investment practices. Why is that?
A big part of the problem is that there is a huge divergence between what the public (voters and citizens) wants and needs and what politicians have actually done. To many in Congress, the only "public" that counts is the one sending them big checks, and the banking establishment keeps on writing their checks. So the banks have obviously learned to keep those cards and checks coming.
What should we do? Here are five ways individuals can do things differently by learning from the history of bank bailouts and then taking strategic action:
|5 Strategies: Learning from Bank Bailout History|
1. Doing Less Business With Banks That Caused Banking Problems
2. Reducing Personal and Business Debt Instead of Increasing It
3. Firing Your Zombie Bank or Troubled Bank
4. Avoiding the Bad Banks and Finding the Good Banks
5. Developing a Contingency Plan: Always Have a Plan B
A bank is a place that will lend you money if you can prove that you don't need it.
— Bob Hope
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2012 Stephen Bush
And now, your thoughts on the subject . . .
Tony Bonura from Tickfaw, Louisiana on November 24, 2012:
This was an interesting and helpful lens. I learned some things from my visit here.
Stephen Bush (author) from Ohio on November 08, 2012:
@LabKittyDesign: Regardless of whether there are additional bailouts, the huge risks assumed by banks do need to stop before the problem is solved. In my view, current banking risks will not be satisfactorily resolved until severe bank limitations (at least as strong as the Glass-Steagall Act which was repealed in 1999) are enacted and enforced.
LabKittyDesign on November 07, 2012:
Any thoughts on Jonathan Tepper's book "Endgame"? He seems to be of the opinion that the 2008 bailout will be the last (if we're reading him right).