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At any given time of day, Chase probably has hundreds of banks and brokerage firms to which it owes money, and vice versa. If Chase didn't pay Merrill Lynch on Drysdale matters, Merrill Lynch wouldn't pay Chase on something else. And around and around we would go until the financial markets turn to butter.

Many on the street thought that the world had come to an end, but just hadn't found out about it yet. This type of thing wasn't done in the better circles. Everyone, thinking that Chase knew something they didn't, sold and sold and sold. Particularly hard hit were bank stocks. Chase dropped nearly 10% in two days as traders waited for the other shoe to fall.

Panic abounded as Paul Volcker, Federal Reserve Chairman, called Chase and explained how things really work in the world. Chase somehow got the message. Simultaneously, on Volcker instructions the Fed quietly opened the windows while the Open Market Desk (The trading arm of the New York branch of the Federal Reserve) became substantial buyers in the market. This scenario was being played out at a time that the Savings and Loan Industry was in shambles and the banks were awash in Latin Debt that was failing.

Questions arose as to the logic of a continued tight money policy, under the circumstances, in which another "Drysdale" could have collapsed the system. The Fed, committed to controlling inflation, did not want to change course, having coming so close to success.


Maybe what Chase knew was that a small banking institution in Oklahoma City was about to fail. Chase well could have known exactly what was going on at Penn Square Bank (the 22nd largest bank in the United States) because Chase was a major participant in Penn Square's loan portfolio. Penn Square was more of a packager of deals for Chase, Continental and a few others rather than a bank. They would go out and find loans and offer participations to their good friends. The people at Chase were good friends.

Penn Square had done quite well collecting finder's fees from their associates, but the loans weren't very good. As a matter of fact, at the time, most of them were in default, and we are talking about over $2 billion. Almost 200 credit unions and saving and loans had money in Penn Square, magnetized by a return of two points more than their competition. These loans were not insured. Allowing Penn Square to sink could have had adverse repercussions on Continental, Chase and countless others, causing a banking panic.

"But no one could ignore what was happening when Chase Manhattan Bank, then the nation's second largest, and Continental Illinois, the sixth, were caught making the kind of risky loans that banks of that size are not supposed to make. Chase had not only bought $212 million worth of what FDIC Chairman Isaac called "shoddy speculative" energy loans from Penn Square, but had to confess to two large losses in earlier failure of two Wall Street securities, dealers, Drysdale Securities and Lombard-Wall." (Self Inflicted Wounds, Hobart Rowen)

Ultimately, Treasury Secretary Regan gave instructions to the Comptroller of the Currency and Federal Deposit Insurance Corporation to close it down. Everyone held his or her breath. The world had not yet come to an end, but it was getting a lot closer. The date was June 30th, 1982, the same day that the Federal Reserve gave some more money to the Mexican Central Bank to keep it going a little longer.

At a reception in Toronto, David Rockefeller, Chairman of Chase said, "No, I don't think (Chase) is overexposed. You ought to remember that just a few years ago everybody was talking about Zaire, Peru, and Turkey. And what happened? Nobody lost hardly any money."

No question that Chase's problems had problems. As we know, they survived but not their sometimes partner, Continental Illinois Bank of Chicago, at least not in the same form that it was in then. On May 9, 1994, an announcement issued by The Commodity News Service conjectured at rumors that had been circulating regarding a Japanese bank taking over Continental. The Japanese translator translated "rumors" as "disclosure" and it hit the fan.

A major run on the bank developed. Not that Continental hadn't been in big trouble for some time, but rumors sometimes became prophesies, which more often than not, became self-fulfilling in times such as those. Continental's sister bank, First Chicago was a mess, Bank of America had big real-estate troubles and Manufacturers Hanover was strangling on its Latin debt. There were probably a dozen of the top twenty banks in the United States, in an equal or greater mess than Continental, but Continental is where the run started.

Because the failure of one could set off a domino effect, the Federal Reserve reluctantly agreed to bail out the bank. The Fed pumped in over $8 billion before they were through, making it the largest bank reorganization in the history of this country. Ultimately, it probably ranks in the global big three along with BCCI and Credit Lyonnais. Then Representative Fernand St. Germain, Chairman of the House Banking Committee, gave his estimation of the magnitude of the bailout. He said, "The size dwarfs the combined guarantees and outlays of the federal government in the Lockheed, Chrysler and New York City bailouts".

Continental's management, for the most part, was replaced and shareholder value became almost worthless, yet the bank survived, not as a retail financial institution but as more of a merchant bank. Yet, during Continental's fight for survival, the Fed allowed dozens of non-money center banks to close their doors. Whereas Continental's customers got in excess of FDIC's normal allowance, the outlying banks' customers received exactly what the rules provide. This was the first time a lynchpin almost fell and the crash would have resounded around the world.

The was little or no interest by the other banks in a shot-gun marriage with Continental as analysis proved the loan portfolio was in far worse shape than even the most pessimistic projections had indicated. Within months, Continental went from the seventh largest bank in the country to the thirteenth and became a ward of the government.

The bank was undercapitalized, in default of the reserve requirements, had poor management and yet, had it not been for an erroneous translation in the foreign press, this entire incident would have been avoided. We have just examined another way of going down the drain.


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