Bailing out banks

January 08, 1991

The collapse of the Bank of New England comes as no surprise, but the nature of the government bailout of the Boston-based institution gives cause for concern.

The Federal Deposit Insurance Corp., in an extraordinary Sunday night press conference, announced that it would guarantee not only deposits up to $100,000 but all deposits. This step greatly increases the government's liability and changes the whole character of the deposit insurance program as well.

This unusual arrangement is justified by the FDIC's William Seidman as a necessary step to stop an incipient run on the bank. That's laudable enough, but once such an open-ended commitment is made, where does it stop?

According to the Wall Street Journal's news account of the New England Bank bailout yesterday, there was one scheme afoot for the bank's bondholders -- people who had loaned money to the bank in the past -- to exchange their bonds for stock in return for the government in effect becoming a stockholder in the institution. Such a step would carry the bailout to yet another, higher level of subsidized losses for the wealthy. Little wonder that Seidman is said to be "leery" of the proposal.

This is already being done to a far greater degree than most people realize. When the S&Ls of the Southwest began to falter as the Reagan economic house of cards began to collapse, with no regulators and very few inspectors to blow the whistle, many of these institutions in desperation began investing with reckless abandon in Michael Milken's "junk bonds." This meant that when the banks reached the point of no return and had to be taken over, the government inherited not only liabilities to depositors which had to be paid, but also a vast amount of "junk bonds" which were worthless.

The bankers might as well have taken the money to Las Vegas.

There's been a cynical saying going around for a couple of years that America has come to stand for free-enterprise profits, and government-socialized losses. The handling of the New England Bank bailout is certain to give credence to that belief.

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