oversight

Financial Crisis Management: Four Financial Crises in the 1980s

Published by the Government Accountability Office on 1997-05-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                United States General Accounting Office

GAO             Staff Study




May 1997
                FINANCIAL CRISIS
                MANAGEMENT
                Four Financial Crises
                in the 1980s




GAO/GGD-97-96
Preface


          The increasing interconnectedness of financial institutions and markets
          has highlighted the need to ensure that diverse federal, state, international,
          and private financial organizations work together to effectively contain
          and resolve financial disruptions. The federal government’s ability to
          manage financial crises effectively is important to the stability of the U.S.
          financial system and economy as well as the worldwide financial system.
          In seeking to expand its current knowledge of financial crisis
          management, GAO studied federal actions that successfully contained four
          major financial crises of the turbulent 1980s—the Mexican debt crisis of
          1982; the near failure of the Continental Illinois National Bank in 1984; the
          run on state-chartered, privately insured savings and loan institutions in
          Ohio in 1985; and the stock market crash of 1987.

          On the basis of a review of emergency response literature, GAO focused on
          three phases of financial crisis management. The preparedness phase
          included activities undertaken prior to the occurrence of a crisis. The
          containment phase included activities undertaken in immediate response
          to a financial crisis to mitigate the financial disruption and lessen ill effects
          on the financial system. The resolution phase included activities
          undertaken to reduce the likelihood of the recurrence of the crisis or
          similar financial crises.

          GAO observed that leadership was critical for effective management and
          containment of each of the four financial crises. Treasury and the Federal
          Reserve led crisis containment efforts because of their financial resources,
          access, and expertise, although each agency had its own distinct and
          complementary leadership role. As part of the executive branch, Treasury
          was better positioned than the Federal Reserve to provide the political
          leadership considered desirable in containing a financial crisis. At the
          same time, the Federal Reserve had critical mechanisms and resources for
          providing temporary liquidity in a crisis—currency swaps, discount
          window lending, and open market operations. Treasury also provided
          temporary liquidity during the Mexican crisis through the Exchange
          Stabilization Fund.

          GAO observed that successful crisis response in each case depended
          greatly on swift and sometimes innovative action, which appeared to help
          reduce in scope and intensity the effect the crisis had on the financial
          system. In addition, the more effective the communication of the federal
          response the more it appeared to help prevent a crisis from worsening,
          because it provided clear and credible information that played a part in
          calming financial markets.



          Page 1                                              GAO/GGD-97-96 Financial Crises
Preface




Several officials told GAO that contingency planning, including interagency
planning, helped facilitate federal preparedness and response to a crisis.
They said that contingency planning helped federal financial regulators
identify resources to contain the crisis as well as potentially vulnerable
firms or markets. GAO encountered mixed views on the part of financial
crisis managers concerning whether or not contingency planning should
be documented. Some officials were reluctant to document their planning
efforts due to fears of triggering a panic or because circumstances of a
crisis are never identical to those in the plan.

GAO  observed that coordination of crisis containment efforts among key
participants was important because rarely did one agency have the
necessary authority, jurisdiction, and resources to contain the crisis. The
decentralized structure of financial regulation often presented challenges
to effective coordination in a crisis. In addition to coordinating with each
other, federal regulatory officials said that they often needed to coordinate
with state governments, international organizations, foreign governments,
and Congress. Crisis containment also required coordination with the
private sector to determine whether the private sector could contain the
crisis without federal assistance, and to identify resources available for
crisis containment.

Reliable and timely information was important to federal efforts to provide
early warning of potential crises and to help regulators decide whether
and how to intervene. Federal financial agencies, including the financial
institution and market regulators, each collected crisis-relevant
information in their routine monitoring of financial activity. However,
several officials told GAO that the federal government’s ability to identify
incipient financial crises or to monitor a crisis once it had occurred was
sometimes limited by the dispersed nature of the government’s crisis
surveillance capability, along with limitations and gaps in the available
information.

Financial crises are complex events often involving multiple markets and
institutions. To fully explore all of the actions and viewpoints involved
would require a much lengthier discussion than this study provides.




Page 2                                            GAO/GGD-97-96 Financial Crises
Preface




However, because the information about each of the four crises GAO
reviewed has not been previously published in consolidated form, GAO is
publishing its results as a staff study to permit appropriate archiving and
retrieval of the information for future reference by GAO staff and others
who may have interest.




Jean G. Stromberg
Director, Financial Institutions and
  Markets Issues




Page 3                                            GAO/GGD-97-96 Financial Crises
Contents



Preface                                                                                           1


Chapter 1                                                                                         6
                       Financial System Environment Changed                                       6
Introduction           Linkages of Financial Markets Affected Nature of Crises                    9
                       Public Sector Often Has a Crisis Management Role                          11
                       Objectives, Scope, and Methodology                                        15

Chapter 2                                                                                        19
                       Summary of Chronology                                                     19
The Mexico Debt        Preparedness: Interagency Contingency Planning Helped Contain             20
Crisis of 1982           Crisis
                       Containment: Swift and Collaborative Action Taken to Avoid                26
                         Immediate Default
                       Resolution: Executive and Legislative Initiatives                         32

Chapter 3                                                                                        35
                       Summary of Chronology                                                     35
The Continental        Preparedness: Surveillance and Planning Prepared Regulators               35
Illinois Bank Crisis   Containment: Joint Discussions Led to Containment Strategy                39
                       Resolution: FDIC Strengthened Oversight of Nationally Chartered           44
                         Banks

Chapter 4                                                                                        47
                       Summary of Chronology                                                     47
The Ohio Savings and   Preparedness: Limited Information and Authority Made Planning             50
Loan Crisis              Difficult
                       Containment: Ohio Governor and Federal Reserve Led Crisis                 51
                         Containment Efforts
                       Resolution: Legislation Enacted to Address Government                     59
                         Securities Fraud and Improve Disclosure

Chapter 5                                                                                        60
                       Summary of Chronology                                                     60
The Stock Market       Preparedness: Routine Market Monitoring and Existing Networks             61
Crisis of 1987           Helped Prepare Regulators
                       Containment: Leadership, Swift Action, and Collaborative Efforts          63
                         Helped Contain Crisis
                       Resolution: Crisis Studies Accompanied by Regulatory and                  67
                         Legislative Initiatives




                       Page 4                                         GAO/GGD-97-96 Financial Crises
               Contents




Appendix       Appendix I: Major Contributors to This Report                               70


Bibliography                                                                               71


Table          Table 1.1: U.S. Federal Financial Organizations Involved in                 11
                 Responding to Four Financial Crises in the 1980s

Figures        Figure 2.1: Selected Events in the Mexico Debt Crisis of 1982               22
               Figure 2.2: Selected Events in the Mexico Debt Crisis of 1982               26
               Figure 2.3: Selected Events in the Mexico Debt Crisis of 1982               31
               Figure 3.1: Selected Events in the Continental Bank Crisis                  37
               Figure 3.2: Selected Events in the Continental Bank Crisis                  44
               Figure 4.1: Selected Events in Ohio Savings and Loan Crisis of              48
                 1985




               Abbreviations

               BIS        Bank for International Settlements
               CBOE       Chicago Board Options Exchange
               CFTC       Commodity Futures Trading Commission
               CME        Chicago Mercantile Exchange
               DJIA       Dow Jones Industrial Average
               ESF        Exchange Stabilization Fund
               FDIC       Federal Deposit Insurance Corporation
               FDICIA     Federal Deposit Insurance Corporation Improvement Act
               FHLBB      Federal Home Loan Bank Board
               FHLBC      Federal Home Loan Bank of Cincinnati
               FIRREA     Financial Institutions Reform, Recovery, and Enforcement
                                Act
               FRS        Federal Reserve System
               FSLIC      Federal Savings and Loan Insurance Corporation
               IMF        International Monetary Fund
               NASD       National Association of Securities Dealers
               NYSE       New York Stock Exchange
               OCC        Office of the Comptroller of the Currency
               SEC        Securities and Exchange Commission
               SPR        Strategic Petroleum Reserve
               SRO        self-regulatory organization


               Page 5                                           GAO/GGD-97-96 Financial Crises
Chapter 1

Introduction


                      The federal government has faced many challenges in responding to
                      financial disruptions that threaten the stability of the U.S. financial system.1
                       In the 1930s, the United States experienced one of its most devastating
                      financial crises. Loss of public confidence in banks caused disruptions in
                      the financial system and, along with other factors, ultimately led to the
                      Great Depression. In the 1980s, the federal government was challenged by
                      a series of financial disruptions of considerable magnitude.2 Some
                      disruptions became full-scale financial crises that cost taxpayers, firms,
                      and individuals collectively billions of dollars. Others became crises that
                      had the potential to cause widespread damage but were successfully
                      contained. The possibility of other such financial crises can not be
                      dismissed.

                      This report presents our review of four financial crises of the 1980s: the
                      Mexican debt crisis of 1982, the near failure and rescue of the Continental
                      Illinois National Bank in 1984, the Ohio savings and loan crisis of 1985, and
                      the 1987 stock market crash. These crises, which varied in magnitude,
                      were ultimately successfully contained and resolved through joint efforts
                      of federal agencies and others. By documenting these crises and the
                      efforts to contain them, this report seeks to expand current knowledge of
                      financial crisis management.


                      The financial crises of the 1980s were preceded by the abandonment of the
Financial System      Bretton Woods system of fixed currency exchange rates, oil price shocks,
Environment Changed   higher than normal annual rates of inflation, and record-setting interest
                      rates. For almost two and a half decades after World War II, western
                      countries maintained a system linking the prices of foreign currencies to
                      U.S. dollars and to gold. This arrangement, which the United States carried
                      out with its allies, was known as the Bretton Woods international
                      monetary system. External imbalances, inflation, and other economic
                      problems forced the abandonment of the Bretton Woods system, which
                      ended in August 1971 when the United States ceased to make dollars
                      convertible into gold. In March 1973, a system of generalized floating
                      exchange rates was adopted for the major international currencies. This


                      1
                       Our nation’s financial system is the collection of markets, individuals, institutions, laws, regulations,
                      and techniques through which bonds, stocks, and other financial instruments are traded, financial
                      services produced and delivered, and interest rates determined. The financial system enables funds to
                      be channeled from savers to borrowers, payments to be made for goods and services, and risks to be
                      transferred from those less able or willing to manage them to those who are more able or willing to do
                      so.
                      2
                       Financial history offers many examples of financial crises. See Charles P. Kindleberger, Manias,
                      Panics and Crashes: A History of Financial Crises (New York: Basic Books, 1989).



                      Page 6                                                               GAO/GGD-97-96 Financial Crises
                       Chapter 1
                       Introduction




                       followed an 18-month period during which an attempt was made to
                       maintain a regime of fixed exchange rates.

                       The 1970s and early 1980s were characterized by protracted inflation,
                       record-setting interest rates, and higher than normal rates of market
                       volatility. By early 1979 the annual rate of inflation in the United States
                       reached double digits. The rise of oil prices in 1973 to 1974 and 1979 to
                       1980 helped generate an increase in the overall inflation rate. Commodity
                       and real estate prices also soared in the 1970s. To combat inflation, the
                       Federal Reserve launched a strong anti-inflationary monetary policy in the
                       period 1979 to 1982, eventually raising nominal and real interest rates to
                       unprecedented levels for the postwar period. The anti-inflation policy
                       ultimately succeeded in controlling inflation; however, it produced a
                       massive interest rate shock and was a prime factor in precipitating the
                       collapse of the savings and loan industry.3 In the early 1980s, the United
                       States experienced its severest recession since the 1930s.


Crises Affected Many   Throughout the 1970s, banks attempted to increase income by aggressive
Sectors of Financial   lending. Rising oil prices enriched oil exporting countries. These oil
Services Industry      exporting countries were depositing their foreign exchange holdings with
                       large North American, European, and Japanese banks with international
                       experience. With insufficient demand for loans in the United States and
                       encouragement from U.S. government officials, large U.S. banks began to
                       lend to newly industrializing countries as an outlet for these funds. Banks
                       made substantial investments in these countries and other specific sectors,
                       some of which had prospered from high commodity prices during the
                       inflationary period of the 1970s. The sectors included commercial real
                       estate, energy, and farming.

                       One of the first shocks to banks in the early 1980s came when the
                       Comptroller of the Currency closed Penn Square Bank of Oklahoma in
                       July 1982, a bank with easy lending policies and a large portfolio of loans
                       to oil firms.4 It had deposits of $470 million. Many oil and gas explorers
                       and producers were unable to repay their loans due to failure to find oil
                       and gas and declining oil prices. OCC officials told us that Penn Square’s
                       failure was mainly due to management problems and criminal activity. The
                       failure of Penn Square had rippling effects on the economy. Banks

                       3
                       See National Commission on Financial Institution Reform, Recovery, and Enforcement, Origins and
                       Causes of the S&L Debacle: A Blueprint for Reform (Washington, D.C.: July 1993).
                       4
                        FDIC provided deposit insurance to Penn Square and served as receiver for its assets by settling
                       claims against the bank by creditors—including the claims of insured depositors.



                       Page 7                                                             GAO/GGD-97-96 Financial Crises
Chapter 1
Introduction




experiencing losses included Chase Manhattan, Continental Illinois
National Bank, Michigan National Bank, Northern Trust Company, and
Seattle First National Bank. Continental had purchased loans worth
$1 billion from Penn Square. After Penn Square’s closure, Continental
Illinois experienced a run on its deposits and received assistance from the
Federal Reserve and FDIC.

Another shock to the banking industry was the debt crisis of Mexico, a
major U.S. trading partner, which spread to other newly industrializing
nations. In August 1982, Mexico experienced a financial collapse and was
forced to suspend debt repayments to U.S. and foreign banks. By the end
of the 1970s and early 1980s, when oil that Mexico exported commanded
high prices, Mexico had about $100 million in foreign debt. However, when
the price of oil slid, so did Mexico’s foreign exchange earnings. Higher
dollar interest rates meant larger borrowing costs on Mexico’s sizable
external debt. Following the Mexican debt crisis in August 1982, other
developing countries—including Argentina, Brazil, Chile, Peru, Venezuela,
the Philippines, and Yugoslavia—also had debt servicing problems.

The savings and loan industry was also hard-hit by high interest rates, the
maturity mismatch5 of savings and loan balance sheets, and deregulation.
During the inflationary 1970s, many savings and loans became insolvent as
home loan portfolio earnings were exceeded by high interest costs needed
to keep and attract new deposits. By the latter 1970s and the early 1980s,
the industry’s net worth was virtually wiped out by record-setting interest
rates and the maturity mismatch of savings and loan balance sheets.
Deregulation in 1982 permitted savings and loans to enter new lines of
business and led to increasingly risky asset choices. Many in the industry
speculated aggressively with high-risk loans that eventually defaulted, and
the tide of insolvencies continued. Institutions in the Southwest,
California, and Florida were hardest hit.6

Commercial bank failures also increased in the 1980s. When oil prices fell
sharply in 1986, many major banks in Texas failed, and others were sold or
merged with other banks. Declining real estate prices also contributed to
bank failures. Losses on loans to less-developed countries eroded bank
capital. High-quality corporate borrowers began to raise funds in capital


5
 Matched maturities in bank asset-liability management is the funding of loans with deposits of about
equal duration and is intended to minimize interest rate risk.
6
 See Thrift Failures: Costly Failures Resulted From Regulatory Violations and Unsafe Practices
(GAO/AFMD-89-62, June 16, 1989); and Troubled Financial Institutions: Solutions to the Thrift Industry
Problem (GAO/GGD-89-47 Feb. 21, 1989).



Page 8                                                            GAO/GGD-97-96 Financial Crises
                        Chapter 1
                        Introduction




                        markets through bonds and commercial paper—driving banks to do more
                        real estate lending. Banks lost low-cost sources of funds in savings and
                        checking accounts as investors sought investments paying higher rates of
                        return.7

                        The 1980s crises affected many U.S. financial markets, including equity,
                        options, and futures markets. The most significant event in this sector was
                        the market crash of 1987. Although the stock market declined during the
                        recessionary period of 1981 through 1982, stock prices rose to a then
                        post-World War II high between 1983 and 1987 as institutional and foreign
                        investors poured money into the stock market. Some observers believed
                        that concern about rising interest rates at home and abroad and large
                        budget and trade deficits led to the crash of 1987. Other observers
                        attributed the crash to proposed legislation that would have limited the
                        merger and acquisition activity that had contributed to a large part of the
                        increase in stock values during the 1980s. Nearly all stocks suffered a
                        massive sell-off in the 1987 crash, which led to mechanical and liquidity
                        problems in trading and financial systems at exchanges and clearing
                        organizations.


                        Increasing financial linkages among domestic and global financial
Linkages of Financial   markets—a product of new financial products, foreign investment in
Markets Affected        capital markets, and advances in communications technology—affected
Nature of Crises        the nature of financial crises during the 1980s. These linkages also
                        introduced a new dimension to systemic risk8 in the financial system.

                        During the 1980s, foreign investments in U.S. capital markets increased
                        dramatically as did U.S. investment in foreign markets, especially equities.
                        For example, foreign purchases and sales of U.S. securities grew from
                        about $198 billion in 1980 to almost $4.2 trillion in 1990. During the same
                        period, U.S. purchases and sales of foreign stocks and bonds grew from
                        about $53 billion to about $904 billion. Financial linkages increased for
                        many reasons, including the increased use of exchange-traded and


                        7
                         See Martin Feldstein, The Risk of Economic Crisis, Chicago: University of Chicago Press, 1991.
                        8
                         Systemic risk is the possibility that failure of one or more financial organizations or countries will
                        trigger a chain reaction and cause the collapse of other financial organizations or countries. A chain
                        reaction of failures could take place because of linkages between and among markets and due to
                        participation by the same institutions in several markets. Systemic risk is the risk that a disturbance
                        could severely impair the workings of the financial system and, at the extreme, cause a complete
                        breakdown. A breakdown in capital markets could disrupt the process of savings and investment,
                        undermine the long-term confidence of private investors, and cause turmoil in the normal course of
                        economic transactions.



                        Page 9                                                              GAO/GGD-97-96 Financial Crises
Chapter 1
Introduction




over-the-counter derivative products.9 Derivative products, among other
purposes, provide needed protection against risks associated with
fluctuations in currency exchange rates, interest rates, and other prices
and indexes. Beginning in the 1970s, private corporations—large
commercial banks, securities firms, and institutional investors—began
using derivative financial instruments on a wide scale, which helped foster
linkages among equities, debt, and futures markets.

Advances in telecommunications and information technology had
furthered linkages among financial industries and markets and also
increased certain risks. Advances in communications and computer
technology enhanced market participants’ ability to quickly learn of
foreign market conditions and do business worldwide. Cited as a
contributing factor to the 1987 market crash were complex,
technology-aided trading strategies. Moreover, the volume of trading
during the crash challenged automated systems and created problems for
systems that cleared and settled transactions.10

Many disruptions in the 1980s—beginning with the silver crisis of 198011
—heightened awareness that shocks could spread across markets,
institutions, and borders, thus enlarging the scope of crises. All the major
foreign securities exchanges experienced substantial increases in prices
before the 1987 crash—and during the crash, sharp drops in value. The
disruption to the U.S. financial system could have been great if the 1987
stock market crash had not ended when it did. In 4 trading days in
October 1987, the Dow Jones Industrial Average lost about one-third of its
total value—almost $1 trillion. Had the precipitous decline continued for
another day, massive disruptions to the U.S. financial system and the
financial systems of other countries might have occurred.12



9
 Derivative products are instruments that derive their value from a reference rate, index, or the value
of an underlying asset. See Financial Derivatives: Actions Needed to Protect the Financial System
(GAO/GGD-94-133, May 18, 1994).
10
 See Clearance and Settlement Reform: The Stock, Options, and Futures Markets Are Still at Risk
(GAO/GGD-90-33, Apr. 11, 1990).
11
  In March 1980, declining silver futures prices generated calls for hundreds of millions of dollars more
margin from Hunt family members and related entities as well as calls for additional deposits to
maintain required collateralization for loans. To fulfill these cash needs, the Hunts borrowed heavily
from broker-dealers, banks, and others. A concern existed that the Hunt default might lead to the
failure of one or more large broker-dealers and possibly jeopardize futures clearing houses,
broker-dealers, and banks.
12
 See Financial Markets: Preliminary Observations on the October 1987 Crash (GAO/GGD-88-38,
Jan. 26, 1988).



Page 10                                                             GAO/GGD-97-96 Financial Crises
                                        Chapter 1
                                        Introduction




                                        In the 1980s, as today, federal financial agencies had congressionally
Public Sector Often                     determined roles in financial crisis management. Table 1.1 highlights the
Has a Crisis                            major responsibilities of the federal agencies. The Federal Reserve and the
Management Role                         Department of the Treasury, the nation’s finance ministry, had broad
                                        responsibilities for the health of the financial system. Three agencies—the
                                        Federal Reserve, Office of the Comptroller of the Currency (OCC), and
                                        Federal Deposit Insurance Corporation (FDIC)—were responsible for
                                        ensuring the safety and soundness of federally chartered banks and
                                        state-chartered banks that were federally insured. The same responsibility
                                        for federally insured savings associations was assigned to the Federal
                                        Home Loan Bank Board (FHLBB).13 The National Credit Union
                                        Administration supervises insured credit unions. Since Congress permitted
                                        banks and savings and loans to operate under a state or national charter,
                                        responsibility for supervisory oversight of those institutions often involved
                                        federal and state regulators. With many self-regulatory organizations
                                        (SRO),14 the Securities and Exchange Commission (SEC) and Commodity
                                        Futures Trading Commission (CFTC) were responsible for market integrity
                                        and investor protection in the securities and futures markets, respectively.
                                        State regulators were responsible for oversight of insurance companies.

Table 1.1: U.S. Federal Financial
Organizations Involved in Responding    Federal agency                     Responsibility
to Four Financial Crises in the 1980s   CFTC                               Regulates the commodity futures and options markets
                                                                           and seeks to ensure fairness and integrity in the
                                                                           marketplace. Responsible for ensuring the economic
                                                                           utility of futures markets—price discovery and offsetting
                                                                           price risk—by encouraging their integrity and protecting
                                                                           market participants against manipulation, abusive trading
                                                                           practices, and fraud. Oversight includes exchanges,
                                                                           some off-exchange instruments, and market participants.
                                        FDIC                               Promotes and preserves public confidence in banks and
                                                                           protects the money supply by providing deposit
                                                                           insurance to commercial banks, savings banks, and
                                                                           savings and loan associations. FDIC’s mission is to
                                                                           maintain stability in the national financial system by
                                                                           insuring bank depositors and reducing the economic
                                                                           disruptions caused by bank failures.
                                                                                                                               (continued)




                                        13
                                          By authority of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA),
                                        the Office of Thrift Supervision replaced the Federal Home Loan Bank Board as primary regulator of
                                        state and federally chartered savings institutions. The Federal Home Loan Bank Board was abolished.
                                        14
                                         SROs include such organizations as the Chicago Board Options Exchange (CBOE), the Chicago
                                        Mercantile Exchange (CME), the National Association of Securities Dealers (NASD), the New York
                                        Stock Exchange (NYSE), and the Options Clearing Corporation (Options CC).



                                        Page 11                                                          GAO/GGD-97-96 Financial Crises
Chapter 1
Introduction




Federal agency            Responsibility
FHLBB                     Supervised the Federal Home Loan Bank System and the
                          Federal Savings and Loan Corporation (FSLIC) and
                          regulated federally chartered savings and loan
                          associations and federally chartered savings banks,
                          supervised savings and loan holding companies, and
                          shared with the states the supervision of FSLIC-insured
                          state-chartered savings and loan associations.
Federal                   As U.S. central bank, makes and administers policy for
Reserve                   the nation’s credit and monetary systems. Through
System                    discount window operations and supervisory and
                          regulatory banking functions, helps to maintain the
                          banking industry in sound condition, capable of
                          responding to the nation’s domestic and international
                          financial needs and objectives. Regulates and supervises
                          bank holding companies and state-chartered banks that
                          are Federal Reserve members.
OCC                       Part of the Department of the Treasury that regulates
                          about 2,700 national banks. Approves organizational
                          charters, promulgates rules and regulations, and
                          supervises the operations of national banks through
                          examinations. Examinations assess the financial condition
                          of banks, the soundness of their operations, the quality of
                          their management, and their compliance with laws, rules,
                          and regulations.
SEC                       Administers federal securities laws that seek to provide
                          protection for investors; ensures that securities markets
                          are fair and honest; and, when necessary, provides the
                          means to enforce securities laws through sanctions.
Treasury                  A major policy advisor to the president that formulates
                          and recommends domestic and international economic,
                          financial, tax, and fiscal policies; serves as financial agent
                          for the U.S. government; and manufactures coins and
                          currency.

Source: GAO.



An international financial crisis may also involve foreign countries and
international organizations. Three key international organizations are the
International Monetary Fund (IMF), the International Bank for
Reconstruction and Development (World Bank), and the Bank for
International Settlements (BIS). Both IMF and the World Bank were
established following World War II and funded by subscriptions or quota
shares from the United States and other members. IMF, which was involved
in one of the four crises we discuss, was established to promote
international monetary cooperation and exchange rate stability and
provide short-term lending to members experiencing balance-of-payments
difficulties. Originally, IMF was to make medium-term loans of 3 to 5 years’



Page 12                                               GAO/GGD-97-96 Financial Crises
                            Chapter 1
                            Introduction




                            duration for balance-of-payments support. Its lending was to be based on a
                            country’s fiscal and monetary policies, exchange rates, and other
                            macroeconomic factors. The World Bank, on the other hand, was to
                            provide developing countries long-term loans for development when
                            private financing was unavailable. Over the past several decades, however,
                            both IMF and the World Bank have provided longer term financial
                            assistance to countries involved in economic adjustments. BIS, a central
                            bank for central banks, is both a wholesale money market bank accepting
                            deposits from central banks and a forum promoting cooperation among
                            central banks. Established in 1930, BIS performs a variety of trustee and
                            other banking functions, mainly for central banks and international
                            organizations. With encouragement and guarantees from leading central
                            banks, BIS has helped provide bridge financing15 to a number of central
                            banks in Latin America and Eastern Europe pending disbursement of IMF
                            and World Bank credits.


Policy Tools Available to   In a series of laws passed during this century, Congress gave federal
Contain Crises              financial organizations responsible for the health of the financial system a
                            variety of policy tools to provide liquidity to help prevent or contain a
                            financial crisis.16 These include open market operations, access to the
                            Federal Reserve’s discount window, the Exchange Stabilization Fund, and
                            deposit insurance.

                            Before the Federal Reserve was established in 1913, periodic financial
                            panics led to many bank failures, associated business bankruptcies, and
                            general economic contractions. In establishing the Federal Reserve,
                            Congress gave it three important tools to carry out responsibilities as
                            lender of last resort and regulator of the supply of money: open market
                            operations, foreign currency operations, and discount window lending.
                            Open market operations enable the central bank to buy and sell
                            government securities, influencing the quantity and growth of legal
                            reserves and thereby enhancing or diminishing liquidity to the overall
                            banking system. The Federal Reserve can undertake foreign currency
                            transactions to counter disorderly conditions in exchange markets.
                            Discount window lending is a line of credit facility provided by the Federal
                            Reserve primarily to depository institutions and occasionally to other
                            institutions whose financial distress might harm the economy. The line of


                            15
                             In the context of international finance, bridge financing is short-term credit extended to countries in
                            anticipation of longer term financing.
                            16
                              See the Federal Reserve Act of 1913, the Banking Act of 1933, and the Gold Reserve Act of 1934.



                            Page 13                                                             GAO/GGD-97-96 Financial Crises
                            Chapter 1
                            Introduction




                            credit must be secured by adequate collateral, which is determined by the
                            Federal Reserve.

                            Another policy tool available for containing financial crises is the Treasury
                            Department’s Exchange Stabilization Fund (ESF).17 This fund provides the
                            Treasury Secretary a means to (1) conduct international monetary
                            transactions for the purpose of stabilizing the exchange value of the dollar,
                            (2) counter disorderly market conditions, or (3) extend short-term credit
                            to foreign governments when such credits are backed by assured sources
                            of repayment. Congress has provided the Treasury Department wide
                            latitude in its operation of ESF. The Secretary’s decisions regarding the use
                            of ESF resources are subject to approval by the President but remain final
                            and unreviewable by any other government official.

                            In the Banking Act of 1933, Congress created the federal deposit insurance
                            fund to better protect depositor savings and reduce the number of runs on
                            bank deposits. At the time of the Continental bank and Ohio savings and
                            loan crises, federal deposit insurance was administered by two separate
                            entities, the Federal Deposit Insurance Corporation (FDIC) and the Federal
                            Savings and Loan Insurance Corporation (FSLIC). FDIC and FSLIC provided
                            deposit insurance for the nation’s banks and savings and loans,
                            respectively. The insurance funds of these entities were funded primarily
                            through assessments on members. Both funds enjoyed the full faith and
                            credit of the U.S. government. In exchange, federally insured depository
                            institutions would be subject to strict regulatory supervision and
                            examination and limited in the types of activities they could pursue.18


U.S. Government: Ultimate   Financial crises of the 1980s strained the basic regulatory framework for
Lender of Last Resort       protecting the nation’s financial system. Despite their deposit insurance
                            mechanisms, the savings and loan industry turned to the federal
                            government in the 1980s for assistance. The nation’s experience with
                            financial crises has increased public awareness that the federal
                            government, and therefore the American taxpayer, is the ultimate lender of
                            last resort. This means providing liquid funds to those financial institutions
                            in need, especially when alternative sources of funding have dried up. That
                            is, the federal government is the entity the international financial
                            community and financial markets regard as a major source of funds to


                            17
                              See 31 U.S.C. §5302.
                            18
                             FSLIC was dissolved in 1989 by FIRREA. A new fund, the Savings Association Insurance Fund, was
                            created and FDIC was designated as its administrator.



                            Page 14                                                        GAO/GGD-97-96 Financial Crises
                     Chapter 1
                     Introduction




                     provide liquidity in a crisis. Ultimately, the U.S. government bore the costs
                     of several crises.

                     The experience of banks and savings and loans in the 1980s provided
                     ample evidence of the seriousness of the risks involved in concentrations
                     of certain types of financial exposure—particularly when insufficient
                     capital is held to protect against risk exposures. The failure of
                     policymakers and regulators to effectively contain the savings and loan
                     crisis proved costly to American taxpayers. Through FIRREA, Congress
                     created a new agency—the Resolution Trust Corporation—to resolve
                     failed savings and loans, liquidate their assets, and pay off insured
                     depositors. The collapse of the savings and loan industry resulted in
                     taxpayers incurring a large expense estimated, as of 1996, to be about
                     $132 billion.19


                     The objective of this study is to describe how federal financial agencies
Objectives, Scope,   with responsibilities for financial institutions and markets recognized,
and Methodology      contained, and eventually resolved four financial crises that occurred in
                     the 1980s.


Scope                During the survey phase of our work, we sought to identify all financial
                     disruptions in the 1970s and 1980s that had the potential, if not quickly
                     contained, to cause wide-ranging damage to the financial system. We
                     decided that information on some events that occurred during the
                     1970s—such as the Penn Central20 commercial paper crisis and the failure




                     19
                      See Financial Audit: Resolution Trust Corporation’s 1995 and 1994 Financial Statements
                     (GAO/GGD-96-123, July 2, 1996).
                     20
                       In June 1970, Penn Central—the largest railroad in the United States and the sixth largest business
                     enterprise in the country—declared bankruptcy and threatened the commercial paper market. Penn
                     Central had about $200 million in outstanding commercial paper and after reporting losses, it was no
                     longer able to sell commercial paper nor roll over maturing issues. Corporations that relied heavily on
                     commercial paper had to seek alternative sources of funding. Actions by the Federal
                     Reserve—encouragement of money center banks to lend to customers who were unable to roll over
                     commercial paper and discount window lending—provided liquidity, enabling the commercial paper
                     market to continue functioning. This prevented the crisis from developing into a full-scale panic.



                     Page 15                                                            GAO/GGD-97-96 Financial Crises
    Chapter 1
    Introduction




    of Franklin National Bank21 and Bank I.D. Herstatt22—as well as official
    recollections of those events, were too dated to enable us to reconstruct
    an accurate chronology and understanding of the crises. These financial
    crises also were too dated for us to determine the interactions among the
    various agencies and officials involved in containing and resolving them.

    We then considered the following financial disruptions that occurred in
    the 1980s:

•   silver crisis of March 1980,
•   Drysdale Government Securities failure of May 1982,
•   Mexico debt crisis of August 1982,
•   Continental Illinois Bank crisis of May 1984,
•   Ohio savings and loan crisis of March 1985,
•   market crash of October 1987, and
•   Drexel Burnham Lambert failure of February 1990.23

    We selected the Mexico debt crisis, the Continental Illinois Bank crisis, the
    Ohio savings and loan crisis, and the 1987 market crash for further review
    and in-depth analysis on the basis of the following criteria:

•   Decisions and actions had to be quickly made and implemented.
•   Diverse federal and nonfederal financial organizations were involved.
•   The disruption was significant, occurred quickly, and involved an abrupt
    and widespread reversal of expectations of market participants about the
    stability of particular institutions or markets that, if left unchecked, could
    have caused significant damage not only to affected markets or
    institutions but to other parts of the financial system and the economy.

    21
      In October 1974, the Franklin National Bank of New York—the 20th largest bank in the United
    States—was declared insolvent by OCC. At the time, it was the largest bank failure in U.S. history.
    Nine months before the collapse Franklin had $3.7 billion in deposits. Franklin had borrowed heavily
    in the Eurodollar interbank market and had speculated unsuccessfully in foreign exchange and
    municipal securities markets. When Franklin was closed, it had borrowed $1,723 million from the
    Federal Reserve discount window. This lending by the Federal Reserve avoided instability in domestic
    and foreign financial markets. Losses from Franklin’s failure totaled $59 million.
    22
      In June 1974, German banking authorities (Das Bundesaufsichtsamt fur das Kreditwesen) closed
    Bankhaus I.D. Herstatt in Cologne and ordered its liquidation. Herstatt was a large bank with
    international operations and a reliance on profits from foreign exchange and gold speculation. It had
    assets of more than 2 billion German marks. Hundreds of large and small companies and public
    authorities feared for their deposits. Several U.S. banks received no foreign exchange settlement
    payments. The total loss was $467 million.
    23
      Drexel’s holding company declared bankruptcy in February 1990. In 1989, it had settled felony insider
    trading charges, suffered decreased revenues as issuers in the high-yield bond market (upon which
    Drexel relied for a substantial portion of its revenues) began to default on payment obligations, and
    had severe short-term funding problems when its commercial paper rating was lowered. See pp. 44-46
    of Securities Firms: Assessing the Need to Regulate Additional Financial Activities (GAO/GGD-92-70,
    Apr. 21, 1992).


    Page 16                                                            GAO/GGD-97-96 Financial Crises
                  Chapter 1
                  Introduction




              •   Federal agencies could rely on their existing statutory and regulatory
                  authorities and resources to deal with the problem. Congressional action
                  was not needed before federal agencies could respond to the crisis.
              •   Senior officials were available to be interviewed.

                  Taken as a whole, the crises we selected for our review sample reflected
                  diversity in (1) the nature of the problem, (2) the financial institutions or
                  markets affected, and (3) the types of players involved. We believe that the
                  four cases selected cover a wide-ranging set of experiences involving
                  different markets and participating decisionmakers from many sectors of
                  government. Throughout, our primary interest was how federal
                  organizations exercised their existing authority to cope with sudden
                  financial distress.


Methodology       In conducting our study, we first undertook an extensive literature search
                  of congressional testimony, books, journals, and newspaper articles
                  pertaining to financial crises. This review enabled us to chronologically
                  describe the four events and identify the participants involved in
                  containing and resolving them and the actions the participants took.

                  We also reviewed the social science research literature in this area, which
                  deals with responses to natural and technological disasters, for
                  information relevant to our work on financial disruptions. Emergency
                  situations have been the subject of social science research for decades.24
                  Although a comprehensive review of all such research was not feasible,
                  we reviewed the studies that disaster analysts suggested were the most
                  significant and relevant to financial crises. Our review of disaster literature
                  led us to conceptualize financial crisis management in terms of three
                  primary phases, which we have defined as follows:

              •   Preparedness is the pre-crisis or pre-impact phase and includes the earliest
                  sign of possible danger and any activities undertaken to prepare for
                  managing a potential financial crisis before the crisis occurs.
              •   Containment is the period when the crisis actually occurs and includes
                  immediate activities undertaken in response to a financial crisis to
                  mitigate the financial disruption and to prevent or lessen ill effects that
                  could result due to financial linkages.

                  24
                   See Emergency Management: Principles and Practices for Local Government, Thomas Drabek and
                  Gerald Hoetmer (Editors), International City Management Association (Washington, D.C., 1990);
                  Emergency Management: Strategies for Maintaining Organizational Integrity, Thomas Drabek,
                  Springer-Verlag (New York, 1990); Normal Accidents: Living With High Risk Technologies, Charles
                  Perrow (New York, 1984).



                  Page 17                                                        GAO/GGD-97-96 Financial Crises
    Chapter 1
    Introduction




•   Resolution is the period of attempting to mitigate any long-term effects
    and includes activities undertaken to restore institutions and markets to
    normalcy and to reduce the likelihood that the crisis or similar crises will
    recur.

    We interviewed more than 70 federal, private sector, and state and local
    officials involved in the four financial crises to determine the nature of
    their involvement, interactions they had with other participating officials,
    and the rationale for their actions. Generally, we asked the officials to
    draw on their experience in these events and discuss the important
    lessons from that experience—observations they would share with others
    who might go through a similar experience in the future. In addition to the
    interviews, we reviewed books, journal articles, congressional testimony,
    speeches, and newspaper articles. We also reviewed agency records,
    including letters, transcripts of meetings, memoranda, notes, special
    studies, and other documents relating to each organization’s involvement
    in the four crises. Such records were not available for all crises.

    We received technical comments on this report from the Commodities
    Futures Trading Commission, Federal Deposit Insurance Corporation,
    Federal Reserve, Office of the Comptroller of the Currency, Securities and
    Exchange Commission, and other officials involved in these crises. We
    incorporated the comments where appropriate.




    Page 18                                           GAO/GGD-97-96 Financial Crises
Chapter 2

The Mexico Debt Crisis of 1982


               During the early 1980s, Mexico, a major U.S. trading partner, experienced
               a financial collapse precipitated in part by sharp declines in oil prices,
               which reduced Mexico’s foreign exchange holdings from the sale of its oil.
               The crisis began formally on August 12, 1982, when Mexico’s Secretary of
               Finance informed the Federal Reserve Chairman, the Secretary of the
               Treasury, and the IMF Managing Director that Mexico would be unable to
               meet its August 16 obligation to service $80 billion in mainly
               dollar-denominated debt obligations to U.S. and foreign banks. The
               Mexico debt crisis illustrated that growing ties between domestic and
               global capital markets could trigger a domestic financial crisis.


               By the time that Mexico was unable to meet debt obligations to U.S. and
Summary of     foreign banks, the Federal Reserve and Treasury had jointly developed a
Chronology     strategy for U.S. assistance to prevent a financial crisis. The strategy was
               to condition the granting to Mexico of substantial extended credit on a
               commitment to an IMF economic reform or stabilization program; at the
               same time, the United States would provide short-term emergency credit
               and currency swaps1 as necessary. When the crisis came in August 1982,
               the United States took the lead in a multinational response and played a
               key role in implementing the strategy. Mexican governmental entities,
               European and Japanese central banks and finance ministries, IMF, and
               commercial banks in the United States and abroad were also involved in
               crisis containment efforts. The Federal Reserve played a key role in
               organizing the responses of (1) U.S. and foreign commercial banks, which
               were asked to accept a moratorium on principal payments, provide $5
               billion in new loans, and restructure existing debt; and (2) central banks in
               Europe and Japan, which were asked to provide $925 million in liquidity
               support. The Federal Reserve lent Mexico a total of $1.05 billion. The
               Department of the Treasury took the lead in putting together the more
               immediate executive branch responses, which involved a $1 billion ESF
               swap, a Department of Energy and Department of Defense Strategic
               Petroleum Reserve prepayment of $1 billion for oil that the U.S. purchased
               from Mexico, and a Department of Agriculture $1 billion Commodity
               Credit Corporation loan guarantee to Mexico to facilitate the import of
               grains and fundamental foods. Treasury also provided a $600 million
               longer term swap in conjunction with the Federal Reserve and BIS. IMF led
               economic reform negotiations with Mexico and led an effort to obtain
               $5 billion in new commercial bank loans for Mexico, and provided close to
               $4 billion in medium-term credits.

               1
                Foreign exchange swaps are bilateral agreements to exchange two currencies at one date and to
               reverse the transaction at some future date. When a foreign central bank initiates the swap drawing, it
               uses the dollars to finance sales of dollars to support its own currency.



               Page 19                                                            GAO/GGD-97-96 Financial Crises
                        Chapter 2
                        The Mexico Debt Crisis of 1982




                        The Mexican debt crisis began on Thursday, August 12, 1982, when
Preparedness:           Mexico’s Secretary of Finance informed the Federal Reserve Chairman,
Interagency             the Secretary of the Treasury, and the IMF Managing Director that Mexico
Contingency Planning    would be unable to meet its August 16 obligation to service about
                        $80 billion in mainly dollar-denominated debt obligations to U.S. and
Helped Contain Crisis   foreign banks.2 Mexico owed $25 billion of this debt to U.S. banks.3 The
                        situation had the potential for upsetting the financial stability of the
                        industrialized world. Because the private sector was initially unwilling to
                        lend additional money to Mexico, the United States, IMF, and central banks
                        of developed countries had to step in and fill the vacuum.

                        According to various U.S. government officials, the Mexico debt crisis,
                        which developed visibly over several months, was not a surprise. The
                        question, starting in March 1982, was not whether Mexico was
                        approaching crisis but what to do about it. For months before the start of
                        the crisis, Federal Reserve and Treasury officials had been watching
                        changes in Mexico’s foreign exchange reserves, borrowing patterns,
                        balance of trade, and domestic economic and political situations. Crisis
                        management leadership was an issue, but it was resolved before the crisis
                        began. Generally, leadership in preparedness was shared by the Federal
                        Reserve and Treasury, with Treasury focusing on political aspects and the
                        Federal Reserve on the economic aspects of containment and resolution
                        of the crisis. Three meetings between financial officials of the Mexican
                        Ministry of Finance, the Bank of Mexico, the Federal Reserve, and
                        Treasury concerning the deteriorating situation had already occurred
                        before the August 12 start of the crisis. U.S. officials said they had a
                        general understanding of a range of potential problems that Mexico’s
                        inability to repay its debts would precipitate. Federal Reserve and
                        Treasury officials said they had discussed and generally decided on their
                        respective agencies’ responses to Mexico’s expected requests for
                        assistance, but a single written interagency contingency plan was not
                        developed. U.S. officials said that, generally, the Federal Reserve,
                        Treasury, and other organizations were sharing available information and
                        communications were well coordinated.




                        2
                         There were about 25 different kinds of Mexican debt. Debtors included the national oil company, the
                        development bank, the telephone company, and other government corporations. A quarter of the debt
                        was accumulated by the Mexican state oil company.
                        3
                         At the time Mexico was the largest international borrower from U.S. commercial banks.



                        Page 20                                                          GAO/GGD-97-96 Financial Crises
                           Chapter 2
                           The Mexico Debt Crisis of 1982




Agencies Shared            Fearful of a foreign currency crisis, Federal Reserve, Treasury, and the
Information, Planned       Department of State (State) officials said they were monitoring Mexico’s
Response, and Resolved     borrowing, balance of trade, foreign exchange trends, and domestic
                           economic and political situations for months before the start of the crisis.
Leadership Issues Before   Senior officials at the Federal Reserve and Treasury said they met to
the Crisis Began           discuss Mexico’s likely request for assistance and develop a U.S. strategy.
                           These were more “when/how” than “what if” discussions—that is, when
                           Mexico asks for help, how shall we respond? The Federal Reserve and
                           Treasury officials identified the first opportunities to meet with Mexico’s
                           newly appointed top financial officials at various multinational finance
                           meetings as well as during visits by these officials to Washington, D.C.

                           Federal Reserve officials had information about the exposure to Mexican
                           debt of most U.S. banks. They had determined, on the basis of country
                           lending data that the bank supervisory agencies—in particular,
                           OCC—maintained routinely,4 that Mexican debt accounted for 44 percent of
                           the capital of the 9 largest U.S. banks and 35 percent of the capital of the
                           15 biggest U.S. regional banks.5 Officials also knew that if payments
                           ceased, bank capital positions would rapidly deteriorate and threaten the
                           banking system. They also understood that Mexico’s debt servicing
                           problems were likely to spread to other developing countries.

                           Preparedness planning took place before the crisis began. On January 7,
                           1982—7 months before the crisis broke—State officials asked for an
                           interagency meeting on the Mexico debt situation. Reports from the
                           Treasury attache in the U.S. Embassy in Mexico City expressed concern
                           about Mexico’s ability to finance its debt and access to U.S. financial
                           markets. Federal Reserve and Treasury officials said they viewed State’s
                           requests as inappropriate because they saw the potential crisis as one best
                           addressed as an economic rather than as a political problem. They said
                           they were concerned that State might insist that terms of U.S. assistance
                           be softened for foreign policy or diplomatic reasons. That is, Treasury
                           officials were concerned that State would urge assistance even if the
                           country was not taking economic adjustment and reform measures. The
                           Federal Reserve and Treasury initially resisted State’s call for a meeting.
                           When the meeting did occur on March 23, more than 2 months after the
                           State Department’s request, Treasury officials said they asserted


                           4
                            This information is maintained by the Interagency Country Exposure Review Committee. OCC
                           develops and analyzes information on and assesses risk in international lending, including the
                           evaluation of transfer risk associated with exposures to countries experiencing difficulties servicing
                           their external debt.
                           5
                            Banks are ranked according to size based on the amount of their assets.



                           Page 21                                                             GAO/GGD-97-96 Financial Crises
                                                               Chapter 2
                                                               The Mexico Debt Crisis of 1982




                                                               themselves as leaders of the meeting. Once State Department officials
                                                               understood that the Federal Reserve and Treasury officials were alert to
                                                               Mexico’s debt problem, they stepped back.

                                                               The initiative of top Mexican financial leaders played an important role in
                                                               U.S. preparedness efforts. Soon after their appointments, Mexico’s
                                                               Secretary of Finance and Director General of the Bank of Mexico
                                                               requested separate meetings with the Federal Reserve, the Department of
                                                               the Treasury, and IMF—the three key organizations whose support Mexico
                                                               would need if a financial crisis developed. (See fig. 2.1.)



Figure 2.1: Selected Events in the Mexico Debt Crisis of 1982 (May, June, July)

                          May                                                            June                                                       July

Date:                                                          Date:                                                     Date:

3       First visit of top Mexican finance officials and key    1      Bank of America has diffculty syndicating $2.5    23 Third visit of Mexican finance officials to the
        staff to the Federal Reserve, Treasury, and IMF.               billion loan for Mexican governmental entities.           Federal Reserve, Treasury, and IMF.

30 Bank of Mexico approaches the Federal                        11 Second visit of Mexican financial officials to        31 Bank of Mexico swaps pesos for $700 million
        Reserve about an overnight currency swap of                    the Federal Reserve, Treasury, and IMF.                   overnight with the Federal Reserve under
        pesos for dollars under existing reciprocal                                                                              existing reciprocal currency arrangements.
        currency arrangements. The Federal Reserve              29 The Federal Reserve agrees to an overnight
        agrees to the swap.                                            currency swap of $700 million under existing
                                                                       reciprocal currency arrangement.

                                                                30 Federal Reserve Open Market Committee agrees
                                                                       to allow Bank of Mexico to draw down its full
                                                                       $700 million currency swap on an extended
                                                                       basis if certain conditions are met. Bank of
                                                                       Mexico draws $200 million overnight. Open
                                                                       Market Committee lets stand its conditional
                                                                       approval for the extended swap. The Open
                                                                       Market Committee wants the swap contingent
                                                                       on Mexico agreeing to an IMF program.



                                                               Source: GAO analysis.




Agencies Shared                                                Mexican officials met with U.S. officials on three separate occasions
Information and Views                                          before the crisis emerged in August. Treasury and State officials said they
Before Crisis Broke                                            prepared for these meetings by developing and agreeing on the positions
                                                               they would take. Treasury staff briefed the Treasury Secretary on Mexico’s
                                                               situation, requests Mexico might make, and proposed U.S. responses. The
                                                               Treasury Secretary met with the Federal Reserve Chairman to discuss
                                                               requests and responses before meetings with the Mexican officials. As of
                                                               early August, Mexico had liquid reserves of less than $200 million, and the



                                                               Page 22                                                                   GAO/GGD-97-96 Financial Crises
                           Chapter 2
                           The Mexico Debt Crisis of 1982




                           country was losing dollars at the rate of $100 million a day.6 Mexican
                           capital was being moved out of the country for a safe haven in the United
                           States and elsewhere. Mexico appeared unable to generate export
                           surpluses and maintain confidence in its economy, which were essential
                           for Mexico to find the hard currency needed to service its loans.

                           Treasury and the Federal Reserve had $1 billion in currency swap
                           arrangements with Mexico: $300 million from Treasury’s Exchange
                           Stabilization Fund and $700 million from the Federal Reserve’s swap line.7
                           Overnight drawings on the Federal Reserve’s swap arrangement were used
                           to bolster month-end figures for dollar reserves.8 Treasury and Federal
                           Reserve officials both told their Mexican counterparts that before any
                           substantial credit was granted to Mexico on other than an overnight or
                           short-term basis, Mexico should have a convincing economic stabilization
                           program to restore confidence in the peso and the Mexican economy. That
                           is, Mexico should have an IMF-approved economic adjustment or reform
                           program.9 IMF requires that borrowing countries commit to reforms that
                           improve the country’s economy and balance of payments. Federal Reserve
                           and Treasury officials said they knew, however, that Mexico’s current
                           president—who would soon be replaced by a successor—was unwilling to
                           adopt the policy measures that would be required for an IMF program.
                           According to these officials, the president was in the last year of a 6-year
                           term and did not want to admit to having made any economic policy
                           errors.


Before Crisis, Officials   Federal Reserve and Treasury officials said they agreed on a two-part
Coordinated to Agree on    strategy for dealing with Mexico: (1) refuse to grant Mexico any
Strategy                   substantial credit unless Mexico committed to seeking an IMF adjustment
                           program; but (2) continue to support Mexico with advice and overnight
                           currency swaps until the December 1, 1982, installation of Mexico’s next

                           6
                            See Joseph Kraft. The Mexican Rescue. New York: Group of Thirty, 1984.
                           7
                            A major feature of foreign currency operations of the Federal Reserve is the swap network, which
                           consists of reciprocal short-term credit arrangements with 13 foreign monetary authorities and with
                           the Bank for International Settlements. These arrangements enable the Federal Reserve to borrow the
                           foreign currencies it needs for intervention operations to support the dollar. They also enable the
                           partner foreign central banks to borrow the dollars needed to support their currencies. See The
                           Federal Reserve System: Purposes and Functions, Board of Governors of the Federal Reserve,
                           Washington, D.C.: 1984.
                           8
                           See Paul A. Volcker and Toyoo Gyohten. Changing Fortunes: The World’s Money And The Threat To
                           American Leadership. New York: Times Books, 1992.
                           9
                           IMF seeks to maintain stability in the world economic and financial system. See Paul R. Masson and
                           Michael Mussa, The Role of IMF: Financing and Its Interactions with Adjustment and Surveillance,
                           Washington, D.C.: 1995.



                           Page 23                                                          GAO/GGD-97-96 Financial Crises
                        Chapter 2
                        The Mexico Debt Crisis of 1982




                        president, who was expected to seek IMF help. Any longer term credits
                        would have to be repaid from IMF medium-term loans. According to
                        Federal Reserve officials, at the end of May, Mexican officials asked the
                        Federal Reserve to swap pesos for dollars overnight so Mexico could meet
                        its requirements for a certain level of foreign reserves as backing for its
                        currency. The Federal Reserve agreed to the overnight currency swap.


Agencies Jointly        Over the next several months, U.S. officials said this strategy was
Developed Contingency   challenged as Mexico’s need for assistance escalated. Mexican officials
Plans                   asked the United States for an extended swap as a bridge loan to a $2 to
                        $3 billion jumbo loan they planned to arrange. The bridge loan was later
                        obtained not through an extended swap, but through a loan from U.S.
                        commercial banks. U.S. officials said they explored contingency plans to
                        address the possibility that Mexico’s President would not seek IMF help,
                        but no such plans were put into writing. The outgoing President of Mexico
                        had entered office in 1976 while a tough and unpopular IMF program was in
                        progress. Treasury, Federal Reserve, and State officials said they
                        discussed a variety of strategies and worked through their sometimes
                        differing assessments of those plans. Among other ideas, they said they
                        discussed alternatives to IMF credits to assure repayment of swaps if a
                        crisis developed, including supplying dollars as prepayment for oil. The
                        Federal Reserve could not approve an extended swap without an assured
                        means of repayment. To have this means of repayment, Federal Reserve
                        staff drafted a letter from the Secretary of the Treasury to the Chairman of
                        the Federal Reserve in which Treasury agreed to provide backing for the
                        swaps by assuring repayment of any drawings by Mexico.

                        At the end of April, Mexico requested a $600 million overnight currency
                        swap with the Federal Reserve to satisfy international reserve reporting
                        requirements. At the end of June, the Bank of Mexico requested a swap on
                        an extended basis, which the Federal Reserve’s Federal Open Market
                        Committee approved. The Federal Reserve officials said they wanted such
                        a swap contingent on Mexico agreeing to an IMF stabilization program to
                        repay the swaps. When the request from the Bank of Mexico was changed
                        at the last minute to an overnight swap for $200 million, the Federal
                        Reserve Chairman asked the Federal Open Market Committee to let its
                        approval stand, enabling him to make the swap available if needed to avert
                        a liquidity crisis and provided conditions were satisfied. According to
                        Federal Reserve officials, the Federal Reserve deposited $200 million in
                        dollars in Mexico’s account at the Federal Reserve Bank of New York, and
                        the Bank of Mexico gave the Federal Reserve an equivalent quantity of



                        Page 24                                          GAO/GGD-97-96 Financial Crises
Chapter 2
The Mexico Debt Crisis of 1982




pesos at the going exchange rate, with a promise to reexchange them
when the swap expired. U.S. officials agreed that swaps were temporary
remedies and not the solution to the much larger debt repayment problem.

On July 23, Mexican finance officials again visited Treasury, the Federal
Reserve, and IMF in Washington, D.C. Participants in the meetings said that
Mexico’s situation was discussed at length, particularly whether or not
Mexico had the foreign currency reserves needed to get through August.10
U.S. officials said they again stressed that dollars would not be provided
on an extended basis to Mexico without that country’s commitment to an
IMF stabilization or reform program. Mexico’s President reportedly would
not seek IMF help even though borrowing was increasingly difficult. U.S.
officials said they believed that the President of Mexico would not be
interested in an IMF program until Mexico had run out of foreign reserves.

The situation then sharply deteriorated. Mexico officially asked for the full
$700 million Federal Reserve swap at the end of July. Planning efforts
ensured that everything was in place. According to Federal Reserve
officials, the Federal Open Market Committee had given its approval the
prior month, and officials were able to use the instrument that had been
drafted to limit the length of time that Federal Reserve swap funds were in
use. The swap drawing was provided August 4 and was supposed to last
while Mexico began discussions with IMF. The funds were quickly
depleted, setting the stage for the full-blown Mexican debt crisis. (See fig.
2.2.)




10
 Foreign currency reserves are the stock of official assets denominated in foreign currencies that can
be used to meet external payment obligations. In most cases, reserves are managed by the central
bank and are part of its balance sheet.



Page 25                                                           GAO/GGD-97-96 Financial Crises
                                                         Chapter 2
                                                         The Mexico Debt Crisis of 1982




Figure 2.2: Selected Events in the Mexico Debt Crisis of 1982 (August)

                                                                           August
Date:                                                     Date:                                              Date:

4   Bank of Mexico swaps pesos for $700 million in        15 Mexico's Secretary of Finance contacts heads    20 Mexican officials meet with representatives of
    an extended swap. Mexican officials agree to             of major creditor banks, alerts them to             creditor banks at the Federal Reserve Bank
    seek an IMF adjustment program if necessary              Mexico's problems, and invites them to a            of New York. Representatives of over 100
    for repayment. The funds are quickly depleted.           meeting of Mexico's bankers during the              banks attend. Mexico's Secretary of Finance
                                                             next week.                                          discusses Mexico's condition and liquidity
 5 Mexico announces a two tier exchange rate for                                                                 problem, U.S. and other central bank support,
    the peso. The higher exchange rate is for Mexican     16 Treasury's Exchange Stabilization Fund              and plans for an IMF program. Mexico's Secretary
    government payments and key imports.                      lends $1 billion to the Bank of Mexico             of Finance then asks for a 90-day moratorium
                                                              for about a week.                                  on principal payments.
12 Mexico's Secretary of Finance telephones the
    Federal Reserve Chairman, the Secretary               17 Mexico's Secretary of Finance announces         21 Representatives of 14 banks form a
    of the Treasury, and the IMF Managing                     assistance package.                                bank advisory group to start work on
    Director to inform them Mexico can not                                                                       moratorium and other issues. The advisory
    meet its August 16 debt obligations to                18 Representatives of central banks meet in            group works to identify all creditor banks. The
    banks and that he and the Director General of             Basle, Switzerland, under the sponsorship          advisory group asks all identified banks
    the Bank of Mexico will come to Washington,               of the Bank for International Settlements,         for a 90 day payment moratorium starting
    D.C., to discuss the situation.                           and agree in principle to a loan of $750           August 23.
                                                              million as a bridge to an IMF program if
    Mexico announces foreign exchange markets                 their central bank governors agree.            24 Mexico repays $1 billion to Exchange
    will not open on August 13.                               Spain adds $175 million. The United                Stabilization Fund and receives $1 billion as
                                                              States agrees to match the total provided          advance payment for oil purchased
13 Mexican finance officials meet with officials of           and provides $925 million.                         for the strategic petroleum reserve.
    the Federal Reserve, Treasury, and IMF.
                                                          19 Mexico's foreign exchange markets reopen.       26 The Bank for International Settlements
14 Officials from Mexico's Ministry of FInance,                                                                  announces $1.85 billion loan, $925 million
   Bank of Mexico, the Federal Reserve, Treasury,             Mexico's Secretary of Finance meets with           of which comes from the United States.
15 Office of Management and Budget, Energy, and               officials of U.S. banks.                           Funds are to be made available in three
    State work out provisions of a $1 billion currency                                                           stages depending on progress toward
    swap, the purchase of Mexican oil, and                    The President of the Federal Reserve Bank of       agreement on an IMF economic adjustment
    agricultural credits. Federal Reserve Chairman            New York hosts a dinner at the Federal             program.
    contacts heads of European, Canadian, and                 Reserve Bank of New York at which he,
    Japanese central banks and gets indication of             Mexico's Secretary of Finance, the Director
    support in principle for lending to Mexico.               General of Bank of Mexico, the Chairman
    Meeting to take place the coming week in Basle,           of the Federal Reserve Board, and the
    Switzerland, under the auspices of the Bank for           Deputy Secretary of the Treasury, together
    International Settlements.                                with key staff, discuss strategy for the
                                                              August 20 bankers meeting.




                                                         Source: GAO analysis.



                                                         The crisis formally began on Thursday, August 12, 1982, when Mexico’s
Containment: Swift                                       Finance Secretary informed the Treasury Secretary and the Federal
and Collaborative                                        Reserve Chairman that Mexico had almost run out of foreign exchange
Action Taken to Avoid                                    reserves and would not be able to meet its obligations to foreign banks on
                                                         August 16. Money that was supposed to last a month or two drained out of
Immediate Default                                        Mexico’s foreign exchange reserves in a flight of money abroad. Federal
                                                         Reserve and Treasury officials said they knew immediately that the crisis



                                                         Page 26                                                         GAO/GGD-97-96 Financial Crises
                          Chapter 2
                          The Mexico Debt Crisis of 1982




                          had come. They said that outright default would have ruined Mexico’s
                          credit rating and shut off the further lending that was essential to the
                          operation of its economy. Creditor banks would suffer losses, and the
                          solvency of some banks could be threatened. U.S. and foreign officials said
                          that they were concerned because the world’s largest commercial banks
                          had heavy exposure to Mexico as well as other developing countries. The
                          potential for worldwide financial system instability could not be
                          discounted.

                          The next day, Mexican financial officials flew to the United States to meet
                          with Treasury, Federal Reserve, and IMF officials to discuss a plan of
                          action. U.S. officials said they encouraged accelerated negotiations with
                          IMF for a reform program. According to U.S. officials, Mexican officials
                          agreed, but they also said the country would need additional help until the
                          IMF financing could become available.



Agencies Used             According to U.S. officials, the most urgent problem facing the
Contingency Plans to      government was to avoid Mexico’s default on August 16, which could
Avoid Immediate Default   threaten the capital positions of the world’s largest commercial banks. The
                          Treasury Secretary assigned the Deputy Secretary of the Treasury the task
                          of organizing the assistance effort. Treasury agreed that Monday morning
                          it would provide Mexico with a $1 billion swap from its Exchange
                          Stabilization Fund (ESF) for 1 week.11 However, the swap would have to be
                          secured, and Mexico had little undedicated cash flow. Various federal
                          officials said they turned to one of the possibilities they had discussed
                          during preparedness planning—namely, supplying dollars as prepayment
                          for a U.S. purchase of oil from Mexico. Mexico’s 1981 contract to supply
                          oil to the Department of Defense’s Strategic Petroleum Reserve provided a
                          precedent for this possibility.

                          U.S. officials told us that arranging a U.S. government oil purchase from
                          the Mexican government, with the proceeds of the sale to secure the loan,
                          was difficult and required considerable effort by the Treasury Deputy
                          Secretary and cooperation from the Departments of Defense and Energy,
                          the Office of Management and Budget, and other U.S. government

                          11
                            ESF was originally established to provide the Secretary of the Treasury with funds to conduct
                          international monetary transactions to stabilize the dollar’s exchange value. The Secretary of the
                          Treasury may use ESF consistent with U.S. obligations in IMF regarding orderly exchange
                          arrangements and a stable system of exchange rates. Financing is considered on a case-by-case basis
                          on the basis of a demonstrated need for liquidity, evidence of an appropriate economic adjustment
                          program in cooperation with IMF, and an assured source of repayment. For a more detailed discussion
                          of ESF see pp. 114-117 and 148-152 of Mexico’s Financial Crisis: Origins, Awareness, Assistance, and
                          Initial Efforts to Recover (GAO-GGD-96-56, February 23, 1996).



                          Page 27                                                          GAO/GGD-97-96 Financial Crises
                           Chapter 2
                           The Mexico Debt Crisis of 1982




                           agencies. Negotiations with the Mexican government were challenging, as
                           both the United States and Mexico were concerned about the domestic
                           political implications of the price for the oil. The difficulty was essentially
                           avoided by obscuring the price. The United States would pay Mexico $1
                           billion from ESF for oil for the Strategic Petroleum Reserve valued at $1.2
                           billion. The oil would be delivered over the course of 15 months, and
                           Mexico would pay a $50 million negotiating fee for the advance from the
                           Treasury ESF.12 The Commodity Credit Corporation would also provide
                           Mexico with a $1 billion credit for the purchase of U.S. agricultural
                           products by October 1. Some U.S. officials thought the price paid for the
                           oil was too high, but they said that the Secretary of the Treasury overruled
                           their objections. The agreement enabled Treasury to activate the $1 billion
                           swap on August 16, 1982. According to U.S. officials, $1 billion dollars was
                           credited to the Bank of Mexico account at the Federal Reserve Bank of
                           New York. The Bank of Mexico subsequently used the funds from the
                           Strategic Petroleum arrangement with the Energy Department to repay
                           Treasury’s $1 billion ESF swap.


Federal Reserve Chairman   As Treasury Department officials worked to avoid an immediate default,
Sought Help From Central   the Federal Reserve Chairman said he focused on providing somewhat
Bankers                    longer term funding for Mexico. The Federal Reserve Chairman
                           telephoned central bankers in other countries to discuss Mexico’s
                           financial difficulties. Mexico’s Secretary of Finance made similar calls to
                           other central bankers and finance ministries. At the Federal Reserve
                           Chairman’s request, the Bank for International Settlements (BIS) in Basle,
                           Switzerland, called a meeting of central bankers for August 18 to discuss
                           Mexico’s situation.13

                           According to U.S. officials, the central bankers agreed that the central
                           banks of industrialized countries would loan Mexico $1.5 billion as a credit
                           bridge to IMF assistance, contingent on assurance of repayment if an IMF




                           12
                            Treasury advanced payment to the Bank of Mexico for $1 billion. The Department of Defense, which
                           actually received the oil, then paid Treasury $1 billion.
                           13
                             BIS is the principal forum for consultation, cooperation, and information exchange among central
                           bankers. In recent years it has mobilized supplementary resources for IMF and arranged bridge
                           financing for heavily indebted developing countries. BIS was established in 1930—and is the oldest
                           functioning international financial organization—to manage Germany’s World War I reparations
                           payments. After World War II, BIS evolved into a clearinghouse for the main European central banks.
                           See “The Bank for International Settlements and the Federal Reserve,” Charles Siegman, Federal
                           Reserve Bulletin October 1994.



                           Page 28                                                          GAO/GGD-97-96 Financial Crises
                              Chapter 2
                              The Mexico Debt Crisis of 1982




                              agreement was not reached.14 The United States would advance half and
                              the rest would be split among central banks in Europe and Canada and the
                              Bank of Japan. Spain and the United States added an additional
                              $350 million at the last moment, bringing the total to $1.85 billion. The
                              funds were made contingent upon Mexico showing it could put up
                              adequate collateral if IMF negotiations for a long-term economic
                              stabilization program fell through. The U.S. share of the $1.85 billion was
                              $925 million and consisted of a new Treasury ESF $600 million swap with
                              the Bank of Mexico and a new Federal Reserve swap line of $325 million.
                              According to U.S. officials, these funds were to provide Mexico with
                              adequate financing until a larger package could be arranged.


Federal Reserve Facilitated   U.S. officials said that to provide time for IMF to negotiate a program with
Principal Payment             Mexico, Mexico sought an agreement with U.S. commercial banks that
Moratorium Agreement          would provide for a 90-day postponement of principal payments on
                              Mexico’s debt. The heads of about 100 leading commercial banks attended
                              a meeting on August 20 in New York at the Federal Reserve Bank of New
                              York to discuss the Mexican debt situation.15 According to Federal
                              Reserve officials, on August 21, Mexico’s Finance Secretary met with an
                              advisory group of U.S. commercial bank representatives.16

                              Emphasizing at the August 20 meeting that any agreements reached were
                              between Mexico’s Ministry of Finance and the banks, according to meeting
                              participants, the president of the Federal Reserve Bank of New York
                              described the funding provided by the U.S. government to Mexico as well
                              as multilateral negotiations for the $1.5 billion, later raised to $1.85 billion.
                              The Finance Secretary of Mexico told the bankers that Mexico would seek
                              an IMF program, and he asked the banks to accept postponement of
                              Mexico’s principal payments for 90 days. With the support of this bank
                              advisory group, headed by three Co-Chairmen, the Mexican government
                              identified all the banks with loans outstanding and requested that they
                              postpone payments due for the 90 days. No bank specifically objected to
                              the request for a standstill on payments, and central bank and Mexican
                              officials interpreted this to mean that commercial banks agreed to the

                              14
                                The countries participating in this agreement were Belgium, Canada, France, Germany, Italy, Japan,
                              the Netherlands, Sweden, the United Kingdom, and the United States. Spain and Switzerland
                              cooperated with the agreement.
                              15
                               Because the large banks had sought participation of other smaller banks in foreign loans, estimates
                              of the number of banks that actively participated in loans to Mexico ranged from 500 to over 1,000.
                              16
                               The advisory group banks were Citicorp, Chase, Chemical, Morgan Guaranty, Bank of America,
                              Bankers Trust, Manufacturers Hanover, Bank of Tokyo, Lloyds, Societé Générale of Belgium, Bank of
                              Montreal, Swiss Bank, Deutsche Bank, and Banamex.



                              Page 29                                                           GAO/GGD-97-96 Financial Crises
                           Chapter 2
                           The Mexico Debt Crisis of 1982




                           terms proposed by Mexico’s Finance Secretary. The advisory group also
                           developed information on maturing debts.


Containment Was Slowed     On September 1, unexpected actions by the President of Mexico slowed
by Unexpected Actions of   negotiations related to the IMF austerity program. In his last annual
Mexican President          address, the President nationalized all Mexican banks because, he said,
                           they had provoked and aided the capital flight. The President also imposed
                           foreign exchange controls and denounced wage and spending restraints.
                           These actions caused confusion about the Mexican government’s
                           willingness to reform its economy.

                           According to Federal Reserve officials, the announcement resulted in a
                           surge of requests for repayments of dollar deposits in the foreign offices of
                           Mexican banks, which brought the international foreign exchange clearing
                           system to the edge of breakdown. Mexican banks could not honor demand
                           for dollar deposits, and it was feared that all the foreign currency
                           assistance provided might be used up in honoring these claims. A bank
                           advisory group pressured banks with claims to roll over debts. On
                           September 7, 1982, the Federal Reserve Bank of New York deposited
                           $70 million from money advanced to Mexico by BIS in the Bank of Mexico’s
                           account. According to Federal Reserve officials, a standstill was arranged
                           so that the foreign branches of Mexican banks received reduced requests
                           to honor demands for repayment.

                           According to Federal Reserve officials, in September IMF provided
                           Mexico’s Finance Secretary with a carefully worded memo setting forth
                           conditions for negotiations. The Finance Secretary informed IMF that the
                           negotiations could continue. When Mexico requested access to the second
                           part of the BIS and U.S. swap lines, however, the central banks were
                           reluctant to provide access because Mexico’s progress toward an IMF
                           agreement seemed slow. (See fig. 2.3.)




                           Page 30                                           GAO/GGD-97-96 Financial Crises
                                                         Chapter 2
                                                         The Mexico Debt Crisis of 1982




Figure 2.3: Selected Events in the Mexico Debt Crisis of 1982 (September, November, December)

                    September                                                    November                                                     December
Date:                                                    Date:                                                         Date:

1       Mexico nationalizes banks and establishes         10 Mexico's Ministry of Finance sends IMF an official        1       Mexico's new President takes office.
        foreign currency exchange controls.                      letter of intent to enter into an economic
        Director General of the Bank of Mexico                   adjustment program.                                   23 IMF Managing Director announces that $4.3 billion
        resigns.                                                                                                               in new loans has been pledged and that he will
                                                         16 IMF Managing Director advises representatives                      recommend approval of the Mexican adjustment
 7 Federal Reserve Bank of New York deposits                     of major banks that Mexico's creditor banks must              program.
        $70 million in Bank of Mexico's account at the           agree in writing to provide $5 billion in new loans
        Federal Reserve Bank of New York. These funds            before he will recommend that the IMF Executive               IMF Executive Board approves the agreement
        were provided by Mexican authorities to U. S.            Board approve the economic adjustment program                 with Mexico.
        offices of Mexican banks to help ease demand             for Mexico.
        on dollar deposits.



                                                         Source: GAO analysis.




Federal Reserve Chairman                                 The Mexican government agreed to the terms of an IMF program on
Encouraged Solution                                      October 23. The Federal Reserve Chairman acted quickly to encourage the
                                                         containment of the crisis. Two days later, on the 25th, he informed BIS that
                                                         the United States was prepared to permit limited drawdowns of its portion
                                                         of the funds to Mexico, on the basis of the progress of the Mexico-IMF
                                                         agreement.

                                                         The Finance Secretary of Mexico announced the agreement’s terms on
                                                         November 10. The announcement stated that Mexico would cut its budget
                                                         deficit from 16.5 percent of gross national product to 8.5 percent to
                                                         encourage private investment, reduce its foreign borrowings in 1983 to
                                                         $5 billion from $20 billion in 1981, cut back the growth of the money
                                                         supply to deal with inflation, hold inflation to 55 percent in 1983, reduce
                                                         subsidies, limit wage increases, and increase exports. Taxes were to be
                                                         raised. The details of the agreement were laid out in an attached
                                                         memorandum on economic policies.

                                                         With this agreement in hand, the Managing Director of IMF informed the
                                                         U.S. and foreign banks they would have to provide written commitments
                                                         for an additional $5 billion in loans to Mexico by December 15 before the
                                                         IMF assistance plan could be implemented; Mexico needed the additional
                                                         loans to repay BIS and Federal Reserve loans and to build reserves. Unless
                                                         the banks came up with the money, the Managing Director of IMF
                                                         reportedly said that he would not recommend that the Executive Directors
                                                         of IMF accept the Mexican program.




                                                         Page 31                                                                       GAO/GGD-97-96 Financial Crises
                        Chapter 2
                        The Mexico Debt Crisis of 1982




                        Once again, the Federal Reserve Chairman encouraged action on the
                        resolution. He quickly announced his support for the new loans. He also
                        indicated that new loans U.S. banks made to Mexico as part of a resolution
                        package to service that country’s international debt in an orderly manner
                        should not be subject to supervisory criticism as imprudent. With this
                        reassurance, the banks agreed to extend more loans to Mexico and began
                        to negotiate terms and reschedule the $20 billion in loans coming due in
                        1983 and 1984. The banks also accepted a second 90-day moratorium. The
                        banks launched lengthy negotiations among themselves about fairly
                        sharing the new loans to Mexico.


Pace of Containment     Once Mexico’s new President took office on December 1, 1982, the pace of
Quickened Under New     containment quickened. Steps in the restructuring program—eased
President of Mexico     exchange controls and increased fuel prices and interest rates—were
                        announced within a week by Mexican government officials, and Mexican
                        finance officials and the bankers agreed to terms on December 8. On
                        December 22, with a commitment of $4.3 billion in new lending from the
                        banks, the IMF Managing Director announced that a critical mass of new
                        lending had enabled the IMF program to move forward. Throughout this
                        period and in the weeks following, U.S. officials said that the United States
                        and foreign central banks encouraged regional and smaller banks to give
                        full consideration to making loans to Mexico sufficient to reach the
                        previously announced goal of $5 billion. In the end, 526 banks participated
                        in the lending to Mexico.

                        By the end of 1983, the containment effort could be called a success.
                        According to U.S. officials, Mexico had repaid the interest arrears on its
                        loans as well as emergency loans and currency swaps, established
                        economic reforms, and restructured its debt through 1984. Mexico had not
                        defaulted. Large U.S. and foreign banks had not failed, and financial
                        system collapse had been avoided.


                        To encourage more critical assessments of the risk of lending to foreign
Resolution: Executive   countries and more prudent U.S. bank international lending, Congress
and Legislative         passed the International Lending Supervision Act of 1983.17 Generally, the
Initiatives             act sought to balance the interest of debtor countries in maintaining
                        access to private credit markets against the need for maintaining a safe
                        and sound banking system. The act required OCC, FDIC, FHLBB, and the


                        17
                          Pub. L. No. 98-181, Title IX, as amended, 12 U.S.C. §§ 3901-3912.



                        Page 32                                                               GAO/GGD-97-96 Financial Crises
                                Chapter 2
                                The Mexico Debt Crisis of 1982




                                Federal Reserve to establish uniform systems of supervision and ensure
                                that, among other things,

                            •   agency assessments of the adequacy of bank capital include country risk,
                            •   banks achieve and maintain special reserves for foreign loans as required
                                by the agencies,18
                            •   banks provide quarterly data on international banking activities to the
                                agencies,
                            •   banks publicly disclose information about their exposure in foreign
                                countries that is material to bank assets and capital, and
                            •   banks amortize fees from loans over the life of loans.

                                The act significantly increased the oversight responsibilities of the Federal
                                Reserve and other banking agencies with respect to foreign lending. The
                                act directed federal banking agencies to consult with supervisory
                                authorities of other countries to reach understandings aimed at achieving
                                effective and consistent supervisory policies and practices with respect to
                                international lending. The act also required federal banking agencies to
                                establish regulations for accounting for fees on international loans.


The Baker and Brady Plans       As the decade of the 1980s proceeded, other less-developed
                                countries—principally Latin American countries—went through debt
                                crises. The approach used to contain the Mexican debt crisis in 1982 was
                                used with these other countries. Two successive U.S. government
                                initiatives were undertaken to readdress developing country debt. Since
                                each initiative was launched by the Secretary of the Treasury, the plans
                                bore the Secretary’s last name. In 1985 the Baker plan tried to revive
                                economic growth in developing countries by insisting that the heavily
                                indebted middle income developing countries undertake economic reform
                                programs designed to promote growth with the support of private banks
                                and multilateral development banks. But the Baker plan did not succeed in
                                restoring growth in these countries, and concerns grew about the
                                monetary burden of the debt. In 1989, the Brady plan recognized that some

                                18
                                  The act provides for the maintenance of special reserves when the appropriate federal regulator
                                determines that the quality of an institution’s assets has been impaired by an inability of public or
                                private borrowers in a foreign country to make payments on their external indebtedness for reasons
                                that include a failure by the country to, for example, move toward implementing sound economic
                                policies that can restore growth and enhance creditworthiness. Such reserves are not required for
                                countries that are maintaining debt service and are working with international institutions to develop
                                and implement sound economic policies. The act was amended in 1989 to provide for additional
                                agency review of risk exposures, and appropriate additions to general reserves, of institutions with
                                medium- and long-term loans outstanding to any highly indebted country. A highly indebted country is
                                any country designated as such in the World Bank’s annual world debt tables. See Foreign Debt
                                Reserving Act of 1989, Pub. L. No. 101-240, § 402.



                                Page 33                                                           GAO/GGD-97-96 Financial Crises
Chapter 2
The Mexico Debt Crisis of 1982




of the troubled debtors might not be able to fully service their debts and
restore growth at the same time. The Brady plan sought permanent
reductions in the debtors’ existing debt-servicing obligations in countries
with commitments to economic reform plans. Mexico reduced its
debt-servicing burden under the Brady plan in 1990 by reducing its stock
of debt, lengthening maturity, and lowering interest payments.




Page 34                                          GAO/GGD-97-96 Financial Crises
Chapter 3

The Continental Illinois Bank Crisis


                    The Continental Bank crisis began on May 8, 1984, when Continental
                    Illinois National Bank, then a major money center bank ranked the
                    sixth-largest U.S. bank in terms of assets, experienced the beginning of a
                    sudden run on its deposits. Beset by rumors about its difficulties,
                    Continental faced a liquidity crisis of major proportions. Federal agencies
                    agreed that Continental’s failure would threaten the immediate health of
                    many smaller banks whose deposits it held. This crisis illustrated that a
                    financial crisis could develop as a result of a major financial institution
                    having a high loan concentration in a few business sectors, such as oil or
                    real estate.


                    On May 8, 1984, the Continental Illinois National Bank (Continental),
Summary of          which held a large amount of nonperforming loans,1 experienced the
Chronology          beginning of a sudden run on its deposits. Initially, the Federal Reserve
                    encouraged bank lending and provided massive amounts of liquidity
                    support. Federal banking agencies crafted a multipart strategy to (1) stop
                    the run and (2) sell or arrange to recapitalize the bank. They announced
                    that FDIC would place a temporary $2 billion subordinated note in the
                    bank, that the ultimate resolution of Continental’s problems would not
                    subject depositors or general creditors to loss, and that the Federal
                    Reserve would continue to provide liquidity support through the discount
                    window. Other money center banks participated by taking $500 million of
                    the subordinated note. This successfully slowed the run. Unable to sell the
                    bank, FDIC permanently resolved Continental’s problems several months
                    later with a capital infusion of $1 billion into Continental’s holding
                    company and the purchase of $5.1 billion of its poor-quality loans.
                    Treasury resolved a disagreement among the bank agencies about the
                    treatment of shareholders. In consultation with the Department of Justice,
                    Treasury settled disagreements regarding the treatment of bondholders.


                    On May 8, 1984, when the crisis began, Continental was a major money
Preparedness:       center bank. In 1981 it was ranked as the sixth-largest U.S. bank in terms
Surveillance and    of assets. Continental was also the nation’s leading commercial and
Planning Prepared   industrial lender and was considered a preeminent money center
                    wholesale bank.2 Continental had hundreds of correspondent banks and
Regulators
                    1
                     Nonperforming loans are those not paying principal and interest according to the original terms of the
                    loan agreement. When the principal and interest payments on a loan are past due by 90 days or more,
                    the loan is considered in default.
                    2
                     Continental had 57 offices in 14 states and 29 foreign countries with $34 billion in assets, about 12,000
                    employees, and about 21,000 shareholders.



                    Page 35                                                              GAO/GGD-97-96 Financial Crises
Chapter 3
The Continental Illinois Bank Crisis




over $30 billion in deposits, 90 percent of which were uninsured foreign
deposits or large certificates substantially exceeding the $100,000 deposit
insurance limit. Continental was the largest provider of correspondent
banking services in the country. At the time of the crisis, according to U.S.
government documents, Continental held a large amount of
nonperforming energy and real estate loans that resulted from inadequate
management controls. Due to these nonperforming loans, Continental’s
credit rating was downgraded in July of 1982. As a result of the
downgraded credit rating, the federal funds and certificate of deposit
markets began to dry up as the bank lost the confidence of domestic
money markets. Continental turned to foreign money markets for funding.
Throughout 1982, 1983, and the first part of 1984, Continental regularly
required $8 billion in overnight funds. In the first months of 1984 the
Vice-Chairman, President, and Chief Financial Officer resigned from
Continental. As rumors spread about the bank’s ill health, maturities on
Continental notes began to shorten, and the bank had to offer higher rates
of interest to attract lenders. Continental was relying heavily on volatile
European funding sources. In response to rumors about the bank’s
financial difficulties, large uninsured depositors—particularly foreign
banks—were removing funds to avoid losses in case the bank failed.3 The
bank lost about $9 billion in funding, and the prospect was for the total to
reach the $15 to $20 billion range of lost funding. (See fig. 3.1.)




3
 Continental lost about $15 billion in funding in the 10-day period prior to May 17, 1984.



Page 36                                                              GAO/GGD-97-96 Financial Crises
                                                    Chapter 3
                                                    The Continental Illinois Bank Crisis




Figure 3.1: Selected Events in the Continental Bank Crisis (May)

                                                                             May

8    Commodity News Service reports that            11   Heads of Federal Reserve, Comptroller of the         15   Chairmen of Federal Reserve, Comptroller of the
     Continental might be bought and has received        Currency, and FDIC meet to discuss placing                Currency, and FDIC decide to put $2 billion into
     special attention from regulators.                  $2 billion subordinated debt in Continental.              Continental and meet with Treasury Secretary.
     Depositors begin to withdraw funds from             Continental borrows $3.6 billion from Federal             Treasury Secretary agrees to assistance package
     Continental.                                        Reserve Bank of Chicago.                                  and suggests commercial banks participate.

                                                         Continental approaches Morgan Guaranty                    First National proposes merger with Continental.
9    Board of Trade Clearing Corporation leads           officials for help in arranging a credit line from
     trading community move out of Continental.          major commercial banks.                              16   Chairmen of Federal Reserve, Comptroller of the
     Depositor withdrawals continue.                                                                               Currency and FDIC meet with heads of major
     Continental borrows $850 million from the      12   Continental President and the President of the            banks to discuss their participation in the
     Federal Reserve.                                    Federal Reserve bank of Chicago talk with                 assistance package.
                                                    13
                                                         leaders of 15 of the nation's largest banks.
                                                         Continental sends messages informing                      FDIC chairman announces that "FDIC would
10   OCC news release states that OCC is not
     aware of any significant changes in the             overseas banks of safety net.                             ensure...all deposits at Continental, no matter
     bank's operations, as reflected in its                                                                        how large."
     published financial statements, that would     14   Continental announces that 16 of the nation's
     serve as the basis for rumors that OCC              largest banks have extended it $4.5 billion in       17   Regulators announce a temporary assistance
     solicited aid for Continental from Japanese         credit for 30 days.                                       program of a $2 billion subordinated debt note,
     banks.                                                                                                        that Continental resolution will protect
                                                                                                                   depositors and general creditors, and that the
     Continental President contacts 200 banks                                                                      Federal Reserve will support Continental at the
     to deny rumors.                                                                                               discount window. Continental President
     Depositor withdrawals continue.                                                                               announces Continental availability for merger or
                                                                                                                   takeover. Continental's line of credit is raised
                                                                                                                   to $5.5 billion with 28 participating banks.


                                                    Source: GAO analysis.




                                                    As uncertainty about the bank’s health continued in May 1984, the bank
                                                    was unable to meet its funding requirements. Beset by rumors about its
                                                    difficulties, Continental faced a liquidity crisis of major proportions.
                                                    According to FDIC documents, federal agencies agreed that Continental’s
                                                    failure would threaten the immediate health of many smaller banks whose
                                                    deposits it held and would have severe consequences for the entire
                                                    economy. It would also, they agreed, generate flights to quality throughout
                                                    the financial markets—that is, investors and depositors in money center
                                                    banks would seek more profitable investments and safer places for their
                                                    funds, respectively—and create severe funding problems for other large,
                                                    highly leveraged money center banks suspected of weakness because of
                                                    poor-quality loans in their portfolios. The FDIC Chairman said that
                                                    something had to be done quickly to stabilize the situation. By May 11,
                                                    1984, when other funding sources were unavailable, the Federal Reserve
                                                    loaned Continental $2.8 billion at the discount window.




                                                    Page 37                                                                 GAO/GGD-97-96 Financial Crises
                          Chapter 3
                          The Continental Illinois Bank Crisis




                          According to an FDIC official, the timing of the run on Continental was the
                          only aspect of the crisis that surprised regulatory officials. According to
                          the Comptroller of the Currency, through its routine monitoring and
                          surveillance of Continental’s financial condition, OCC was aware of
                          Continental’s problems, which had developed over several years. In the 2
                          years before the run, OCC had provided nearly constant supervision with
                          bank examiners located on-site in the bank. After a 1982 bank
                          examination, OCC sought corrective measures and took enforcement
                          action.

                          Regulatory officials said they had not met to jointly develop contingency
                          plans to address a possible run on the bank. However, OCC, Federal
                          Reserve, and FDIC officials said they had informal relationships and had
                          taken steps individually that prepared them to manage the crisis. In
                          addition, federal officials involved in managing this crisis had previously
                          worked together. For example, staff of the Federal Reserve, FDIC, OCC, and
                          Treasury had communicated and coordinated on the resolution of the
                          Penn Square Bank in 1982.


Agencies Were Aware of    Continental’s funding difficulties began in July 1982, when the failure of
Continental’s Condition   Penn Square—one of its correspondent banks—revealed that Continental
Through Routinely         had more than $1 billion in problem energy loans.4 Problems in
                          Continental’s loan portfolio grew in the years following the Penn Square
Collected Information     failure. Continental owned nearly $1 billion in shipping loans of
                          questionable quality and also had loan exposure to the Mexican and
                          Argentine debt crises. Continental’s lenders were increasingly concerned
                          about the bank’s creditworthiness.

                          Although regulatory agency officials said they were aware of Continental’s
                          problems, they said that no interagency meetings were held to discuss
                          Continental’s financial condition or federal responses to a possible run on
                          the bank. Before the run in May 1984, OCC was monitoring the development
                          of the bank’s funding problems and reporting to the Federal Reserve Bank
                          of Chicago and FDIC. In fact, for months before the run, OCC and Federal
                          Reserve Bank of Chicago officials told us that they had tried to contain
                          Continental’s problems by urging the bank to improve the quality of its
                          loan portfolio, retain earnings to rebuild capital, and investigate ways of
                          writing off bad loans.

                          4
                           Penn Square was a small bank in Oklahoma City that made energy exploration loans to many
                          companies who failed to find oil and gas and faced sharp drops in energy prices. Penn Square sold
                          these loans to other banks for a fee. Continental purchased $1.1 billion of these loans. Penn Square had
                          more than 24,000 accounts with $250 million in insured deposits.



                          Page 38                                                            GAO/GGD-97-96 Financial Crises
                           Chapter 3
                           The Continental Illinois Bank Crisis




                           OCC  routinely collected considerable documentary information about
                           Continental’s condition, including the quality of Continental’s loan
                           portfolio and the stability of its funding.5 This information, and the
                           agencies’ attention to it, increased federal agency preparedness for the
                           crisis that later occurred. Once the run was under way, regulators said
                           they made a special effort to collect information on correspondent bank
                           exposures to Continental for a detailed determination of the systemic risk
                           associated with a Continental failure. However, the Federal Reserve, FDIC,
                           OCC, and Treasury officials said they understood the general magnitude of
                           the crisis without having details on correspondent bank exposures.


Federal Reserve and FDIC   The Federal Reserve and FDIC had already taken steps that prepared them
Were Strategically         for the crisis. The Federal Reserve Bank of Chicago had developed
Prepared in Some Ways      documents describing its response to a run on a “major” money center
                           bank—with the unwritten understanding that the unnamed bank was
                           Continental. The Federal Reserve Bank of Chicago had planned to arrange
                           extraordinary levels of collateral to secure discount window lending and,
                           if needed, quick possession of more collateral.6 Although FDIC had not
                           developed a specific response to a run on Continental, the agency had
                           prepared legal documentation for the placement of subordinated debt in a
                           large bank. FDIC had originally developed this documentation to respond to
                           another possible crisis, but it was adaptable for use in responding to the
                           Continental crisis.


                           Generally, federal agencies shared the leadership in containing the
Containment: Joint         Continental crisis as each agency exercised its statutory authority. Agency
Discussions Led to         officials said they agreed readily on some containment and resolution
Containment Strategy       strategies and less readily on others. If the federal agencies had met to
                           make contingency plans before the crisis occurred, as was done in the
                           case of the Mexican debt crisis, they might have avoided having to resolve
                           their differing views in a crisis setting.




                           5
                            On April 2, 1984, OCC determined that Continental had no significant additional domestic liquidity
                           available, excluding the Federal Reserve discount window, and that major sources of international
                           funding were drying up. Even so, OCC did not declare Continental insolvent.
                           6
                            The discount window is a line of credit facility maintained by the Federal Reserve for direct loans to a
                           financial institution. All institutions that hold required reserves with the Federal Reserve are eligible to
                           borrow at the discount window.



                           Page 39                                                               GAO/GGD-97-96 Financial Crises
                       Chapter 3
                       The Continental Illinois Bank Crisis




Officials Agreed on    Top officials of OCC, FDIC, and the Federal Reserve had the first of many
Intervention and       joint discussions about the Continental crisis on the morning of May 11,
Containment Strategy   1984, at Federal Reserve headquarters in Washington, D.C.7 They
                       immediately agreed that the government should intervene to prevent the
                       bank’s failure. They believed Continental’s failure would seriously threaten
                       the banking system. They also agreed that FDIC would not pay off
                       depositors by liquidating the bank and meeting its obligations from the
                       proceeds. Regulators thought that a pay-off would be disruptive to the
                       financial system and FDIC, could cause a run on other money center banks,
                       and could disrupt relations between U.S. banks and foreign creditors. At
                       this time federal banking regulatory agencies generally wanted the
                       management and shareholders of Continental to be accountable for
                       mistakes they made, and OCC communicated this to Continental officials.
                       An interim financial assistance program was to ensure that Continental
                       would have the capital resources, liquidity, and the time it needed to end
                       the crisis of confidence and resolve problems in an orderly and permanent
                       manner. Agency officials also agreed that FDIC should purchase $2 billion
                       in subordinated debt from Continental, and the Federal Reserve should
                       provide loans to Continental through its discount window as long as FDIC
                       was involved in providing capital to Continental.8 The subordinated debt
                       note was viewed as a short-term funding solution—that is, a mechanism to
                       stabilize Continental’s funding sources.9

                       Other elements of the strategy emerged in discussions among Treasury
                       and the other money center banks. On Monday, May 14, the Secretary of
                       the Treasury said he suggested, and bank regulators agreed, that other
                       banks should participate in the FDIC-subordinated note to demonstrate the
                       banking system’s confidence in Continental. After discussions revealed
                       that the other banks had concerns about the riskiness of this participation,
                       the FDIC Chairman suggested that FDIC assure the banks and all depositors
                       and lenders that the resolution of the bank would not result in any losses
                       in dealings with Continental. After some discussion, the other regulators
                       agreed to this, and the banks participated by taking $500 million of the
                       note.




                       7
                       See Irvine H. Sprague. Bailout: An Insider’s Account of Bank Failures and Rescues. New York: Basic
                       Books, 1986.
                       8
                        Federal Reserve discount window borrowing reached a daily high of $7.6 billion in August 1984.
                       9
                        The note was conditioned on Continental’s accepting certain restrictions related to hiring,
                       promotions, and other factors. FDIC could replace senior management; remove members of the Board
                       of Directors; and, in principle, control the bank.



                       Page 40                                                          GAO/GGD-97-96 Financial Crises
                            Chapter 3
                            The Continental Illinois Bank Crisis




                            The discount window loans to Continental—which quickly exceeded any
                            previous bank loan from any Federal Reserve Bank—gave Continental the
                            funding it needed to pay off maturing notes. However, this Federal
                            Reserve assistance did not mitigate the market’s distrust of Continental’s
                            financial strength, and normal funding was impossible.


Joint Agency                With the hope of ending the run and restoring confidence in Continental,
Announcement of Rescue      FDIC, OCC, and the Federal Reserve jointly announced on May 17th the

Package Slows Run           placement by FDIC of the $2 billion subordinated debt note. As
                            subordinated debt, the note would be the last debt repaid in the event of a
                            failure. Therefore, all current creditors would be repaid before FDIC. This
                            was by far the largest commercial bank bailout in FDIC history. FDIC
                            provided $1.5 billion of the subordinated debt, and a group of seven major
                            U.S. banks provided the balance. In addition, a consortium of 28 banks
                            provided Continental with a $5.3 billion funded line of credit, which was
                            later replaced by a $4.5 billion standby line of credit. The agencies also
                            announced that the resolution of the bank would not impose losses on
                            anyone. This meant that FDIC would not pay off depositors by liquidating
                            the bank and meeting its obligations from the proceeds—which could fall
                            short and would take a considerable period of time. Instead, FDIC would
                            support a takeover, find a merger partner, or recapitalize the bank; in any
                            event, all Continental obligations would be honored. The Federal Reserve
                            would continue to meet the bank’s liquidity requirements.

                            This announcement did not completely end the run. Withdrawals from
                            Continental slowed considerably after the announcement, but they
                            continued. However, the announced intervention bought regulators some
                            limited time to explore alternatives.


Secretary of the Treasury   In keeping with its statutory authority, FDIC officials said it developed the
Mediates Agencies’          solution to Continental’s problem in consultation with the other regulatory
Disagreement Over Rescue    agencies. FDIC first allowed the bank to look for a merger partner or a
                            buyer. When Chemical, Citicorp, and First Chicago banks reviewed
Methods                     Continental’s loan files, they decided that Continental was in worse shape
                            than they expected and declined to participate in a merger or purchase.
                            Regulators said they were concerned that Continental could worsen the
                            financial condition of an acquiring institution. The regulators said they
                            believed that any merger or purchase would likely require massive FDIC
                            assistance. FDIC developed a plan to place capital in the bank and resolve
                            the difficulties through open bank assistance. The continuing withdrawals



                            Page 41                                           GAO/GGD-97-96 Financial Crises
Chapter 3
The Continental Illinois Bank Crisis




from the bank limited the amount of time available for the resolution
effort.

Regulatory officials said they resolved several disputes in the development
of the resolution. Concerned that the bank’s shareholders would not
support a package that left them entirely at risk, FDIC proposed that the
resolution leave the shareholders with 15 percent of the bank’s stock free
and clear so that the shareholders would not be at risk to absorb further
losses. FDIC would hold 85 percent of the stock. OCC and the Federal
Reserve said they objected strongly, arguing that the government should
not bail out stockholders of the bank or its holding company, who should
risk a complete loss on their investment. The agencies brought the dispute
to the Secretary of the Treasury, who agreed with OCC and Federal Reserve
officials that stockholders should be at risk. FDIC agreed that the final
package would leave the stockholders at risk of losing their entire
investments.

A similar dispute arose over the treatment of the bank holding company’s
bondholders.10 All agencies agreed that the holding company bondholders
should be at risk—but their bonds had indenture covenants11 preventing
infusions of capital into the bank from outside the holding company by
sales to others of bank securities without the approval of debt holders.
Placing capital directly into the bank without waivers from bondholders,
which would not help the holding company, could provoke a lawsuit.
Placing the capital in the holding company to be downstreamed into the
bank avoided legal complications but left the holding company solvent and
the bondholders whole.

Treasury officials said they believed that the holding company
bondholders should not be bailed out and the assistance should be placed
directly in the bank. As the primary regulator of bank holding companies,
Federal Reserve officials said they argued that the holding company
should be bailed out to avoid major financial and confidence problems in
other bank holding companies. FDIC officials said they argued that
Continental could not afford the legal battles involved with a direct
placement of capital in the bank; they also said that placing subordinated
debt that does not count as capital—and that does not have legal


10
  Continental’s parent holding company was Continental Illinois Corporation.
11
  Indenture covenants are formal agreements between bond issuers and bondholders specifying the
terms and conditions of bonds. The indenture covenants may include such considerations as, for
example, amount of issue, interest to be paid, maturity date, repayment schedule, call provisions,
collateral pledged, appointment of a trustee, and other items.



Page 42                                                          GAO/GGD-97-96 Financial Crises
Chapter 3
The Continental Illinois Bank Crisis




complications—would not adequately reassure the public that the bank
was properly capitalized. Treasury officials said they continued to insist on
the placement of subordinated debt. The head of FDIC eventually took the
issue to the Secretary of the Treasury, who indicated that FDIC should use
its legal authority to press ahead with its plan to downstream assistance
from the holding company to the bank. FDIC’s version of the assistance
package was supported by a legal opinion from the Department of Justice.

The final rescue package was announced at a joint OCC, FDIC, and Federal
Reserve news conference by the FDIC Chairman on July 26, 1984. The
permanent assistance program was designed to prevent the failure of
Continental and enable the bank to restore its position as a viable
self-financing entity. FDIC placed $1 billion in the holding company in
exchange for holding company stock. This $1 billion was immediately
downstreamed to the bank as equity capital. FDIC also purchased troubled
loans with a face value of $5.1 billion for $3.5 billion. FDIC paid for the
troubled loans by assuming Continental’s debt to the Federal Reserve
Bank of Chicago. Final accounting of cost to FDIC was $1.6 billion.

Key management changes were also announced. FDIC had the right to
convert up to 80 percent of the preferred stock. Stockholders were left
with a 20-percent stake in the bank, but losses on the bad loan portfolio
were charged against that stake and eventually wiped it out. FDIC sold its
remaining interest in Continental in June 1991. Continental continued to
operate, but as a much different institution. (See fig. 3.2.)




Page 43                                          GAO/GGD-97-96 Financial Crises
                                                          Chapter 3
                                                          The Continental Illinois Bank Crisis




Figure 3.2: Selected Events in the Continental Bank Crisis (July, September)

                                                        July                                                                                September

16   Interagency regulator group begins work on                23   FDIC assumes Treasury will drop objection to         25   Federal Reserve Bank of Chicago tells FDIC it
     agreement with Continental.                                    plan and prepares congressional briefing.                 will file public lien on all Continental assets.
     FDIC plans to take two-thirds of the holding                   Treasury still objects and the briefing is                Federal Reserve Bank of Chicago thinks
     company and loan losses are to be charged                      cancelled.                                                Continental does not have enough collateral.
     against the shareholders' remaining third.                                                                               Federal Reserve Chairman persuades Federal
                                                               25   Question of FDIC's legal authority referred to            Reserve Bank of Chicago President to wait
     Treasury disagrees with decision to provide aid                Justice Department. Justice says that if FDIC             on lien.
18
     through the holding company and believes the                   has a basis to conclude this approach was
                                                                    necessary then transaction is legal.                      Final assistance package approved by
     plan needs Treasury approval.                                                                                            Continental stockholders.
                                                                    Treasury Secretary criticizes plan as bad public
     Borrowings from the Federal Reserve, FDIC,                     policy in memo to Chairmen of FDIC, Federal
     and safety net banks are $8.2 billion.                         Reserve, and Comptroller of the Currency. FDIC
                                                                    Chairman supports the plan, and the Federal
19   FDIC Chairman proposes taking 85% of stock                     Reserve approves protection of holding
     and giving stockholders the remaining 15%                      company bondholders.
     without liability. Comptroller of the Currency
     objects strongly. FDIC board meets with                        At joint news conference with Federal Reserve,
                                                               26
     Treasury Secretary and Federal Reserve                         FDIC, and OCC, Continental announces
     Chairman. Treasury Secretary decides                           permanent assistance package. $1 billion is
     shareholders must be liable for loan                           placed in holding company and downstreamed
     losses. Deal returns to old format with an 80/20               to Continental. FDIC purchases troubled loans
     split. Stock options included in package.                      with a face value of $5.1 billion for $3.5 billion
     Meeting also includes discussion of legality                   and assumes Continental debt to the Federal
     of assistance to holding company.                              Reserve Bank of Chicago.

21   Negotiators draw up plan.                                      Borrowings from Federal Reserve, FDIC, and
                                                                    safety net banks reach $12.6 billion.
22   Treasury and Federal Reserve discuss format
     of rescue.




                                                          Source: GAO analysis.



                                                          FDIC officials told us that the Continental failure led to some changes in
Resolution: FDIC                                          procedures at FDIC. For example, before the Continental failure, FDIC
Strengthened                                              examined only state-chartered banks that were not members of the
Oversight of                                              Federal Reserve System. After Continental, FDIC conducted examinations
                                                          of state-chartered banks that were members of the Federal Reserve
Nationally Chartered                                      System as well as nationally chartered banks like Continental. Also, FDIC
Banks                                                     officials said they began to meet weekly with senior officials of other
                                                          federal bank supervisory agencies to exchange information about
                                                          emerging bank problems.

                                                          Hearings on the failure of Continental were held in September and
                                                          October 1984 by the House Committee on Banking, Finance, and Urban




                                                          Page 44                                                                    GAO/GGD-97-96 Financial Crises
                                 Chapter 3
                                 The Continental Illinois Bank Crisis




                                 Affairs. Senate hearings were not held. The failure of Continental raised
                                 questions for the Committee about

                             •   whether regulators had created a two-tier system for large and small
                                 banks, with large banks being considered “too big to fail”;
                             •   whether Congress should have a voice in rescue plans created by bank
                                 regulators;
                             •   whether the decades-old system of deposit insurance needed to be
                                 reformed; and
                             •   whether Congress should further deregulate banks.


Legislative Initiatives to       Although Congress considered several banking bills in 1984 through 1986
Limit “Too Big to Fail”          that contemplated a wide variety of banking topics, bank reform
Policy                           legislation did not pass during this period. In 1987, Congress passed the
                                 Competitive Equality Banking Act of 1987 (P.L. 100-86). Among other
                                 things, the act gave FDIC bridge bank authority to facilitate FDIC’s
                                 disposition of failed banks. The bridge bank is to assume the assets and
                                 liabilities and carry on the business of the failed bank for a limited time
                                 until the bank is acquired or merged. Bridge bank authority essentially
                                 buys FDIC time to arrange an orderly merger or acquisition and enables the
                                 agency to delay resolution of holding company issues until other issues are
                                 resolved.

                                 The Federal Deposit Insurance Improvement Act of 1991 (FDICIA)12
                                 established cost constraints for regulators resolving financial difficulties of
                                 banks. Before the passage of FDICIA, FDIC could fully protect all bank
                                 depositors and creditors, regardless of cost, if the bank was deemed
                                 essential to its community. The new act narrowed the circumstances
                                 under which FDIC could act in this way. The least-cost provision of the act
                                 sought to limit the circumstances under which uninsured deposits are fully
                                 protected by preventing FDIC from incurring a loss when it protects them.13
                                 Only when a large bank failure is determined to pose a systemic risk to the
                                 nation’s financial system may FDIC protect all deposits and nondeposit
                                 liabilities in a failing depository institution and sustain a loss. FDICIA also
                                 required that such action be approved in advance by FDIC’s Board of
                                 Directors, the Board of Governors of the Federal Reserve, and the
                                 Secretary of the Treasury in consultation with the president. Absent such
                                 approval, FDIC must resolve the problems of a failing institution using the

                                 12
                                   P.L. 102-242.
                                 13
                                  1992 Thrift Resolutions: RTC Policies and Practices Did Not Fully Comply With Least-Cost Provisions
                                 (GAO/GGD-94-110, June 17, 1994).



                                 Page 45                                                         GAO/GGD-97-96 Financial Crises
Chapter 3
The Continental Illinois Bank Crisis




resolution method that is least costly to the insurance fund—which can be
a liquidation in which only insured deposits are protected. Other legal
changes would also influence how FDIC would handle a failure like
Continental’s today. Also, the Resolution Trust Corporation Completion
Act of 198814 prohibited the use of federal deposit insurance funds to
benefit shareholders in connection with a resolution.




14
  P.L. 103-204.



Page 46                                        GAO/GGD-97-96 Financial Crises
Chapter 4

The Ohio Savings and Loan Crisis


               The Ohio savings and loan crisis began on March 5, 1985, when the most
               widespread run on depository institutions since the Great Depression
               began. The run was set off by the collapse in March of Home State Savings
               Bank, the largest of Ohio’s 71 privately insured savings and loan
               institutions. About $4 billion in deposits of a half-million depositors were
               threatened at 71 institutions. This crisis showed that a financial crisis
               occurring in a financial institution that is not federally insured could
               involve the federal government in a financial rescue. This case also
               illustrated the linkage that had developed between securities markets and
               financial institutions. Factors that helped contain the Ohio savings and
               loan crisis included the joint leadership of the Ohio Governor’s Office and
               the Federal Reserve, provision of liquidity by the Federal Reserve
               Cleveland Bank, innovative action by the state of Ohio and federal
               regulators, and collaboration between federal and state regulators.


               The 1985 Ohio savings and loan crisis was the most widespread run on
Summary of     depository institutions since the Great Depression. The run was set off by
Chronology     the collapse in March of Home State Savings Bank, the largest of Ohio’s 71
               privately insured savings and loan institutions. A concern of the Federal
               Reserve was that the run could spread to other states with private
               insurance funds and ultimately to federally insured savings and loans.
               Because the 71 thrifts were not federally regulated, federal agency officials
               said they lacked immediate access to important crisis-related information.
               At the Ohio Governor’s request, the Federal Reserve provided liquidity
               support to qualified thrifts experiencing heavy withdrawals. Federal
               Reserve officials and staff also worked closely with the Ohio Governor,
               sometimes engaging in nonroutine activities. Federal Reserve officials
               helped the state monitor the run, collect information, respond to questions
               from the public, and find a permanent solution to the instability.
               Ultimately, the run was contained through a state-declared bank holiday,
               temporary limits on withdrawals, and state-mandated conversion of most
               of Ohio’s privately insured thrifts to federally insured status. The Federal
               Home Loan Bank of Cincinnati provided the thrifts with federal deposit
               insurance. By the middle of June 1985, most thrifts had reopened with
               federal insurance, and confidence had been restored in nearly all of the
               institutions.

               Figure 4.1 lists a chronology of events in the Ohio savings and loan crisis.




               Page 47                                           GAO/GGD-97-96 Financial Crises
                                      Chapter 4
                                      The Ohio Savings and Loan Crisis




Figure 4.1: Selected Events in Ohio
Savings and Loan Crisis of 1985                   Sunday                               Monday                                     Tuesday
(March)




                                      3                                   4                                           5
                                                                                ESM Government Securities                   Depositors stage run on
                                                                                is closed by regulators.                    Home State.
                                                                                Home State asks Federal                     Federal Reserve Bank of
                                                                                Reserve Bank of Cleveland                   Cleveland asks Federal
                                                                                about borrowing                             Home Loan Bank of
                                                                                documents.                                  Cincinnati for information
                                                                                                                            about Home State and
                                                                                                                            Guarantee Fund.




                                      10                                  11                                          12
                                           Governor of Ohio                    Federal Reserve Bank of                     Governor of Ohio appoints
                                           announces closure of                Cleveland staff monitor                     conservator to wind up Home
                                           Home State and appoints             activities from positions                   State affairs.
                                           conservator to wind up its          at Guarantee Fund thrifts.                  Guarantee Fund institutions
                                           affairs.                            Deposit outflow is $6 million.              have $13.4 million outflow.
                                           Federal Reserve Bank of
                                           Cleveland announces
                                           Guarantee Fund thrifts
                                           eligible to borrow
                                           at discount window.


                                      17                                  18                                          19
                                           After meeting with thrift           Governor of Ohio orders                      Governor of Ohio meets
                                           executives, Governor of             48-hour extension of bank                    separately with Federal
                                           Ohio decides to extend the          holiday.                                     Reserve Chairman and
                                           bank holiday 2 more days.           Federal Home Loan Bank                       Federal Home Loan Bank
                                           Federal Home Loan Bank              officials call Ohio thrifts and              Board Chairman in
                                           Chairman meets with Federal         ask whether they intend to                   Washington, D.C.
                                           Reserve Chairman in                 seek federal insurance.                      Federal deposit insurance
                                           Washington, D.C., to discuss                                                     exams are to begin
                                           Ohio thrift situation.                                                           at Guarantee Fund
                                                                                                                            institutions.


                                      24                                  25                                          26
                                           Federal deposit insurance           Deposit outflows are $7.7                    Eighteen institutions are now
                                           examinations continue.              million.                                     open on a full-service basis.
                                                                                                                            Deposit outflows are $3.9
                                                                                                                            million.




                                      Page 48                                                                    GAO/GGD-97-96 Financial Crises
                                                      Chapter 4
                                                      The Ohio Savings and Loan Crisis




         Wednesday                             Thursday                               Friday                                 Saturday

                                                                         1                                       2
                                                                              ESM Government Securities               Guarantee Fund officials
                                                                              audit report withdrawn.                 discuss ESM and Home State
                                                                                                                      situation with Ohio
                                                                                                                      Superintendent of the
                                                                                                                      Division of Savings and Loan.




6                                    7                                   8                                       9
     Federal Reserve Bank of              Governor of Ohio calls              Home State announces
     Cleveland ships cash to              Federal Reserve Bank of             Saturday closure.                        Federal Reserve Bank of
     Home State.                          Cleveland President to              State of Ohio gives Federal              Cleveland starts monitoring
     Federal Reserve Bank of              discuss Home State and ask          Reserve Bank of Cleveland                and analyzing data on
     Cleveland and Federal                for assistance.                     data on Guarantee Fund                   Guarantee Fund thrifts.
     Home Loan Bank do not                Ohio Superintendent of              thrifts.                                 Home State conservator is
     have data on Home                    Savings and Loans, Guarantee        Home State signs note to                 named.
     State.                               Fund, and Home State meet to        borrow at the discount                   Ohio Superintendent of
     Federal Reserve Bank of              discuss discount window             window.                                  Savings and Loan has
     Cleveland sends examiners            borrowing.                                                                   meeting to discuss Home
     to Home State to review                                                                                           State options.
     collateral.

13                                   14                                  15                                      16
     Ohio legislature lends               Federal Home Loan Bank              Governor of Ohio declares                State of Ohio asks
     $50 million to new state             Chairman tells Ohio                 3-day bank holiday.                      Federal Reserve Bank of
     deposit insurance fund.              delegation that insurance           Federal Reserve Bank of                  Cleveland to discuss sale of
     Guarantee Fund runs total            applications will be handled        Cleveland President                      Home State and other thrifts
     $23 million.                         expeditiously.                      indicates liquidity help will be         with out-of-state financial
     Federal Home Loan Bank               Guarantee Fund runs total           available when thrifts reopen.           institutions.
     takes preliminary look at            $64 million.                        Governor of Ohio and                     Ohio Superintendent of
     Guarantee Fund thrifts.              Thrift executives tell              Federal Reserve Bank of                  Banks asks federal bank
                                          Governor of Ohio they may           Cleveland meet with Ohio                 regulatory agencies to help
                                          not make it through next            financial institutions to                examine Guarantee Fund
                                          day.                                ask their help.                          thrifts.

20                                   21                                  22                                      23
     State of Ohio requires all           One Guarantee Fund thrift            A task force is set up by               Federal deposit insurance
     Guarantee Fund thrifts to get        gets federal deposit                 State of Ohio to coordinate             examinations continue.
     federal deposit insurance.           insurance.                           Superintendent of                       Guarantee Fund thrifts
     Guarantee Fund thrifts are                                                Savings and Loans, Federal              reopen for limited service.
     opened with partial                                                       Reserve Bank of Cleveland,              Guarantee Fund thrifts have
     withdrawals allowed.                                                      and Federal Home Loan                   $5.4 million in runs.
     Federal Reserve Chairman                                                  Bank actions.
     reiterates Ohio thrift
     eligibility for liquidity
     assistance.



27                                   28                                  29                                      30
     Deposit outflows of $2.9             Deposit outflows of $4.4             Twenty-six thrifts are now              Deposit outflows of $1.3
     million.                             million.                             open for full service.                  million.




                                                      Source: GAO analysis.




                                                      Page 49                                                               GAO/GGD-97-96 Financial Crises
                        Chapter 4
                        The Ohio Savings and Loan Crisis




                        In 1985, savings and loan institutions in Ohio experienced the most
Preparedness: Limited   widespread run on depository institutions since the Great Depression.
Information and         About $4.3 billion in deposits of a half-million depositors were threatened
Authority Made          at 71 institutions. The run, which began on March 5, resulted from
                        publicized losses of $150 million from Home State Savings Bank (Home
Planning Difficult      State), Ohio’s largest privately insured savings and loan institution.1 The
                        run continued despite efforts by Ohio and Ohio Deposit Guarantee Fund
                        officials to reassure the public. State officials said that depositor funds
                        were safe, and officials of the private Guarantee Fund said that depositors
                        would not lose their money. The Ohio Deposit Guarantee Fund was a
                        private, state-chartered insurance system that guaranteed 100 percent of
                        all deposits. After questions were raised on a radio talk show about the
                        ability of the Guarantee Fund to meet the needs of Home State depositors,
                        withdrawals began at other thrift institutions.

                        Home State’s losses were due to the failure on March 4, 1985, of a largely
                        unregulated government securities dealer, ESM Government Securities,
                        following a massive fraud involving false audit reports. ESM was missing
                        about $300 million in customer funds. Home State was heavily exposed to
                        this failed securities dealer through repurchase agreement transactions.2
                        Lax supervision had allowed Home State to borrow almost 50 percent of
                        its funds through ESM. As the result of ESM’s failure, Home State and
                        American Savings and Loan Association in Florida, which were
                        part-owned by the same person, sustained substantial losses. Home State
                        estimated losses at $150 million or more.

                        Home State’s deposits, like those of the other state-chartered and privately
                        insured Ohio thrifts, were insured by the Ohio Deposit Guarantee Fund.
                        Immediately before the run on Home State, the Guarantee Fund had total
                        assets of $130 million to guarantee about $4.3 billion in deposits for about
                        500,000 depositors. According to Federal Reserve officials, the thrifts had
                        chosen private deposit insurance because such insurance was less
                        expensive and burdensome compared to federal deposit insurance. The
                        Guarantee Fund had no legal power to ensure compliance by its members
                        and had no cease and desist power. According to a Guarantee Fund
                        official, the privately insured Ohio thrifts were regulated by the Ohio
                        Department of Commerce’s Division of Savings and Loan Associations.



                        1
                         On March 6, 1985, the Cincinnati Enquirer reported that Home State might suffer large losses in
                        connection with the failure of ESM.
                        2
                         Repurchase agreements are contracts to sell and subsequently repurchase securities at a specified
                        date and price.



                        Page 50                                                           GAO/GGD-97-96 Financial Crises
                            Chapter 4
                            The Ohio Savings and Loan Crisis




Federal Agencies Had        When the run on privately insured thrifts began, federal agencies had little
Limited Information About   information about the Guarantee Fund or thrifts it insured. The Federal
Home State                  Reserve Bank of Cleveland had been concerned for some time about the
                            condition of the fund and its insured thrifts. However, the fund had not
                            honored the Reserve Bank’s 1982 requests for information.3 FHLBB, which
                            had failed in its attempts to bring the privately insured institutions under
                            Federal Savings and Loan Insurance Corporation (FSLIC) coverage, also
                            lacked information about the condition of the thrifts.4 The Guarantee Fund
                            had collected information on the financial condition of the thrifts it
                            insured, but it did not share this information with the Federal Reserve.

                            Although Ohio state banking regulators and officials of the guarantee fund
                            were aware of the exposure of Home State to ESM Government Securities,
                            they said they had not initiated any interagency meetings with federal
                            officials to prepare for a possible crisis resulting from the failure of Home
                            State. Ohio state regulators had initiated interagency meetings, but those
                            meetings had not involved federal officials. About 5 months before the
                            run—in October 1984—the Ohio Superintendent of Savings and Loans met
                            with officials of ESM Government Securities, Home State, and the
                            Guarantee Fund to caution them on Home State’s exposure to ESM.
                            However, according to a state official, state banking officials were
                            reluctant to issue cease and desist orders because state judges would not
                            support them. In addition, the Guarantee Fund had no authority to issue or
                            enforce a cease and desist order.


                            A lack of information about the scope of the crisis and the financial
Containment: Ohio           condition of the 71 Ohio thrifts complicated and slowed federal and state
Governor and Federal        responses to the crisis, which took about 3 months to resolve. State and
Reserve Led Crisis          federal officials said the State of Ohio and the Federal Reserve intervened
                            after it was clear that Home State and many of the other Ohio thrifts were
Containment Efforts         in poor financial shape and unable to stop the runs on their deposits, and
                            the private Guarantee Fund was insufficient to cover depositor
                            withdrawals.




                            3
                             The Federal Reserve Bank of Cleveland was aware of financial problems at at least one privately
                            insured thrift as a result of its discount window transactions.
                            4
                             FSLIC was established by Congress in 1934 to insure deposits in savings and loan institutions and
                            savings banks. The Financial Institutions Reform, Recovery, and Enforcement (FIRREA) Act of 1989
                            transferred the assets and liabilities of the Corporation to a new deposit insurance fund called the
                            Savings Association Insurance Fund. This fund is operated by the Federal Deposit Insurance
                            Corporation.



                            Page 51                                                           GAO/GGD-97-96 Financial Crises
                           Chapter 4
                           The Ohio Savings and Loan Crisis




                           Among other things, the containment and resolution efforts involved
                           discount window borrowing to satisfy deposit withdrawals, intensive
                           information gathering to monitor the run, carefully managed
                           communications with the public, the declaration of a bank holiday for the
                           thrifts, emergency state legislation, and an intensive effort to bring
                           Guarantee Fund-insured thrifts under federal deposit insurance.

                           According to Federal Reserve and Federal Home Loan Bank officials,
                           leadership during the Ohio savings and loan crisis came primarily from the
                           Governor of Ohio and officials of the Federal Reserve. The legal authority
                           necessary to contain and resolve the crisis rested with the Governor of
                           Ohio. Federal Reserve officials—including the president and staff of the
                           Federal Reserve Bank of Cleveland and the Federal Reserve Board
                           Chairman—facilitated decisions and actions of the Ohio Governor.
                           According to the Governor of Ohio, the Federal Reserve also provided
                           liquidity support to the privately insured thrifts, supplied bank examiners
                           to monitor the run and conduct federal deposit insurance examinations,
                           and assisted in other ways.


Federal Agencies Did Not   Federal financial officials said they disagreed about the necessity to
Agree on Necessity of      become involved in the Ohio savings and loan situation. The top FHLBB
Involvement                official told us that he was responsible for regulation and oversight of
                           federally chartered thrifts and the operation of FSLIC and was not inclined
                           to involve FHLBB in crisis management efforts, since the thrifts had elected
                           private rather than federal deposit insurance. A Federal Reserve official
                           told us that the Federal Reserve Board Chairman was instrumental in
                           encouraging Federal Home Loan Bank officials to provide federal deposit
                           insurance for qualified Ohio thrifts. According to Federal Reserve and
                           Ohio officials, FDIC officials were also reluctant to be involved; they
                           considered the crisis a state problem.


Federal Reserve Opened     On March 4—the same day that ESM failed—the Federal Reserve Bank of
Discount Window as Run     Cleveland received a request from Home State for information about
Continued                  discount window borrowing. After reviewing Home State’s application, the
                           Federal Reserve Bank of Cleveland judged Home State’s collateral
                           acceptable and began discount window lending.5 During the week of
                           March 5 through 9, the Federal Reserve Bank of Cleveland followed
                           routine procedures to make cash shipments to various Home State offices.

                           5
                            The Depository Institutions Deregulation and Monetary Control Act of 1980 (P.L. No. 96-221) gave
                           nonmember depository institutions, including the state-chartered thrifts in Ohio, eligibility for discount
                           window borrowing.



                           Page 52                                                             GAO/GGD-97-96 Financial Crises
                             Chapter 4
                             The Ohio Savings and Loan Crisis




                             Federal Reserve officials told us they were increasingly concerned that
                             Home State’s problems could spread to other privately insured Ohio
                             savings and loans.

                             By the end of the first week of the run, Home State depositors had
                             withdrawn an estimated $155 million, and the Guarantee Fund had
                             advanced $45 million to satisfy deposit demands, according to a Guarantee
                             Fund official. On March 10, 1985, the Federal Reserve emphasized in a
                             public statement that privately insured, state-chartered depository
                             institutions could be eligible for discount window assistance.


Federal Reserve Believed     During the week of March 4 through 9, the Federal Reserve Bank of
Risk of Contagion Made       Cleveland officials said they worked to determine Home State’s financial
Containment Efforts          condition and the likelihood that the run would threaten other institutions
                             in Ohio and other parts of the country.6 They were also concerned about
Necessary                    the payment system, since Guarantee Fund thrifts had correspondent
                             clearing relationships with commercial banks. In addition, the Federal
                             Reserve Bank of Cleveland helped educate some members of the Ohio
                             Governor’s staff about banking issues, including possible approaches to
                             solving the Home State problem. On March 6, a senior Federal Reserve
                             examiner who had reviewed Home State’s books told the president of the
                             Federal Reserve Bank of Cleveland that the financial condition of Home
                             State was as bad as any he had seen.

                             Federal Reserve Bank of Cleveland officials said they conferred with other
                             Federal Reserve officials in Washington, D.C., and New York about
                             possible effects of the run on other thrifts and banks. Federal Reserve
                             officials decided that the Federal Reserve was compelled to act to contain
                             the crisis because of the possibility of contagion and possible effects on
                             the dollar in international foreign exchange markets. The decision was
                             difficult because of the lack of reliable information on the financial
                             condition of the privately insured institutions.


Federal Reserve Led          Federal Reserve officials said the lack of information on the financial
Efforts to Obtain Reliable   condition of Guarantee Fund thrifts delayed decisive action by the state of
Information                  Ohio and the Federal Reserve and prompted debates about the existence
                             of risk to the financial system. When Home State’s problems were first
                             disclosed, little information was available to state and federal agencies.

                             6
                              Georgia, Maryland, North Carolina, Pennsylvania, Rhode Island, and Utah also had privately insured
                             savings and loans.



                             Page 53                                                          GAO/GGD-97-96 Financial Crises
                          Chapter 4
                          The Ohio Savings and Loan Crisis




                          The Federal Home Loan Bank of Cincinnati had quarterly and annual
                          reports of the Guarantee Fund insured thrifts, but these were considered
                          of little value because they had not been verified by on-site federal
                          examinations and did not provide information about financial linkages,
                          such as creditor relationships.

                          With assistance from Ohio thrift regulators, the Federal Home Loan Bank
                          of Cincinnati, the Office of the Comptroller of the Currency, and FDIC, the
                          Federal Reserve said it initiated a large effort to quickly determine the
                          financial condition of the privately insured Ohio thrifts and how many
                          would qualify for liquidity assistance through the discount window.7 On
                          March 6, 1985, several senior members of the Federal Reserve Bank of
                          Cleveland’s Division of Bank Supervision and Regulation reviewed records
                          at Home State. On March 8, 1985, the Federal Reserve received the
                          available examination reports from the state on thrifts with deposits
                          insured by the Guarantee Fund. Next, about 200 examiners—most of them
                          Federal Reserve examiners—were deployed throughout the state on
                          March 11 to collect operational and financial information on those thrifts.
                          The Federal Reserve Bank of Cleveland and the Federal Home Loan Bank
                          of Cincinnati began assessing the condition of Guarantee Fund thrifts. On
                          this basis, the Federal Reserve Bank of Cleveland decided which thrifts
                          could survive with liquidity assistance from the discount window until a
                          permanent solution could be devised.


Ohio Governor Developed   The then-Governor of Ohio told us that on March 6, 1985, he received a
Basic Strategy            telephone call from the owner of Home State, who told him that the failure
                          of ESM Government Securities had caused his thrift problems. The
                          Governor asked his chief of staff to define the problems, ascertain the
                          causes of the problems, and determine whether other thrifts were
                          threatened. The Governor received assurances from his staff that there
                          were no problems. Federal Reserve officials initially had difficulty
                          convincing the Governor of Ohio that the situation could prove serious.
                          The Governor also discussed the Home State situation with state
                          legislative leaders. He and they agreed that Ohio had to act to protect
                          depositors and thrifts; they also agreed, however, that the state would not
                          put money into Home State, although it should do something to protect
                          other institutions. One of the Governor’s objectives was to quickly find a
                          buyer for Home State.



                          7
                           The discount window loans would be made by the Federal Reserve Bank of Cleveland and secured by
                          government and agency securities, commercial loans, and residential mortgages.



                          Page 54                                                       GAO/GGD-97-96 Financial Crises
                              Chapter 4
                              The Ohio Savings and Loan Crisis




State and Federal Officials   The weekend of March 9 and 10, the Governor met with advisors to
Discuss Objectives and        discuss options; he also formally requested help from the president of the
Strategies                    Federal Reserve Bank of Cleveland. Federal Reserve officials and the
                              Governor’s staff discussed the possibility of bringing the privately insured
                              thrifts under federal deposit insurance. The president of the Federal
                              Reserve Bank of Cleveland told us that on March 10, 1985, the Federal
                              Reserve invited several large Ohio bank holding companies to discuss
                              purchasing Home State. Similar meetings with out-of-state institutions
                              concerning Home State and other privately insured thrifts that would not
                              qualify for federal insurance took place on March 16 and 17. The potential
                              buyers, which were unable to determine the financial condition of Home
                              State, wanted the state to provide indemnification or compensation for
                              losses. The Governor said he believed this would be unacceptable to the
                              legislature and voters.

                              Federal Reserve and Ohio state officials said they worked closely together,
                              despite the differences in their primary goals. Federal Reserve officials
                              were most concerned about stopping the run and preventing it from
                              spreading to other states. State officials were most concerned about
                              limiting the financial exposure of the state of Ohio and minimizing losses
                              to individual depositors. Officials of the Federal Reserve Bank of
                              Cleveland and the Ohio Governor’s Office had not worked together before,
                              and neither group fully understood at first the other’s responsibilities,
                              concerns, and resources, according to officials we interviewed. Officials
                              said that educational efforts required considerable time.

                              During the weekend of March 9 and 10, Federal Reserve officials said they
                              discussed the objectives of the Federal Reserve’s involvement; possible
                              future events; and operational and logistical actions, including ways to
                              improve operations for monitoring the run. Federal Reserve officials
                              focused on promoting cooperative efforts among the various parties
                              involved in managing the crisis.


To Enhance Coordination       Federal Reserve officials anticipated problems communicating and
and Communication,            coordinating with their examiners in the field who were monitoring the
Federal Reserve Engaged       run. The Federal Reserve Bank of Cleveland said it set up a situation room
                              to facilitate communication and coordination during crisis containment
in Nonroutine Activities      efforts. The room, which was near the offices of senior officials, was
                              equipped with 20 telephones, maps, televisions, and radios to monitor the
                              crisis, including media reports. Examiners were briefed about events,
                              provided with the latest financial information on thrifts insured by the



                              Page 55                                           GAO/GGD-97-96 Financial Crises
                              Chapter 4
                              The Ohio Savings and Loan Crisis




                              Guarantee Fund and packages of documents necessary for discount
                              window borrowing for the thrifts, and equipped with cellular telephones or
                              pagers.

                              Federal Reserve officials said, and Federal Reserve documents
                              demonstrate, that they engaged in other nonroutine activities to facilitate
                              crisis containment efforts. On March 11, 1985, Federal Reserve examiners
                              were positioned throughout Ohio near Guarantee Fund thrifts to
                              unobtrusively survey levels of depositor traffic in thrift lobbies and
                              parking lots. Examiners were to report activity back to the situation room.
                              The examiners were instructed to avoid doing anything that would alarm
                              thrift employees or their customers. Examiners were also to deliver
                              documents for borrowing at the discount window and establish secure
                              warehouses for collateral. Situation room personnel began to contact the
                              thrifts to advise them of the availability of the discount window, inquire
                              about withdrawals, and offer to send an examiner to deliver borrowing
                              documents and secure collateral.


Federal Reserve               Communications with the public were carefully managed by the Federal
Communicated Carefully        Reserve Bank of Cleveland. Officials of the Ohio Superintendent of
With the Public and Media     Savings and Loans, the conservator of Home State, and the Guarantee
                              Fund were not answering questions from the public. According to Federal
                              Reserve documentation, the Public Information Department at the Federal
                              Reserve Bank of Cleveland took calls from depositors, bank officers and
                              directors, municipal officials, congressional offices, and the print and
                              broadcast media. Questions concerned when deposits would be available,
                              deposit insurance, why thrifts had been closed, and how depositors were
                              supposed to pay their bills. The most difficult task was explaining that the
                              thrift crisis was the responsibility of the state of Ohio and not the federal
                              government and that the Federal Reserve was acting as a facilitator.

                              To ensure consistency and minimize confusion in communications with
                              the media, two officials were assigned the task of communicating with
                              media representatives. The Federal Reserve publicly restated its policy
                              that state-chartered institutions were eligible for liquidity assistance
                              through the discount window under normal terms and conditions.


As Runs Spread, Ohio          The runs on deposits intensified, spreading to other institutions insured by
Governor Closed Home          the Guarantee Fund, despite continued assurances from officials of the
State and Legislature Acted   State of Ohio and the Guarantee Fund that depositor money was safe.



                              Page 56                                           GAO/GGD-97-96 Financial Crises
                          Chapter 4
                          The Ohio Savings and Loan Crisis




                          About $23.4 million in withdrawals occurred on March 13 and $63.9 million
                          on March 14. According to Federal Reserve documentation, six Guarantee
                          Fund-insured thrifts were particularly hard-hit. At the drive-in windows of
                          some Cincinnati institutions, examiners observed some lines as long as
                          100 cars.

                          The Governor of Ohio and the state legislature took several actions to
                          reduce the widening depositor withdrawals. The Governor told us that he
                          announced that Home State would not reopen for business; he also
                          appointed a conservator to wind up the thrift’s affairs. At the time of its
                          failure, Home State had $1.4 billion in assets and 92,000 accounts at 33
                          offices. Home State’s problems would clearly exhaust the $130 million
                          Guarantee Fund.

                          On March 13, 1985, the Ohio legislature passed a bill that appropriated
                          $50 million for a new fund to back the remaining Guarantee Fund
                          thrifts—excluding Home State—and provided for thrift contributions of
                          $40 million. On March 14, the Chairman of the Federal Home Loan Bank
                          Board met with members of Ohio’s congressional delegation in
                          Washington, D.C. The Chairman of the Federal Home Loan Bank told us
                          that the subject of the meeting was expedited approval of federal deposit
                          insurance for the thrifts insured by the Guarantee Fund. Also on March 13,
                          1985, Federal Home Loan Bank officials began examining state reports on
                          thrifts to estimate the number eligible for federal deposit insurance.


Governor Declared Bank    The then-Governor of Ohio told us that on March 14, 1985, officials of
Holiday and Established   some of the privately insured thrifts told him that they were unable to stay
Public Communications     open through the end of the next day and lacked adequate collateral for
                          discount window borrowing to meet depositor demands. The Governor
Center                    considered several options: doing nothing, imposing limits on withdrawals,
                          or closing the thrifts. He decided to close the privately insured thrifts for
                          72 hours to stop the runs and buy time to devise a permanent solution to
                          the problem.

                          The then-Governor of Ohio said that on March 15, 1985, he and the
                          president of the Federal Reserve Bank of Cleveland held a news
                          conference announcing a Guarantee Fund thrift holiday for the remaining
                          70 thrifts.8 The president of the Federal Reserve Bank of Cleveland also
                          announced that liquidity help would be available when thrifts reopened.
                          That same day, the state of Ohio opened a telephone bank staffed by 300

                          8
                           Executive Order 85-7.



                          Page 57                                          GAO/GGD-97-96 Financial Crises
                            Chapter 4
                            The Ohio Savings and Loan Crisis




                            people to handle inquiries from the public concerning the state’s actions
                            and the safety of deposits. The day before the closed thrifts were due to
                            reopen, on March 17, the Governor met with over 100 thrift executives,
                            who told him they were concerned about additional runs on deposits.
                            After the discussion, the Governor decided to extend the bank holiday by 2
                            days.9


Governor and Federal        The Governor’s strategy was to restore depositor confidence by
Officials Pushed for        (1) completing emergency legislation requiring federal deposit insurance
Federal Insurance           for the Guarantee Fund-insured thrifts, (2) pursuing expedited approval of
                            federal deposit insurance from the federal government for those thrifts by
                            March 19, and (3) reopening those thrifts by March 19. According to
                            Federal Reserve documents, on March 19 and 20 Federal Reserve
                            examiners examined closed thrifts to determine which would be eligible
                            for federal deposit insurance. Some thrifts were well managed, in sound
                            financial condition, and would qualify for federal insurance; others were
                            not likely to qualify. On March 18 and 19, the Federal Home Loan Bank of
                            Cincinnati telephoned the privately insured thrifts to determine their plans
                            to seek federal deposit insurance. Over 200 examiners were sent to
                            expedite the application process for thrifts that indicated they would apply
                            for federal deposit insurance.


State Legislature Limited   The then-Governor of Ohio told us that on March 20, the Ohio state
Withdrawals, Required       legislature enacted a law that provided for the reopening of the closed
Federal Deposit Insurance   thrifts—on a limited basis in some cases and on a full-service basis in
                            others. The law limited thrifts to no more than $750 in withdrawals per
                            month per customer and required thrifts to have federal deposit insurance
                            before opening on a full-service basis. On March 29, 1985, 26 of the former
                            71 Guarantee Fund institutions had reopened with a full range of banking
                            activities—most with federal insurance. By the 24th of April, 51 of the 71
                            thrifts had opened, 31 with federal deposit insurance and 19 without, as
                            approved by the Ohio Superintendent of Savings and Loans. As of June 14,
                            1985, all but 8 of the original 71 privately insured thrifts had opened on a
                            full-service basis.

                            Home State, acquired by Hunter Savings and Loan of Cincinnati, reopened
                            on June 14, 1985. The state of Ohio had contributed a total of $129 million,
                            in addition to the resources provided by the Guarantee Fund, to reopen
                            Home State. The state of Ohio received $134 million from lawsuits.

                            9
                             Executive order 85-8.



                            Page 58                                          GAO/GGD-97-96 Financial Crises
                         Chapter 4
                         The Ohio Savings and Loan Crisis




                         Following the containment of the Ohio savings and loan crisis, two federal
Resolution:              laws were enacted to address problems that surfaced during the
Legislation Enacted to   crisis—fraudulent sales activities of government securities and disclosure
Address Government       to depositors about their depository institution’s insurance coverage. The
                         Government Securities Act of 1986 (P.L. 99-571) created tighter regulation
Securities Fraud and     of government securities brokers and dealers like ESM Government
Improve Disclosure       Securities. The act focused on secondary brokers and dealers that sell
                         government securities by requiring the dealers to register with SEC. It also
                         required new regulations designed to prevent fraudulent and manipulative
                         practices and protect the integrity, liquidity, and efficiency of the market
                         for government securities. Previously, such government securities brokers
                         and dealers were not regulated. The act required government securities
                         brokers and dealers to file independently audited balance sheets and
                         income statements at least once a year. Dealers were to meet regulatory
                         standards showing they had adequate cash reserves and properly managed
                         customer accounts and securities. Newly regulated members were
                         required to join a stock exchange, which made them subject to exchange
                         regulation.

                         The Federal Deposit Insurance Corporation Improvement Act of 1991 (P.L.
                         102-242) required all state-chartered banks, thrifts, and credit unions
                         without federal deposit insurance to conspicuously disclose that fact to
                         existing and prospective customers. These institutions were also required
                         to disclose that depositors are not guaranteed return of their money if the
                         institution fails. The provision also applied to any other institution, as
                         determined by the Federal Trade Commission, that might be mistaken for
                         a bank.




                         Page 59                                          GAO/GGD-97-96 Financial Crises
Chapter 5

The Stock Market Crisis of 1987


               The stock market crisis began on October 19, 1987, when a large and rapid
               sell-off of equity securities led to mechanical and liquidity problems in
               trading and financial systems at stock, options, and futures exchanges and
               associated clearing organizations. Credit relationships between financial
               firms and banks were also strained. The market break was extraordinary
               in terms of the speed and extent of falling prices and skyrocketing trading
               volume. This crisis showed that the size and potential impact of increased
               linkages between the equities markets and futures markets could change
               the character of a financial crisis. Factors that contributed to containing
               the crisis included the complementary leadership of the financial
               exchanges, the Treasury Department, and the Federal Reserve; the early
               offer of liquidity by the Federal Reserve to keep the markets functioning;
               swift and innovative action by federal financial regulators; and the
               collaboration of the private and public sectors.


               On October 19th, 1987, an accelerated and massive sell-off of equity
Summary of     securities and futures and options contracts led to automation and
Chronology     liquidity problems in U.S. financial markets and institutions. Difficulties
               also occurred in the clearance and settlement system and in bank
               extensions of credit to securities firms. European and Pacific rim financial
               centers experienced similar declines. Federal officials were most
               concerned that the U.S. system for allocating credit would be halted. To
               keep markets open and functioning as they should, federal officials and
               agencies took various actions in accordance with their individual
               authorities and responsibilities. For example, the White House and
               Treasury collaborated in making public announcements to foster
               confidence in the markets. Treasury discussed with finance ministries in
               London and Tokyo and other financial centers the importance of providing
               liquidity support to their markets. The Federal Reserve also discussed with
               other central banks the importance of providing liquidity support. The
               Federal Reserve provided prompt and sizable liquidity through open
               market operations. Around noon on October 20th, the market was
               plummeting and uncertainty existed about whether NYSE could remain
               open. However, buying activity in one stock index futures contract around
               noon signalled the turnaround of the markets. By the end of the week,
               markets were calmer, but some officials involved in trying to manage the
               crisis believed that luck played a major role in the recovery.




               Page 60                                          GAO/GGD-97-96 Financial Crises
                    Chapter 5
                    The Stock Market Crisis of 1987




                    On October 19 and 20, 1987, a large and rapid sell-off of equity securities
Preparedness:       led to automation and liquidity problems in trading and financial systems
Routine Market      at stock, options, and futures exchanges and associated clearing
Monitoring and      organizations. Credit relationships between financial firms and banks were
                    also strained. The crash was extraordinary in terms of the speed and
Existing Networks   extent of falling prices and skyrocketing trading volume. From the close of
Helped Prepare      trading Tuesday, October 13, to the close of trading Monday, October 19,
                    the Dow Jones Industrial Average (DJIA) declined by almost one-third,
Regulators          representing about a $1 trillion loss in value of all outstanding U.S. stocks.1
                     On October 19, the DJIA plunged 508 points (23 percent).2 NYSE volume was
                    604 million shares, more than twice the average daily volume for the year.

                    The individual markets experienced a variety of difficulties on the 19th
                    and 20th of October. NYSE specialists faced large order imbalances
                    throughout both days. NYSE’s automated order entry system was
                    overloaded because of insufficient capacity. Due to reduced
                    over-the-counter market-maker3 participation, investors had difficulty
                    getting timely price information, and NASD transaction reports were
                    delayed. A proliferation of option transactions within the same underlying
                    securities at CBOE in response to rapid price changes slowed trading. CBOE
                    stopped offering some options on individual stocks that were not trading
                    and did not trade one stock index option contract for over 1 hour. CME’s
                    clearing department received late payments4 and delayed some of its
                    payments, and CME suspended trading in the S&P 500 index futures
                    contract for about an hour on October 20, 1987. Derivatives option and
                    futures markets became disconnected from equity markets. Some
                    securities firms said that their banks were refusing to lend them additional
                    funds. Many firms were overwhelmed with customer orders, and some
                    firms were pressuring NYSE and NASD to stop trading so that they could
                    catch up with customer order flows.

                    At mid-day on October 20, the securities markets and the financial system
                    approached breakdown. The ability of stock, options, and futures markets


                    1
                    The DJIA, a price-weighted index of 30 stocks listed on NYSE, is the most widely followed indicator of
                    U.S. stock market movements.
                    2
                     Since the 1920s, only the drop of 12.8 in the DJIA on October 28, 1929, and the fall of 11.7 percent the
                    following day, which together constituted the Crash of 1929, have approached the October 19 decline
                    in magnitude.
                    3
                     Market makers are professional securities dealers who have an obligation to buy when there is an
                    excess of sell orders and to sell when there is an excess of buy orders.
                    4
                     These late payments were not rule violations, and CME took no action to declare the firm making the
                    late payments in default.



                    Page 61                                                              GAO/GGD-97-96 Financial Crises
                           Chapter 5
                           The Stock Market Crisis of 1987




                           to price equities was in question, and those markets were described as
                           disconnected. Many individual stocks ceased to trade because few buyers
                           were in the market, and trading in many individual options was halted.
                           Stock index futures were selling at a large discount, and investors were
                           questioning the value of equity assets. Rumors circulated that several
                           major market participants, including a clearinghouse, were about to fail.
                           The financial system was close to gridlock, and a widespread credit
                           breakdown seemed possible. The primary concern of federal officials was
                           that the U.S. system for allocating credit would be halted, and the financial
                           system would stop functioning.


Agencies Depended          Although the Federal Reserve had developed a written plan that outlined
Largely Upon Information   potential responses to a range of financial crises, no interagency meetings
and Existing               had been held before October 1987 to prepare for a market crash like the
                           one that occurred. However, an SEC official told us that a joint SEC-CFTC
Communication Networks     effort in 1986 to monitor expiration day effects—so-called triple-witching
                           days—helped prepare them to handle the market crash.5 The readiness of
                           federal officials and agencies to manage the market crash largely
                           depended upon the availability of information that federal agencies had
                           routinely collected, the existing communication networks among the
                           agencies, and the ability of the agencies to influence the behavior of
                           market participants and their creditors.

                           At the time of the crash, federal regulators, exchanges, and clearing
                           organizations routinely collected information on the financial health of
                           firms, the trading of financial instruments, and payments. Federal
                           regulators received quarterly detailed reports of firm capital levels. These
                           reports provided information on the likely resilience of firms to market
                           volatility. Exchanges and some federal regulators collected information on
                           the trading of financial instruments, such as customer identity, the number
                           of shares or contracts, price, and other trading information. CFTC collected
                           trading data through its large trader reporting system. Exchanges and the
                           over-the-counter securities market also collected information about the
                           performance of their specialists or market makers. CME’s clearing
                           department had a system that provided information about payments in the
                           futures clearance and settlement system.

                           Many of the federal agencies involved in responding to the market crash
                           had established interagency communication networks before the market

                           5
                            The term “triple-witching days” refers to the third Friday of March, June, September, and December,
                           when options and futures on stock indices expire concurrently and trading on index futures, index
                           options, and underlying stocks has been characterized by increased volume and price volatility.



                           Page 62                                                           GAO/GGD-97-96 Financial Crises
                          Chapter 5
                          The Stock Market Crisis of 1987




                          crash occurred. SEC, CFTC, and the exchanges had jointly developed a
                          telephone list of public and private sector market officials that included
                          both office and home phone numbers. Also, CFTC had routinely invited SEC
                          officials to market surveillance meetings focusing on volatility in stock or
                          options futures contracts, including a special surveillance meeting called
                          for the afternoon of Monday, October 19, on the basis of the previous
                          Friday’s 120-point drop. Many officials at SEC and CFTC had worked with
                          exchange and firm officials and understood their responsibilities,
                          concerns, and organizational resources. However, Federal Reserve and
                          Treasury officials had limited working experience with SEC and CFTC
                          officials.6 Also, the SEC Chairman, who was new to his position, had little
                          working experience with other senior federal financial officials.


                          Generally, federal officials and agencies acted within their respective
Containment:              authorities in responding to the market crash. Officials and agencies
Leadership, Swift         shared information willingly, although some information was simply
Action, and               unavailable. Interagency and public communications were occasionally
                          problematic. The most significant policy decisions, especially the decision
Collaborative Efforts     on whether or not to close NYSE, were made collaboratively. The NYSE
Helped Contain Crisis     Chairman consulted on this matter with officials at other exchanges,
                          federal regulatory agencies, Treasury, the Federal Reserve, and the White
                          House.


Federal Officials Acted   Federal officials and agencies responded to the market crash in
Within Their Agencies’    accordance with their respective authorities and responsibilities.
Authority                 Treasury’s objective was to keep markets open and encourage investor
                          confidence in the markets. To this end, according to the Secretary of the
                          Treasury, Treasury officials (1) consulted with and encouraged the
                          Federal Reserve to provide liquidity with open market operations;
                          (2) prepared a message for the president to encourage investor confidence
                          in the financial markets, including a call for a budget summit agreement to
                          reassure credit markets about the direction of long-term interest rates; and
                          (3) discussed with finance ministries in London, Germany, and Tokyo the
                          importance of providing liquidity support to their markets.

                          SEC and CFTC objectives were to preserve the integrity and economic utility
                          of securities and futures markets. To do this, SEC expedited various rule
                          reviews, and both SEC and CFTC consulted with exchanges and clearing

                          6
                           After the silver market crisis of 1979-1980, CFTC established quarterly interagency financial futures
                          surveillance meetings involving staff from CFTC, the Federal Reserve, and Treasury. SEC was invited
                          to participate after initiation of stock futures trading in 1982.



                          Page 63                                                            GAO/GGD-97-96 Financial Crises
                             Chapter 5
                             The Stock Market Crisis of 1987




                             organizations to ensure that these organizations were fulfilling their
                             responsibilities. One expedited rule review allowed additional issuer stock
                             buy-back programs so that companies could purchase their own securities
                             as long as they did not engage in manipulative activities.7 SEC and CFTC also
                             collected and disseminated information to federal officials on the financial
                             condition of member firms. The exchanges and NASD were directly
                             responsible for keeping their markets liquid and their trading systems
                             open and for monitoring firm capital. The NYSE Chairman consulted with
                             other officials—especially those at SEC and the White House—concerning
                             conditions at NYSE and the implications of closing it. Clearing organizations
                             were to keep payments flowing by ensuring timely payments.

                             The Federal Reserve’s primary objective was to provide financial system
                             liquidity, mainly through system repurchase agreements in open market
                             operations. To that end, and to reassure the markets, the Federal Reserve
                             issued a public statement of its readiness to serve as a source of liquidity
                             to support the economic and financial system. The Federal Reserve also
                             maintained a highly visible presence through open market operations in
                             arranging system repurchase agreements. One Federal Reserve official
                             was concerned that the liquidity put into the financial system would not be
                             working liquidity, i.e., would not be used for its intended purpose. Finally,
                             Federal Reserve officials discussed with officials of major banks the
                             importance of meeting unusually large customer financing needs.


Many Activities of Federal   In responding to the market crash, federal agencies performed many
Agencies Were Routine        well-defined, routine tasks. Exchanges and clearinghouses generally used
                             existing operational procedures to ensure that individual financial
                             instruments were trading and that payments were timely. NYSE operations
                             procedures followed existing rules that allowed specialists additional time
                             to open securities and to halt trading. SEC and CFTC monitored volatility
                             through procedures already developed to oversee expiration day effects.
                             SEC followed a drill to monitor the capital of the 25 largest firms. CFTC used
                             the large trader reporting system to analyze trading for the effects of
                             portfolio insurance and index arbitrage. The Federal Reserve’s
                             arrangements of system repurchase agreements were also a matter of
                             routine.




                             7
                              SEC regulations include a rule designed to prevent an issuer from dominating the market for its
                             securities; the rule pertains to volume, timing, price, and the manner of purchases. See 17 C.F.R. Sec.
                             240.10b-18.



                             Page 64                                                             GAO/GGD-97-96 Financial Crises
                        Chapter 5
                        The Stock Market Crisis of 1987




Agencies Shared         In the market crash case, agencies effectively shared crisis-relevant
Information but Some    information—data related to the financial health of firms, the functioning
Information Was Not     of trading systems, and payments in clearance and settlement systems.
                        Generally, such information went quickly and directly to senior
Available               decisionmakers both inside and outside the federal government. However,
                        federal regulators and some exchanges did not have all the information
                        they wanted.

                        Some of the desired information was available with some difficulty or after
                        some delay. For example, derivatives markets had difficulty pricing
                        options and futures because of an inability to get price data from NYSE.
                        CBOE had to request information from NYSE on which stocks were trading.
                        SEC and CFTC had to request additional information from firms on trading
                        strategies. The Federal Reserve and SEC had to collect information about
                        credit relationships between firms and banks.

                        Other information was simply unavailable. According to a Federal Reserve
                        official we interviewed, no one knew whether capital calculations were
                        correct because equity prices were changing so rapidly. This complicated
                        the task of reassuring banks of the solidity of a firm’s capital. The largest
                        unknown during the crisis, of course, was the market sentiment of
                        participants and when and how much they would buy and sell.


Communications Were     The federal response to the market crash included some significant
Sometimes Problematic   communications problems. A message regarding the possible closure of
                        NYSE that the NYSE Chairman intended to give differed from the message
                        some heard. The NYSE Chairman said he told others that NYSE was having
                        problems, and if the decline continued there would be further problems.
                        Federal regulators and exchanges said that they were told that NYSE was
                        about to close. The NYSE Chairman called SEC and, according to SEC
                        officials, told them that NYSE was about to close. SEC called CFTC, NASD,
                        CBOE, and other exchanges and told them that NYSE was about to close.
                        According to an SEC official, the NYSE Chairman called SEC back about 10
                        minutes later and said that buyers were coming into the market and that
                        NYSE would stay open.


                        Miscommunication on this point also occurred between the SEC Chairman
                        and the print media. On the morning of October 19, 1987, at about 11:15
                        a.m., the SEC Chairman told reporters that he had discussed market
                        conditions with the NYSE Chairman and that a trading halt had been among
                        the items covered. He stressed that if the market fell too rapidly a trading



                        Page 65                                           GAO/GGD-97-96 Financial Crises
                             Chapter 5
                             The Stock Market Crisis of 1987




                             halt was an option. The wire services reported that SEC was considering a
                             trading halt, and SEC officials said that the SEC Chairman was misquoted.
                             About 1 p.m., SEC announced that no such trading halt was under
                             consideration. The NYSE Chairman announced that NYSE did not intend to
                             close unless required to do so by the President. CFTC told reporters that no
                             halt in trading of index futures was under consideration. According to a
                             NYSE official, although the comments attributed to the SEC Chairman
                             appeared to some to have spooked the markets and led to further price
                             declines, the sell-off of equity securities actually had nothing to do with
                             what the SEC chairman said.


Agencies Decided Some        In the market crash case, the heads of federal financial organizations and
Multijurisdictional Issues   exchanges and their senior staff collaboratively decided multijurisdictional
Collaboratively              issues. One example of this was the decision to keep NYSE open even
                             though specialists were overwhelmed and automated systems were
                             malfunctioning. Because this decision had implications beyond equities
                             markets, the NYSE Chairman consulted on this matter with officials at other
                             exchanges, federal regulatory agencies, Treasury, the Federal Reserve, and
                             the White House.

                             Another example of collective leadership was in the case of the near
                             failure of First Options of Chicago Inc. (First Options). Federal Reserve,
                             the Comptroller of the Currency, CBOE, and Options CC officials decided
                             how to keep First Options solvent, although this action was not well
                             coordinated according to OCC officials. First Options, the options clearing
                             firm with the largest number of option market makers, had severe liquidity
                             problems and required an infusion of $312 million from its holding
                             company, Continental Illinois Corporation. Continental bank, the parent
                             company, initially infused cash into First Options but took back the
                             advance at the instructions of OCC officials. These actions violated OCC
                             restrictions on the amount of money a bank can advance to an operational
                             subsidiary. Instead, First Options was made a subsidiary of the holding
                             company and received a cash infusion from the holding company.


Treasury and Federal         In the market crash case, the Federal Reserve and Treasury played
Reserve Led Efforts to       significant leadership roles in helping to restore confidence in the markets.
Calm Markets                 Actions of the Federal Reserve that helped restore confidence in the
                             market included the agency’s statement of readiness to provide liquidity,
                             its support of keeping NYSE open and First Options solvent, and its
                             encouragement of extensions of credit during the market crash.



                             Page 66                                          GAO/GGD-97-96 Financial Crises
                              Chapter 5
                              The Stock Market Crisis of 1987




                              Treasury’s successful effort to reassure institutional and individual
                              investors through statements from the President was especially important.
                              One exchange official we interviewed pointed out that in times of financial
                              panic, the most effective reassurance is likely to come from the White
                              House, especially because elected officials can be held accountable for
                              their words and actions.


                              Immediately after the market crash, various studies sought to describe and
Resolution: Crisis            explain the market crash and recommend actions to prevent such a crash
Studies Accompanied           from occurring again.
by Regulatory and
                              One study commissioned by the President said that the precipitous market
Legislative Initiatives       decline of mid-October was triggered by (1) an unexpectedly high
                              merchandise trade deficit that pushed interest rates to new high levels and
                              (2) proposed tax legislation that led to the collapse of the stocks of a
                              number of takeover candidates. According to this study, the initial decline
                              ignited mechanical selling by a number of institutions employing portfolio
                              insurance strategies and mutual fund groups reacting to requests from
                              investors to exit the fund and receive cash.8 This study concluded the
                              following:

                          •   One agency should coordinate regulatory issues that have an impact
                              across related market segments and throughout the financial system.
                          •   Clearing systems should be unified across marketplaces to reduce
                              financial risk.
                          •   Margins should be made consistent across marketplaces to control
                              speculation and financial leverage.
                          •   Circuit breaker mechanisms should be formulated and implemented to
                              protect the market system.
                          •   Information systems should be established to monitor transactions and
                              conditions in related markets.

                              SEC, CFTC, GAO,and exchanges also conducted studies that identified
                              various issues and set forth recommendations.9 Our study found two areas
                              needing immediate attention to help restore confidence in the markets and
                              alleviate concerns that the markets could crash again. Specifically, we


                              8
                               Presidential Task Force on Market Mechanisms, Report, Washington, D.C.: January 8, 1988.
                              9
                               See Commodity Futures Trading Commission, Division of Economic Analysis. Division of Trading and
                              Markets, Final Report On Stock Index Futures And Cash Market Activity During October 1987,
                              Washington, D.C.: Jan. 1988; and Securities and Exchange Commission, Division of Market Regulation,
                              The October 1987 Market Break, Washington, D.C.: Feb. 1988.



                              Page 67                                                         GAO/GGD-97-96 Financial Crises
Chapter 5
The Stock Market Crisis of 1987




found that (1) problems with the New York Stock Exchange’s systems
adversely affected trade executions and pricing information both in New
York and in other markets, and (2) decisions of federal and self-regulators
were made without benefit of any formal intermarket contingency
planning.10

In March 1988, a Working Group on Financial Markets was appointed by
the President to consider the major issues raised by numerous studies and
their recommendations.11 The members of the Working Group were the
senior officials of Treasury, the Federal Reserve, SEC, and CFTC, with the
Under Secretary for Finance of the Treasury serving as Chairman. The
Working Group made conclusions and recommendations in the areas of
circuit breakers,12 clearance and settlement, margin payments,
contingency planning, capital adequacy, and trade processing systems.13
The Working Group has continued to provide a forum for high-level
discussion of interagency financial regulatory issues.

The Market Reform Act of 1990 included provisions responsive to the
market crash experience.14 These provisions granted SEC additional
authority to suspend trading on a temporary basis in any nonexempt
security and at securities exchanges, subject to a presidential disapproval.
The act also gives SEC emergency authority to take steps to restore order
to securities markets, which can be accomplished through altering rules
on hours of trading, position limits, and clearance and settlement.

SEC, CFTC, and securities and futures exchanges implemented coordinated
circuit breaker mechanisms that provide for a 30-minute trading halt of all
securities and all derivative instruments after a 350-point DJIA decline in a
day and a 1-hour halt after a 550-point DJIA decline. Stock, options, and
futures markets also implemented a teleconferencing system linking
financial markets and regulators. Computer capacity has been increased at
exchanges and at broker-dealers. A 3-business-day settlement period has
also become standard for securities markets, which eliminates 2 days of
potential participant default.

10
 See Financial Markets: Preliminary Observations on the October 1987 Crash (GAO/GGD-88-38,
Jan. 26, 1988).
11
  Executive Order 12631.
12
 Circuit breakers are intended to deal with large and rapid market declines. When a particular price
has fallen by a specified amount over a specific time period, exchanges temporarily halt trading.
13
  Working Group on Financial Markets, Interim Report, Washington, D.C.: May 16, 1988.
14
  Public Law 101-432.



Page 68                                                           GAO/GGD-97-96 Financial Crises
Chapter 5
The Stock Market Crisis of 1987




The Federal Deposit Insurance Corporation Improvement Act of 1991
clarified that in extraordinary circumstances, the Federal Reserve could
lend from its discount window to anyone without legal constraints on the
use to which the credit was being put. As before, however, all borrowers
were required to show that they needed the Federal Reserve’s cash to
remain in business, could not borrow elsewhere, and had secure collateral
to back up the loans.




Page 69                                        GAO/GGD-97-96 Financial Crises
Appendix I

Major Contributors to This Report


                        Thomas J. McCool, Associate Director, Financial Institutions and
General Government      Markets Issues
Division, Washington,   Craig A. Simmons, Director (Retired)
D.C.                    Alison Kern, Assistant Director (Retired)
                        Patrick S. Dynes, Project Manager
                        Gordon Agress, Evaluator
                        Desiree W. Whipple, Reports Analyst


                        James L. Bothwell, Chief Economist
Office of the Chief
Economist,
Washington, D.C.
                        Helen H. Hsing, Director
Office of
Congressional
Relations,
Washington, D.C.




                        Page 70                                        GAO/GGD-97-96 Financial Crises
Bibliography


               Bailey, Norman. “The Response of the Government of the United States to
               the International Debt Crisis 1981-1983.” Report to SELA Conference,
               Caracas, May 30-31, 1984.

               Becker, Joseph D. “International Insolvency: The Case of Herstatt.”
               American Bar Association Journal. Volume 62. October 1976.

               Breeden, Richard C. “Statement Concerning the Bankruptcy of Drexel
               Burnham Lambert Group Inc.” Statement of the Chairman of the Securities
               and Exchange Commission Before the Senate Committee on Banking,
               Housing, and Urban Affairs. March 2, 1990.

               Belluck, Pam. “Continental Illinois Rescue May Doom FDIC Plan to Share
               Insurance Risk.” National Journal June 11, 1984.

               Board of Governors of the Federal Reserve System. The Federal Reserve
               System: Purposes and Functions. Washington, D.C.: 1984.

               Committee on Agriculture, Nutrition, and Forestry. Report of the
               Commodity Futures Trading Commission on Recent Developments in the
               Silver Futures Markets. Washington, D.C.: U.S. Government Printing
               Office, May 1980.

               Committee on Banking, Housing, and Urban Affairs. Lessons to Be
               Learned From The Drexel Failure And Possible Regulatory Affairs.
               Washington, D.C.: U.S. Government Printing Office, March 2, 1990.

               Committee on Government Operations. Ohio Savings And Loan Crisis And
               Collapse of ESM Government Securities, Inc. Washington, D.C.: U.S.
               Government Printing Office, 1985.

               Chaudhuri, Adhip. “The Mexican Debt Crisis, 1982.” Institute for the Study
               of Diplomacy. Georgetown University School of Foreign Service.
               Washington, D.C.: No date.

               Chicago Mercantile Exchange. Finding of the Committee of Inquiry:
               Examining the Events Surrounding October 19, 1987. Chicago: No date.

               Cline, William R. International Debt and the Stability of the World
               Economy. Institute for International Economics. Washington, D.C.:
               September 1983.




               Page 71                                         GAO/GGD-97-96 Financial Crises
Bibliography




Committee on Government Operations. Silver Prices And The Adequacy Of
Federal Actions In The Marketplace, 1979-1980. Washington, D.C.: U.S.
Government Printing Office, 1981.

Committee on Government Operations. Oversight Hearings Into The
Effectiveness of Federal Bank Regulation: Franklin National Bank Failure.
Washington, D.C.: U.S. Government Printing Office, 1976.

Commodity Futures Trading Commission. Division of Economic Analysis.
Division of Trading And Markets. Final Report On Stock Index Futures
And Cash Market Activity During October 1987. Washington, D.C.:
January 1988.

Commodity Futures Trading Commission. Division of Trading and
Markets. Follow-up Report on Financial Oversight of Stock Index Futures
Markets During October 1987. Washington, D.C.: January 6, 1988.

Commodity Futures Trading Commission. Division of Trading and
Markets. Analysis of Trading in the Chicago Board of Trade’s Major Market
Index Futures Contract on October 20, 1987. Washington, D.C.: January 4,
1988.

Conover, C. T. “Statement.” Statement of the Comptroller of the Currency
Before the House Committee on Banking, Finance, and Urban Affairs.
September 19, 1984.

Corrigan, E. Gerald. “The Financial Disruptions of the 1980s: A Central
Banker Looks Back.” Washington, D.C.: Group of Thirty, 1993.

Dean, James W. and Ian H. Giddy. “Averting International Banking Crises.”
Salomon Brothers Center for the Study of Financial Institutions. Graduate
School of Business Administration. New York University. No date.

Drabek, Thomas. Emergency Management: Strategies for Maintaining
Organizational Integrity. Springer-Verlag. New York: 1990.

Drabek, Thomas and Gerard J. Hoetmer (Editors) Emergency
Management: Principles and Practices for Local Government. Washington,
D.C.: International City Management Association, 1990.




Page 72                                         GAO/GGD-97-96 Financial Crises
Bibliography




Dynes, Russell R. and E.L. Quarantelli. “A Perspective on Disaster
Planning.” Disaster Research Center. Newark, Delaware: University of
Delaware, May 1981.

Edwards, Franklin R. “A Tremor That Shook The World: Lessons From
The Crash of 1987.” Commodities Law Letter. Volume VII, Nos. 9 & 10.
November/December 1987.

Eichengreen, Barry and Richard Portes. “The Anatomy of Financial
Crises.” Cambridge, Massachusetts: National Bureau of Economic
Research, January 1987.

Feldstein, Martin. The Risk of Economic Crisis. University of Chicago
Press. Chicago: 1991.

Feldstein, Martin. “Reducing the Risk of Economic Crisis.” National
Bureau of Economic Research. Cambridge, Massachusetts: February 1991.

Fitzpatrick, Colleen and Dennis S. Mileti. “Public Risk Communication.”
Disaster, Collective Behavior and Social Organization. Newark, Delaware:
University of Delaware Press. No date.

General Accounting Office. Financial Audit: Resolution Trust
Corporation’s 1995 and 1994 Financial Statements. (GGD-96-123, July 2,
1996).

General Accounting Office. Mexico’s Financial Crisis: Origins, Awareness,
Assistance, and Initial Efforts to Recover. (GGD-96-56, February 23, 1996).

General Accounting Office. Financial Derivatives: Actions Needed to
Protect the Financial System. (GGD-94-133, May 18, 1994).

General Accounting Office. 1992 Thrift Resolutions: RTC Policies and
Practices Did Not Fully Comply With Least Cost Provisions. (GGD-94-110,
June 17, 1994).

General Accounting Office. Securities Firms: Assessing the Need to
Regulate Additional Financial Activities. (GGD-92-70, April 21, 1992).

General Accounting Office. Clearance and Settlement Reform: The Stock,
Options, and Futures Markets Are Still At Risk. (GGD-90-33, Apr. 11, 1990).




Page 73                                           GAO/GGD-97-96 Financial Crises
Bibliography




General Accounting Office. Troubled Financial Institutions: Solutions to
the Thrift Industry Problem. (GGD-89-47, Feb. 21, 1989).

General Accounting Office. Thrift Failures: Costly Failures Resulted From
Regulatory Violations and Unsafe Practices. (AFMD-89-62, June 16, 1989).

General Accounting Office. Financial Markets: Preliminary Observations
on the October 1987 Crash. (GGD-88-38, January 26, 1988).

General Accounting Office. International Banking: Supervision of Overseas
Lending Is Inadequate. (NSIAD-88-87, May 5, 1988).

General Accounting Office. Farm Credit: Actions Needed on Major
Management Issues. (GGD-87-51, Apr. 1987).

General Accounting Office. “Statement.” Statement for the Record by the
Comptroller General of the United States Concerning the Federal Rescue
of Continental Illinois National Bank Submitted to the House Committee
on Banking, Finance, and Urban Affairs. December 14, 1984.

General Accounting Office. Guidelines for Rescuing Large Failing Firms
and Municipalities. (GGD-84-34, March 29, 1984).

Gould, George D. “Statement.” Statement to the Committee on Energy and
Commerce. Financial Market Regulatory Reform.

Greenspan, Alan. “Statement.” Statement of the Chairman of the Board of
Governors of the Federal Reserve System Before the Senate Committee on
Banking, Housing, and Urban Affairs. Black Monday: The Stock Market
Crash of October 19, 1987. Washington, D.C.: U.S. Government Printing
Office, February 1988.

Hineman, Kalo A. “Statement.” Statement of the Acting Chairman of the
Commodity Futures Trading Commission Before the House Committee On
Agriculture. Review of Recent Volatility in The Stock Market and Stock
Index Futures Markets. Washington, D.C.: U.S. Government Printing
Office, November 4, 1987.

Isaac, William M. “Statement on Federal Assistance to Continental Illinois
Corporation and Continental Illinois National Bank.” Statement of the
Chairman of the Federal Deposit Insurance Corporation Before the House
Committee on Banking, Finance, and Urban Affairs. October 4, 1984.



Page 74                                         GAO/GGD-97-96 Financial Crises
Bibliography




Isaac, William M. “Continental Illinois: The Implications.” Address Before
the Association of Bank Holding Companies. June 22, 1984.

Isaac, William M. and Margaret L. Maguire. “Federal Deposit Insurance and
the Changing Role of the Federal Deposit Insurance Corporation.” No
location. No date.

Jackson, William. “Public Rescue Of Private Liabilities.” Washington, D.C.:
Congressional Research Service, November 20, 1985.

Jickling, Mark. “The Stock Market Crash Revisited.” Washington, D.C.:
Congressional Research Service. October 31, 1989.

Kindleberger, Charles P. Manias, Panics and Crashes: A History of
Financial Crises. Basic Books. New York: 1989.

Kraft, Joseph. The Mexican Rescue. Group of Thirty. New York: June 1984.

Kuczynski, Pedro-Pablo. “Latin American Debt.” Foreign Affairs. Winter
1982/83.

Kuczynski, Pedro-Pablo. Latin American Debt. Twentieth Century Fund.
New York: no date.

Lagadec, Patrick. “Communication Strategies In Crisis Situations.”
International Institute for Applied Systems Analysis. No location.
November 1985.

Leeds, Roger S. and Gale Thompson. The 1982 Mexico Debt Negotiations.
The Johns Hopkins Foreign Policy Institute. Washington, D.C.: 1987.

Masson, Paul R. and Michael Mussa. The Role of IMF: Financing and Its
Interactions with Adjustment and Surveillance. Washington, D.C.: 1995.

Mishkin, Fredric S. “Preventing Financial Crises: An International
Perspective.” Cambridge, Massachusetts: National Bureau of Economic
Research, February 1994.

Morgan Guaranty Trust Company. “Mexico: Progress and Prospects.” New
York: May 1984.




Page 75                                          GAO/GGD-97-96 Financial Crises
Bibliography




National Commission on Financial Institution Reform, Recovery, and
Enforcement. Origins, and Causes of the S&L Debacle: A Blueprint for
Reform. Washington, D.C.: July 1993.

Perrow, Charles. Normal Accidents: Living With High Risk Technologies.
New York: 1984.

Presidential Task Force on Market Mechanisms. Report. Washington, D.C.:
U.S. Government Printing Office, January 8, 1988.

Quarantelli, E.L. “Thirty Years of Catastrophe Research.” States of
Emergency, Technological Failure and Social Destabilization. Edited by
Patrick Lagadec. London: Butterworth-Heinemann, 1990.

Quarantelli, E.L. “What Should We Study? Questions And Suggestions for
Researchers About The Concept of Disasters.” International Journal of
Mass Emergencies and Disasters. March 1987.

Ruder, David R. “Securities and Exchange Commission Recommendations
Regarding The October 1987 Market Break.” Statement of the Chairman of
the Securities and Exchange Commission Before the Senate Committee on
Banking, Housing, and Urban Affairs. February 3, 1988.

Securities and Exchange Commission. Division of Investment
Management. Protecting Investors: A Half Century of Investment Company
Regulation. Washington, D.C.: May 1992.

Securities and Exchange Commission. Division of Market Regulation. The
October 1987 Market Break. Washington, D.C.: February 1988.

Securities and Exchange Commission. The Silver Crisis. Washington, D.C.:
October 1982.

Siegman, Charles. “The Bank for International Settlements and the Federal
Reserve.” Federal Reserve Bulletin. October 1994.

Sinkey, Joseph F. “The Collapse of Franklin National Bank.” Journal of
Banking Research. Summer 1976.

Smith, Gordon W. and John T. Cuddington. International Debt and the
Developing Countries. World Bank. Washington, D.C.: no date.




Page 76                                         GAO/GGD-97-96 Financial Crises
           Bibliography




           Solomon, Burt. “Savings and Loans, on the Run, Searching for a Way to
           Survive.” National Journal. June 15, 1985.

           Spero, Joan E. “Guiding Global Finance.” Foreign Policy. No. 73. Winter
           1988-89.

           Spero, Joan E. The Failure of Franklin National Bank. New York:
           Columbia University Press, 1980.

           Sprague, Irvine H. Bailout: An Insider’s Account of Bank Failures and
           Rescues. Basic Books. New York: 1986.

           Tamarkin, Bob. The Merc: The Emergence of a Global Powerhouse. New
           York: Harper Collins, 1993.

           Volcker, Paul A. and Toyoo Gyohten. Changing Fortunes: The World’s
           Money and the Threat to American Leadership. Times Books. New York:
           1992.

           Welles, Chris. “Drysdale: What Really Happened.” Institutional Investor.
           September 1982.

           Wolfson, Martin H. Financial Crises: Understanding the Postwar U.S.
           Experience. M.E. Sharpe. Armonk, New York: 1986.

           Working Group on Financial Markets. Interim Report. Washington, D.C.:
           May 16, 1988.




(233391)   Page 77                                         GAO/GGD-97-96 Financial Crises
Ordering Information

The first copy of each GAO report and testimony is free.
Additional copies are $2 each. Orders should be sent to the
following address, accompanied by a check or money order
made out to the Superintendent of Documents, when
necessary. VISA and MasterCard credit cards are accepted, also.
Orders for 100 or more copies to be mailed to a single address
are discounted 25 percent.

Orders by mail:

U.S. General Accounting Office
P.O. Box 6015
Gaithersburg, MD 20884-6015

or visit:

Room 1100
700 4th St. NW (corner of 4th and G Sts. NW)
U.S. General Accounting Office
Washington, DC

Orders may also be placed by calling (202) 512-6000
or by using fax number (301) 258-4066, or TDD (301) 413-0006.

Each day, GAO issues a list of newly available reports and
testimony. To receive facsimile copies of the daily list or any
list from the past 30 days, please call (202) 512-6000 using a
touchtone phone. A recorded menu will provide information on
how to obtain these lists.

For information on how to access GAO reports on the INTERNET,
send an e-mail message with "info" in the body to:

info@www.gao.gov

or visit GAO’s World Wide Web Home Page at:

http://www.gao.gov




PRINTED ON    RECYCLED PAPER
United States                       Bulk Rate
General Accounting Office      Postage & Fees Paid
Washington, D.C. 20548-0001           GAO
                                 Permit No. G100
Official Business
Penalty for Private Use $300

Address Correction Requested