Financial Crises: Understanding the Postwar U.S. Experience

The financial crises that erupted during 1982 were managed in such a way that a cumulative debt-deflation process, of the sort that had led to depressions in the past, ¹ was avoided. Nonetheless, the problems of 1982 did not disappear. In fact, their subsequent reemergence again threatened the financial system and the economy with financial crisis.

In general, the problems that borrowers and financial intermediaries had during the recession in 1982 continued on into the subsequent economic recovery and expansion. The severity of the 1981-82 recession, and its occurrence so soon after the 1980 recession, significantly impaired the quality of loans of financial intermediaries. The combination of high real interest rates, low inflation, and the strong dollar, which continued into the expansion, put further pressure on borrowers and made the usual cyclical improvement in credit quality more difficult.

In particular, the failure of Penn Square Bank in 1982 played a major role in the effective failures of Seattle First National Bank (Seafirst) in 1983 and Continental Illinois National Bank and Trust Company in 1984. The structural problems of the nation's thrift institutions, which caused serious concern during 1980-82, contributed to two critical outbreaks in the subsequent period: the run on the deposits of American Savings and Loan Association (a subsidiary of the Financial Corporation of America and the nation's largest thrift), and the crisis of state-insured savings and loan associations in Ohio and Maryland.

In addition, problems in the use of repurchase agreements (RPs), which were involved in the Drysdale incident in 1982, again reappeared. Losses on RP transactions by Home State Savings Bank of Cincinnati played an important role in the Ohio thrift crisis.

As mentioned in chapter 8, a number of the nation's largest banks suffered losses as a result of the loans they had purchased from Penn Square. The two banks with the largest losses were Continental Illinois and Seafirst. Although Continental survived until 1984, Seafirst had to be rescued by an emergency merger with

-92-