Financial Crises: Understanding the Postwar U.S. Experience

By Martin H. Wolfson | Go to book overview

10
The Collapse of Speculative
Lending and Investment

The crises in the state deposit insurance systems in Ohio and Maryland, which involved the first runs by retail depositors since the 1930s, loomed large on the financial landscape in 1985. A similar problem occurred in Rhode Island in January 1991. At this time Rhode Island's governor ordered credit unions and small banks closed because of the bankruptcy of their private insurer, the Rhode Island Share and Deposit Indemnity Corporation. This crisis disrupted the state, and the financial affairs of depositors were thrown into turmoil. Yet at the same time one of the largest banks in the country, the Bank of New England, was being closed by bank regulators, and by 1991 Rhode Island's disturbance seemed relatively minor compared to the monumental events that had shaken the financial system in the late 1980s and early 1990s.

These events included a bailout of savings and loan associations, a stock market crash, financial difficulties and failures of many of the nation's largest financial institutions, the transformation of the corporate landscape by hostile takeovers and leveraged buyouts (with significant financing from junk bonds), the collapse of the junk bond market, and (in 1992) the disruption of the European Monetary System by foreign-exchange speculation. This chapter examines these developments.


The Growth of Speculative Lending and Investment

To an important degree, the story of the 1980s involves the growth, and subsequent collapse, of speculative lending and investment. The dictionary defines speculation as the "assumption of unusual business risk in hopes of obtaining commensurate gain," and this describes well the nature of many financial transactions in the 1980s. This speculative lending and investment involved many major financial institutions and markets. Three of the most intense arenas were commercial real estate, junk bonds, and the stock market.

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