5 Lessons from Americas First Too-Big-To-Fail Bank

By John MaxfieldFool.com

The former headquarters of Continental Illinois National Bank and Trust. Image source: Wikimedia Commons.

While most people associate the concept of "too big to fail" with the financial crisis of 2008-09, its origins actually date back to the 1984 government takeover of Continental Illinois National Bank and Trust. The nation's seventh-largest lender at the time, Continental Illinois found itself on the brink of failure after a series of strategic missteps caused creditors to pull funding from the bank.

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Former Continental Illinois executive James McCollom recounted the Chicago bank's downfall in The Continental Affair: The Rise and Fall of the Continental Illinois Bank. What follows are five things I learned from the book, as well as from an FDIC analysis of the bank's demise:

1. Today's darlings are tomorrow's pariahsIn the years before Continental Illinois was nationalized, it was heralded as one of the best companies -- not just banks -- in the country. From an FDIC report noting the irony:

2. Rapid growth is a red flagIn an excellent history of banking and money in the United States, Money of the Mind, James Grant wrote that:

This perfectly captures the situation at Continental Illinois. Between 1976 and 1981, it expanded at a faster rate than any other bank in its peer group, increasing assets by 111%. Even more emblematic of its subsequent troubles, it expanded its portfolio of commercial and industrial loans by 180% over the same five-year stretch.

3. High profits often precede a fallWith the first two points in mind, it should come as little surprise that record profits oftentimes also precede a fall. In Continental Illinois' case, it was the second-most profitable bank in its peer group from 1977 to 1981.

4. The perils of relying on "hot money"The fastest way for a bank to fail is to rely on "hot money" -- namely, short-term loans from the money market, brokered deposits, and large institutional deposits from abroad. A run on the latter led to Continental's failure.

5. Rumors alone can bring down even the biggest of banksWhile Continental Illinois was guilty of mismanagement, that alone didn't kill the bank. The culprit stemmed instead from an unfounded rumor published by Reuters claiming the bank was on the verge of declaring bankruptcy.

The rumor, telexed into trading pits around the world, unsettled institutional depositors in Japan, who pulled their funds from the bank and, in doing so, triggered a broad-based run on Continental Illinois' funding. Over the next two weeks, the bank lost billions of dollars in deposits and money market funds, had to tap the Federal Reserve's discount window to stay afloat, and ultimately had to be taken over by the FDIC lest the nation's seventh-largest bank fail.

The article 5 Lessons from Americas First Too-Big-To-Fail Bank originally appeared on Fool.com.

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