The Supreme Court yesterday let stand a decision that the Federal Deposit Insurance Corp. must guarantee payment of every obligation arising from the collapse of the United States National Bank in San Diego - the second largest bank failure in American history.
With only Justice Harry A. Blackmun dissenting, the court refused a government petition for review of the ruling that warned of dire consequences.
The ruling significantly restricts the agency's authority "to deal with the consequences of bank failure," Solicitor General Wade H. McCree wrote in the petition.
In addition, McCree said, the decision "may well encourage lenders to make loans to a bank's controlling shareholders, with little or no regard for the financial stability of either the borrowers or the bank; such loans, which could jeopardize the credit of the controlled bank, might contribute to additional bank failures."
Even if the ruling by the 9th U.S. Circuit Court of Appeals doesn't "contribute to financial mismanagement of banks, it turns the FDIC's insurance fund, which Congress created to project innocent depositors in the event of failure, into a guarantor of loans made by professional bankers," McCree said.
Although Congress enacted new bank regulatory legislation early Sunday morning, Reford Wedel, the FDIC's acting general counsel, said it may be a couple of days before he will be able to say whether it alters the situation.
When the FDIC put the USNB in receivership in October 1973, the bank was a huge venture with 62 offices and nearly $1 billion in 344,000 accounts. It also turned out to have about $300 million in uninsured deposits. And its assets of $855 million were $218 million less than its liabilities.
C. Arnholt Smith, the controlling stockholder, is now on trial on state fraud charges. Earlier, he had pladed no contest, and was fined $30,000, on federal charges of scheming to defraud USNB of $27.5 million and to have it lend $175 million illegally. He had been convicted and fined $10,000 on separate federal charges of making illegal campaign contributions.
In the Supreme Court, the central issue involved $45 million in debts incurred by the "Designated Group," which consisted of Smith and his associates.
Because the group controlled USNB, it was "able to obtain USNB's guarantee of their personal debts - debts they could not have incurred if they had relied solely on their own creditworthiness," McCree said.
The device used by the group was standby letters of credit. USNB issued them to other banks to guarantee the group's debts. The letters obligated USNB to pay in event of default by the group.
When the FDIC took over, at least in theory, it could have liquidated the assets. But this would have denied FDIC insurance of about $300 million and disrupted the financial affairs of hundreds of thousands of innocent persons.
Instead, the agency tried to find a bank to buy USNB's assets, assume its liabilities and continue its operations. But all banks approached by the FDIC judged the standby letters of credit as unacceptable risks, and refused to consider a takeover unless the agency either guaranteed the Designated Group's obligations or scrubbed its obligations from the transaction.
Finally the FDIC accepted the highest bid, from Crocker National Bank Under it. Crocker paid $89.5 million for the value of USNB as a growing concern aided by a FDIC loan of $128.8 million representing the difference between those obligations Crocker assumed and the value of the assets it purchased, less the premium paid. FDIC then took a first lien on all USNB assets that Crocker didn't want.
The lien dwarfed all of the USNB assets that remained. Thus the standby letters of credit became worthless.
The FDIC's position was that the Federal Deposit Insurance Act excuse it, as receiver, from antipreference and other provisions of the National Bank Act.
Two of the losers were the First Empire Bank-New York (FEB), which in 1976 merged into the Manufaturers and Traders Trust Co., of Buffalo, and Societe Generale of Paris (Sogen). Their stake was about $11 million.
FEB and Sogen sued. They alleged that the purchase and assumption transaction violated the bank act. The FDIC said that such a transaction is governed by the deposit act.
Federal Judge Leland C. Nielsen ruled for the FDIC. The appeals court reversed last April. It recognized the agency's dual role as an insurer of deposits and as a receiver and said that, in this role, the FDIC frequently must lend or sell to itself."