A federal district judge ruled today that the Federal Reserve Board and the Federal Deposit Insurance Corp. acted properly in dismantling Franklin National Bank in 1974.
Judge Milton Pollack ruled that the two federal agencies were "fair" to the estate of Franklin National Bank and declined a petition of both the estate and one of its creditors to reduce the amount of interest the Federal Reserve received for loans it made to the failed bank.
When Franklin failed in October 1974 it was the 20th largest bank in the country. The failure was the largest in the nation's history.
Sol Neil Crobin, trustee of Franklin, and Connecticut General Life Insurance Co., which owns Franklin National bonds, alleged that the FDIC agreed to pay too high an interest rate to the Federal Reserve in return for the central bank's agreement to release its lien on $2.2 billion of Franklin's assets and to wait for three years to be paid off on the $1.7 billion in loans it made to Franklin between May 1974 and October 1974.
The Fed had a lien on Franklin's assets as collateral for the loans it made the bank.
Stockholders in Franklin and its creditors were paid from Franklin's estate after the Federal Reserve was paid off.
The higher the interest rate the central bank received, the less creditors and shareholders would receive from Franklin's estate.
In order to keep Franklin open and to avoid a run on its deposits, the Fed made the loans to the bank through its so-called discount window.
When Franklin finally failed in October 1974 -- its problems became public in May 1974 -- the FDIC took over the bank as receiver. It immediately sold the bank's 104 branches and some other assets to European American Bank.
At issue was the dual role the FDIC played in the bankruptcy and liquidation. It was both receiver -- the representative of the estate -- and insurer of deposits in the bank.
As insurer, it wanted to sell Franklin's branches and deposits to avoid having to pay off. As receiver, it wanted to get the best possible deal for Franklin's estate, including the lowest possible rate from the Fed.
To be able to sell Franklin to European American the FDIC had to get the Federal Reserve to release its lien on the bank's assets. The plaintiffs argued that the FDIC agreed to excessive interest (about 8 1/2 percent) to get the Fed to hold off on collecting its loan for three years and to release its lien.
Judge Pollack, of the Southern District Court of New York, said that the two agencies negotiated the complex matters at arms length, exercised sound judgment and "were fair to enter receivership estate and were not a breach of fiduciary duty." He also said the Federal Reserve Bank did not act unfairly.