THE FIRST Pennsylvania Bank -- the big Philadelphia bank that the federal regulators rescued this week -- was a victim of inflation. The bank's troubles are one more sign of the strains that high and unpredictable interest rates are imposing on the financial system.
In a deeply cautious reaction to the last recession, the bank began, several years ago, to divert money away from normal commercial lending. Instead, it went into long-term government securities. If inflation and interest rates had declined, the story would have had a happy ending. But, of course, they rose rapidly. The bank had, in effect, lent its money to the government for long periods at interest rates that were fixed. Meanwhile it was borrowing from its depositors for short periods at rates that the market forced steadily higher. That's how the cash squeeze developed.
There was, please notice, no hint of fraud, no adventuring on high-risk loans, no speculation on foreign exchange. On the contrary, the bank's error lay in trusting too much in the conventional -- but obsolete -- idea that long-term government obligations are the ultimate in financial safety. As those who know and love the city will recognize, it was a very Philadelphian mistake.
Safety in banking, under present conditions, requires a careful balance of the maturities of assets and liabilities. There are now banks that have turned themselves into wholesalers of debt, serving their clients -- other banks -- by putting together packages of loans tailored to maintain that crucial balance. For each dollar of time deposits coming due in, say, 60 days, there needs to be a dollar loaned out that will come due in 60 days. That's inflation-proof management, ensuring that interest-rate changes hit both sides of the ledger equally. First Pennsylvania neglected that rule.
The instrument of the rescue is half a billion dollars in loans, two-thirds of it from the Federal Deposit Insurance Corporation at heavily subsidized rates. The rest comes from 22 commercial banks. That's not a small effort, and yet this bank was not fundamentally in bad shape. It's not as if it were holding a lot of defaulted loans. This case is another warning that even very large and conservatively managed institutions can get into difficulties. Here the regulators managed once again to avert a collapse, but it is far from clear that they have adequate scope to deal with the crises that may well lie ahead. The House Banking Committee is considering legislation to remove one obstruction -- the old prohibition against interstate banking mergers and takeovers -- that might prove crucial in a future emergency. The Philadelphia case suggests that the bill needs to be moved along without delay.