THE QUARREL continues over the Continental Illinois National Bank and whether the federal regulators should haver rescued its depositors. The House Banking Committee has been holding hearings, and the chairman, Fernand St Germain, derided the regulators' suggestion that Continental's collapse could have caused the failure of perhaps as many as 100 smaller banks with funds on deposit there. By Mr. St Germain's calculation, the failures would "probably" have been close to zero.
Mr. St Germain is being slightly inconsistent. Over the past month he has been arguing (correctly) that the Continental affair reveals a degree of fragility in the financial system that ought to make other people -- i.e., the Senate Banking Committee -- cautious about those exciting new schemes for further deregulation of the banks. But he is also arguing (not so correctly) that the federal government should not have interceded as it did to keep the bank in business.
True, the present federal policy is unfair. It allows small banks to fail, but not the big ones. The reason for this is that big banks hold very large deposits, of which only the first $100,000 is covered by deposit insurance. In a classic failure, everything beyond the insurance may be lost. Since some of those vanished deposits are money invested by smaller banks, the domino effect is a real possibility.
If Continental had collapsed flat -- as it surely would have done without federal intervention -- the results would have been incalculable. How many smaller banks would have followed it? Certainly more than the House committee's estimate of close to zero, but no one can know how many -- or which ones. That's the insidious thing about it. Everyone hears rumors and begins snatching money out of the local bank. It's been a long time since there have been genuine bank panics in this country, and people seem to have forgotten the speed and force with which they can develop.
While the deposits were guaranteed in the Continental case, the bank's top managers have been replaced, and the stockholders have been all but wiped out. There have been some suggestions that the practice of rescuing big banks will make the bankers careless and shield them from the discipline of the market. But there is not much in Continentals' sad story to encourage any bank's chairman to cut corners. In this instance the owners have emerged very little better than if the bank had been through a conventional failure.
The regulators' job is to defend the stability of the banking system as a whole and to prevent one bank's troubles from spreading. Those are the standards that count. And by those standards, the rescue of Continental was a success.