A Bad Case of the Jitters

By John Greenwald

Manufacturers Hanover is the latest target of rumors in the financial world

The rumors last Thursday first erupted in Europe. Manufacturers Hanover, the fourth-largest U.S. bank, was reported to be scrambling frantically to raise cash abroad because it was no longer able to get money in the U.S. Other American banks, or so the stories had it, also faced new dangers. Then, with little more provocation than that, something akin to a panic began to spread. It swept like a spring twister through markets that were already tense and jittery about the health of the American financial system after the narrow escape from failure a week earlier of Chicago's Continental Illinois Bank.

On Wall Street, investors began battering bank stocks. Hardest hit was Manufacturers Hanover, which lost 3% points, or nearly 11% of its value, in a single day of trading. A sharp slump in bank issues helped drive the Dow Jones industrial average to 1103.43, its lowest level in 15 months. In bond trading, prices also sank. Elsewhere, sell-offs rocked the London Stock Exchange, and the high-flying U.S. dollar went into a steep tailspin.

Manufacturers Hanover denied that it suddenly needed to raise cash and called the rumors "absurd." Senior Vice President James Hambelton said the bank had one of the smallest portfolios of bad loans of any lender its size.

In all, less than 2% of Manufacturers Hanover's loans are nonperforming, or not paying interest. Said Hambelton: "We never had any funding problems." The banker was particularly incensed by reports that Manufacturers Hanover was selling off British government bonds, or "gilts," to help meet obligations. He angrily denied even owning such bonds.

The banking worries reached all the way into the Oval Office of the White House. Thursday afternoon, Treasury officials briefed President Reagan on the turmoil in the markets. White House Spokesman Larry Speakes said afterward that Reagan had been assured that the Manufacturers Hanover rumors were "without foundation."

After all the jitters on Thursday, however, financial markets opened calmly on Friday. The dollar strengthened abroad, and the Dow Jones industrial average rose nearly 4 points, to 1107.10. Bank stocks recouped some of their losses from the previous day. The whiff of panic seemed to be over, at least for now.

Nonetheless, the episode on Thursday showed how vulnerable the financial system has become to runaway rumors. Banking woes ranging from huge portfolios of bad foreign loans, to rising interest rates, to the near collapse of Chicago's Continental have made investors nervously look around at the whole banking system. Only a $7.5 billion Government-led rescue kept Continental (1983 assets: = $42 billion) from becoming the largest U.S. banking casualty in history. Said James Hanbury, a banking analyst for the Manhattan securities firm Wertheim & Co.: "After Continental, investors are acting first and asking questions later."

It was Manufacturers Hanover's mountainous pile of Latin American loans that made it a target for rumors. The $6.5 billion that it has extended to the region's four biggest borrowers represents 10% of the bank's total assets. If a wave of defaults by Latin American borrowers were to take place, Manufacturers Hanover would be in a very difficult situation.

Speculation about a possible Latin American debtors' cartel that would try to dictate new loan terms to bankers has added to the jitters. In a joint statement last week, the Presidents of Brazil, Mexico, Argentina and Colombia complained that the interest rates they are being charged have reached intolerable levels. Said the four: "We do not accept seeing ourselves forced into a situation of insolvency and continuous economic crisis." While some American bankers insist that the formation of a cartel is unlikely, other moneymen remain fearful.

The Latin debt crisis took another turn at week's end when the Dominican Republic broke off talks with the International Monetary Fund. The move jeopardized the Caribbean nation's ability to renegotiate its $2.4 billion in foreign debt, because lenders have insisted that it first reach agreement on an austerity program with the IMF. But Dominican leaders, fearful that IMF demands for a sharp hike in gasoline prices would spark a new round of violent protests, decided to quit the talks.

Among the key questions hanging over the banking system is the future of ailing Continental. The Government-led rescue only temporarily solved the bank's problems. Continental will probably still need to be merged with some stronger institution. The most attentive suitors for Continental appear to be New York's Chemical Bank and First National Bank of Chicago, Continental's neighbor and archrival. Chemical (1983 assets: $51.1 billion) last March acquired Continental's thriving Visa and MasterCard business for $176 million, outbidding First Chicago in the process. After poring over Continental's books last week, Chemical officers privately called the ailing bank's woes "not insuperable," and then publicly added that they were "taking a serious look."

The attention of First Chicago (1983 assets: $36.3 billion), meanwhile, clearly worries Continental. While a merger of the competitors would create America's fourth-largest bank, Continental President David Taylor fears that perhaps a third of his 12,000 employees would lose their jobs because of the resulting duplication of services. Both to head off First Chicago and to open the door to banks like New York-based Chemical, Continental attorneys last week were helping to draft legis lation that would permit a takeover by an out-of-state U.S. bank. Current Illinois law limits potential buyers to institu tions based in the state or in a foreign country.

Despite the merger activity, Taylor insists that Continental still hopes to remain independent. "That is our top priority," he said, "and we are aggressively pursuing that option." A bank task force nicknamed Operation Bootstrap has been devising strategies. One possibility: sell Continental's $2.3 billion in bad loans to investor groups and pump the cash back into the bank.

Continental could still see some bright spots last week. With its solvency at least temporarily assured, customers started to return their money. "Some were a bit sheepish that they were stampeded by a rumor," one bank executive noted. "We don't blame them, but they damn near did us in." Other depositors, however, seemed determined to stay away. Said one wealthy Chicagoan, who shifted the more than $1 million in his children's trust fund to First Chicago: "The worst four-letter word in banking is risk, and Continental took too many of them."

Regardless of what happens to Continental and Manufacturers Hanover, the events of the past two weeks seem certain to have a major impact on U.S. banking. Some politicians are likely to claim that these developments prove that financial institutions should be more closely controlled. In the past few years banks have been gaining ever more freedom from Government regulation. They have been going into areas of finance like securities sales that were previously off limits for them and expanding across state lines into new territory.

Opponents of further deregulation are moving quickly to the attack. Among them is Rhode Island Democrat Fernand St Germain, chairman of the House Banking Committee, who last week introduced a bill that would force commercial banks to sell their discount stock brokerage subsidiaries. Said St Germain of Continental's brush with failure:

"When we are asked to endorse the movement of banks into fields even riskier than conventional banking, this type of incident does strongly suggest the need for careful analysis and caution."

The opposite position is being taken by William Isaac, chairman of the Federal Deposit Insurance Corp., which was a major participant in the Continental bailout. He argued that the bank's problems proved that still more banking restrictions should be lifted. Said he: "To me, this episode is evidence that we must proceed with deregulation." Isaac blamed the bank's troubles partly on a web of entangling state and federal laws. Continental is unable to open offices to seek consumer deposits outside Chicago, for example, because Illinois statutes prohibit branch banking. That has helped make Charts Continental dependent on large foreign customers, who are apt to withdraw their money at the first sign of trouble.

As American money markets closed for a long Memorial Day weekend, concerns about the jittery financial markets remained. C. Fred Bergsten, director of the Washington-based Institute for International Economics, said that the rumors about Manufacturers Hanover "show again how fragile and nervous the markets are." Moreover, the worries about banking are not limited to the U.S. They also involve the whole international financial system. Next week President Reagan and the heads of the world's leading industrial countries will hold their annual economic summit conference in London. After the banking troubles of the past two weeks, they have plenty to talk about. --ByJohn Greenwald. Reported by Lee Griggs/ Chicago and Thomas McCarroll/New York

With reporting by Lee Griggs, Thomas Carroll