IX.

History of Banking

A.

Origins of Banking

Many of today’s banking services were first practiced in ancient Lydia, Phoenicia, China, and Greece, where trade and commerce flourished. The temples in Babylonia made loans from their treasuries as early as 2000 bc. The temples of ancient Greece served as safe-deposit vaults for the valuables of worshipers. The Greeks also coined money and developed a system of credit. The Roman Empire had a highly developed banking system, and its bankers accepted deposits of money, made loans, and purchased mortgages. Shortly after the fall of Rome in ad 476, banking declined in Europe.

The increase of trade in 13th-century Italy prompted the revival of banking. The moneychangers of the Italian states developed facilities for exchanging local and foreign currency. Soon merchants demanded other services, such as lending money, and gradually bank services were expanded.

The first bank to offer most of the basic banking functions known today was the Bank of Barcelona in Spain. Founded by merchants in 1401, this bank held deposits, exchanged currency, and carried out lending operations. It also is believed to have introduced the bank check. Three other early banks, each managed by a committee of city officials, were the Bank of Amsterdam (1609), the Bank of Venice (1587), and the Bank of Hamburg (1619). These institutions laid the foundation for modern banks of deposit and transaction.

For more than 300 years, banking on the European continent was in the hands of powerful statesmen and wealthy private bankers, such as the Medici family in Florence and the Fuggers in Germany. During the 19th century, members of the Rothschild family became the most influential bankers in all Europe and probably in the world. This international banking family was founded by German financier Mayer Amschel Rothschild (1743-1812), but it soon spread to all the major European financial capitals.

The Bank of France was organized in 1800 by Napoleon. The bank had become the dominant financial institution in France by the mid-1800s. In Germany, banking experienced a rapid development about the middle of the 19th century with the establishment of several strong stock-issuing, or publicly owned, banks.

Banking in the British Isles originated with the London goldsmiths of the 16th century. These men made loans and held valuables for safekeeping. By the 17th century English goldsmiths created the model for today’s modern fractional reserve banking—that is, the practice of keeping a fraction of depositors’ money in reserve while extending the remainder to borrowers in the form of loans. Customers deposited gold and silver with the goldsmiths for safekeeping and were given deposit receipts verifying their ownership of the gold deposited with the goldsmith. These receipts could be used as money because they were backed by gold. But the goldsmiths soon discovered that they could take a chance and issue additional receipts against the gold to other people who needed to borrow money. This worked as long as the original depositors did not withdraw all their gold at one time. Hence, the amount of receipts or claims on the gold frequently exceeded the actual amount of the gold, and the idea that bankers could create money was born.

B.

History of Banking in the United States

B.1.

Bank of North America

The first important bank in the United States was the Bank of North America, established in 1781 by the Second Continental Congress. It was the first bank chartered by the U.S. government. Other banks existed in the colonies prior to this, most notably the Bank of Pennsylvania, but these banks were chartered by individual states. In 1787 the Bank of North America changed to a Pennsylvania charter following controversy about the legality of a congressional charter. Other large banks were chartered in the early 1780s by the various states, primarily to issue paper money called bank notes. These notes supplemented the coins then in circulation and assisted greatly in business expansion. The banks were also permitted to accept deposits and to make loans.

Because there were no minimum reserve requirements on deposits, bank notes were secured by the assets of the issuing banks. Most assets took the form of business loans. The only restraint on a bank’s ability to extend loans was the public’s unwillingness to accept its notes. Acceptance of a bank’s notes usually was determined by the bank’s record in exchanging the notes for coins when called upon to do so. Since most of them were able to do this, the early banks enjoyed wide latitude in granting loans.

In 1791 the federal government chartered the Bank of the United States, commonly referred to as the “First” Bank of the United States, to serve both the government and the public. One-fifth of the bank’s capital was supplied by the federal government. The bank was a repository of government funds and a source of loans for individuals and the federal and state governments. The charter of the “First” Bank of the United States was allowed to lapse in 1811, in part because half of its stock was owned by foreigners but also because of opposition to the bank by more than 80 state-chartered banks. The main reason for the conflict between state banks and the “First” Bank of the United States was that the public preferred the notes of the Bank of the United States because of the bank’s excellent reputation. This made it difficult for state banks to attract customers.

B.2.

Second Bank of the United States

During the War of 1812, hard currency (coins) became scarce and many state banks stopped redeeming their notes for coins. This brought into question the underlying value of bank notes and limited their use as money. At the same time, however, banks began increasing the amount of notes they issued. This rapid increase in paper money caused prices to rise and created inflation. These developments created a demand for establishing the “Second” Bank of the United States, which was chartered in 1816. The bank had a stormy career. Many local bankers who had to compete with this government-sponsored bank opposed it, as did President Andrew Jackson. As a result of Jackson’s opposition, the federal government withdrew its deposits in 1833, and three years later, when the bank’s charter was not renewed, it went out of existence.

B.3.

Free Banking and the Safety Fund System

In 1838 New York State passed a free banking law. Before this date all incorporated banks had been chartered by states and had been granted the note-issuing privilege. Under free banking, charters could be obtained without a special act of the state legislature. The main requirement for new banks was that they post collateral of government bonds equal in value to the notes to be issued. In principle, noteholders were protected because, if the bank failed, proceeds from the sale of the collateral would be used to reimburse them. Free banking was soon adopted by other states. Because there was little regulation of new banks, many banks failed and bank fraud occurred. The free-banking years of 1837 to 1863 are also known as the Wildcat Banking era.

In New England, however, the Suffolk Bank in Boston, Massachusetts, had redeemed bank notes of out-of-town banks only if they kept on deposit amounts large enough to cover the redemptions. Since Boston was a trade center, the pressure was great on all New England banks to accept this system, known as the Suffolk banking system. Practically all New England banks had joined the system by 1825.

In the early 1800s New York State also developed the safety fund system, under which each member bank contributed a small percentage of its capital annually to a state-managed fund. The purpose of the fund was to protect noteholders in the event of bank failure. In 1842 Louisiana enacted legislation to limit the number of banks and to require them to maintain one-third of their assets in cash and two-thirds in short-term obligations.

B.4.

The National Banking Act of 1863

The Civil War (1861-1865) brought about the National Banking Act of 1863, and with it a fundamental change in the structure of commercial banking in the United States. Originally named the National Currency Act, but later amended and renamed, the National Banking Act created the system known as dual banking, in which banks could have either a state or federal charter. This system still exists in the United States. The act established the Office of the Comptroller of the Currency in the Department of the Treasury and gave it the power to issue national bank charters to any bank that met minimum requirements. The philosophy of relatively “free banking” continued until 1935 when Congress made it more difficult to obtain a bank charter. The 1863 act allowed nationally chartered banks to issue a uniform bank note backed by U.S. government bonds. The amount of the notes was not to exceed 90 percent of the value of the bonds. Officials hoped that the issuance of uniform bank notes backed by the U.S. government would guarantee the value of bank notes and thereby produce a useful nationwide currency, while also inducing state banks to take out national charters. However, because the regulations accompanying a national charter were much stricter than state charters, a movement toward federal charters did not happen as planned. In 1865 the U.S. Congress enacted a 10 percent tax on any bank or individual paying out or using state bank notes. As a result of the tax, many banks converted to national charters, but many others simply stopped issuing their own notes. Instead, these state banks began to issue their customers demand deposit money—that is, checking accounts, instead of bank notes.

By the 1870’s, deposits were well established as a substitute for paper or coin currency, and state banks experienced a revival. State charters contained several advantages over federal charters. State-chartered banks were allowed to hold lower cash reserves relative to deposits, and less capital. State-chartered banks had more flexible branching opportunities and fewer restrictions on the types of loans that could be made.

The National Banking Act was successful in correcting some failings of the pre-Civil War commercial banking system. It produced a unified national paper currency consisting primarily of national bank notes. Bank crises, however, did not disappear. Panics occurred in 1873, 1884, 1893, and 1907, although the causes of these crises varied. Between 1873 and 1907, demand deposits far outweighed bank note circulation. At times some banks were unable to make immediate payment of demands on these deposits. Consequently these banks failed, and their depositors suffered losses of all or part of the money in their accounts.

B.5.

Federal Reserve Act of 1913

The financial panic of 1907 resulted in the Federal Reserve Act of 1913. This act went further than any earlier legislation in recognizing the importance of stable money and credit conditions to the health of the national economy. Under the Federal Reserve Act, a central bank was reestablished for the United States, the first since the “Second” Bank of the United States. The new bank was charged with maintaining sound credit conditions. To achieve this goal, the Federal Reserve System was given control over the minimum amount of reserves that member banks must hold for each dollar of deposits. It also obtained the power to lend money to member banks and regulate the types of assets they can hold. Members of the Federal Reserve System include national banks, whose membership is required, and state banks, whose membership is optional. Membership requires a bank to buy stock in the Federal Reserve System. Most large banks under state charter have joined the system.

World War I (1914-1918) brought about inflation and a sharp postwar recession (economic slowdown). Although the banks had bought large quantities of U.S. government bonds during the war, they also lent large amounts of money to individuals engaged in stock market speculation. By investing in bonds, banks helped finance government expenditures during the war and the attendant expansion of American productive resources in the decade following World War I. By lending money to speculators, they became a major factor in the climb of stock prices and the wave of speculation that resulted in the crash of 1929.

B.6.

Banking During the Great Depression

The Great Depression of the 1930s dealt a severe blow to the commercial banking industry. Many banks failed (went out of business) when their loans could not be repaid. The number of commercial banks declined from 26,000 in 1928 to about 14,000 in 1933. Total deposits in these banks declined by about 35 percent. Depositors rushed to retrieve their money, a process known as a run on the banks, and the federal government was forced to close all the banks for four days in 1933 to stem the panic. It became apparent to observers that the Federal Reserve System had not solved all the problems of bank stability.

Consequently, during the Great Depression, Congress recognized the importance of a sound banking system and created a number of agencies to restore public confidence in the banking system. Among the first of these was the Federal Housing Administration, which was created in 1934 to insure payment on home loans made by private lending institutions. The guarantee helped preserve the value of bank loans and enabled banks to continue to lend money to homebuyers.

The Banking Act of 1933, also known as the Glass-Steagall Act, created the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits, increase the confidence of depositors, and therefore prevent bank runs. Federal Reserve member banks were required to join the FDIC. Membership was optional for other banks. The Glass-Steagall Act also set interest rate ceilings on deposits to reduce competition among banks, which was considered a cause of bank failures during the Great Depression. It also prevented banks from becoming too involved in investment-banking activities, such as underwriting stocks or bonds for companies. Underwriting, which typically involves selling stocks or bonds at a guaranteed price, can be risky and can cause banks to fail. The act also prevented banks from buying stock, which is a risky activity if the stock market crashes. This prohibition on investment-banking activities lasted until the 1980s.

The banking system began to recover in 1934. By 1937 deposits had reached pre-Depression levels. During World War II (1939-1945), deposits increased rapidly and more than doubled from 1941 to 1946. For the next 40 years the U.S. banking system went through a continuous expansion and modernization. In particular, there was an enormous increase in lending to consumers, through installment loans (loans for a fixed amount repaid in equal monthly payments) and credit card loans (loans for a varied amount repaid more flexibly).

B.7.

Banking After World War II

Some of the legislation enacted during the Great Depression and in the immediate postwar period began to have negative repercussions on the banking industry by the 1970s, according to some experts. Interest ceilings on deposits, which were required by the Glass-Steagall Act, prevented banks from competing with unregulated money market funds or even bonds issued by the U.S. Treasury. As people withdrew deposits to earn higher interest elsewhere (a process known as disintermediation), SLAs found it increasingly difficult to raise funds to make mortgage loans. Many SLAs went out of business. Disintermediation was not the only problem SLAs faced, however. Many SLAs decided to venture into business lending in the early 1980s with drastic consequences as commercial real estate markets collapsed. Many business loans went bad and forced even more SLAs out of business. In 1980, 3,998 SLAs existed in the United States. By 1992 the number had dwindled to only 2,039. There were 672 SLA failures from 1989 to 1992 alone and over 1,200 overall. The SLA crisis ultimately led to the collapse of the Federal Savings and Loan Insurance Corporation. It necessitated a restructuring of deposit insurance in the United States and a government bailout of the SLA industry that cost taxpayers an estimated $200 billion.

Restrictions on how banks could expand geographically also affected the industry. The Bank Holding Company Act of 1956 prohibited bank holding companies from acquiring banks across state lines. As a result of geographic limitations on expansions, banks were forced to operate primarily in local markets, which made banks particularly susceptible to local economic downturns. This act also restricted the activities of bank holding companies, limiting them to only those activities that were closely related to banking.

Legislation enacted in the 1980s and 1990s began to address these issues. The Depository Deregulation and Monetary Control Act of 1980 eliminated ceilings on interest rates. The 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act legalized interstate banking, allowing banks to diversify geographically.

The most sweeping legislation, however, took place in 1999 when Congress removed most of the remaining provisions of the Glass-Steagall Act and replaced it with the Gramm-Leach-Bliley Act, named after Republican Party sponsors Phil Gramm, Jim Leach, and Thomas Bliley, Jr. The act also removed some of the restrictions of the Bank Holding Company Act of 1956 by permitting bank holding companies to engage in the full range of financial services, including lending, deposit taking, investment advising, insurance, stock and bond underwriting, and other investment banking services. The act did not, however, allow bank holding companies to own nonfinancial businesses.

Many observers believed that the new law would increase the dominance of bank holding companies and lead to the establishment of so-called universal banks that offer a full array of financial services, including traditional banking services, insurance, investment advice, and stock and bond brokerage services. These critics cautioned that the new law, combined with the provisions of the 1994 act that ended restrictions on branching and allowed nationwide banking, would ultimately diminish competition for financial services in the United States. Still other critics warned that the deregulation of the banking industry that began under the administration of President Ronald Reagan encouraged banks to make risky investments, especially in new financial instruments known as derivatives. By breaking down the walls between investment banks and commercial banks, these critics argued, the entire financial system was jeopardized.

B.8.

The Financial Crisis of the 21st Century

As the 21st century began, the United States experienced its worst financial crisis since the Great Depression. The crisis came to a head in 2008 when the nation saw its largest bank failure and the near collapse of the investment banking industry. The crisis required an extraordinary intervention by the Federal Reserve System, known as the Fed, and the Department of the Treasury as the bank failures led to a virtual halt in lending by the financial industry. At the urging of the Fed and the Treasury Department, the U.S. Congress passed legislation in the fall of 2008 authorizing a $700-billion bailout package to restore liquidity to the system. Subsequent interventions by the Fed and the Treasury Department involved loans in the trillions of dollars.

To many observers, the crisis began as a result of a bubble (pattern of risky speculation) in the housing industry. As housing prices continued to climb year after year, many lenders hoped to take advantage of the mushrooming market by offering home ownership opportunities to a wider group of customers. They began offering so-called subprime (credit-risky) mortgages to borrowers who ordinarily would not qualify for a mortgage because of a bad credit history, low income, or the lack of cash for a down payment on a house. Many of these subprime mortgages came with adjustable rates, known as ARMs, making them more attractive because monthly mortgage payments were typically lower in the early years of the loan. In 1994 banks and other mortgage lenders originated subprime loans totaling $35 billion. By 2005 the market in subprime mortgages had grown to $625 billion, or 20 percent of all mortgages.

The roots of the crisis, however, lay much deeper and involved a number of other factors. Beginning in the 1970s many banks no longer held onto the mortgages they originated. Instead they sold them to government-sponsored enterprises known as Fannie Mae and Freddie Mac in what was called the secondary mortgage market. By raising new cash through these sales they were able to make more loans. This trend accelerated in the 1980s and began to be applied to other types of debt, including credit card debt, car loans, and student loans. Other investors began to buy mortgages and other types of debts. They were largely unregulated institutions such as finance companies, investment banks, and money market funds. These institutions were not required to keep deposits to back loans, as commercial banks were. They packaged mortgage and other types of debts into securities, a process known as securitization. These mortgage securities were similar to bonds and were sold to other investors.

A typical mortgage security was divided into three bundles or slices, also called tranches, which paid a different amount of interest depending on the level of risk involved. Investors could buy a tranche that consisted of the safest type of debt but yielded the lowest interest payment. Or they could buy so-called mezzanine tranches that entailed slightly more risk but with a higher interest payment. The riskiest tranche was known as the equity tranche, which carried potentially the highest return. These mortgage securities were often known as collateralized mortgage obligations (CMOs).

Beginning in the 1980s, these CMOs were often bought up and pooled into other financial products, including collateralized debt obligations (CDOs). CDOs were derivatives that derived their value from mortgage securities. They were, in effect, like stock mutual funds but instead of pooling stocks from various companies, they pooled together CMOs and other debt securities. Mostly unregulated funds known as hedge funds were among the principal investors in CDOs. Hedge funds were so-called because they supposedly hedged against their investments to protect investors from losses. Except for those that were traded on exchanges, hedge funds were largely unregulated. Hedge funds catered mainly to wealthy investors, investment banks, and pension funds. They became major players in the financial world because they were highly leveraged—that is, they borrowed most of the money they used to invest, often as much as 15 to 30 times what actually belonged to the fund.

The development of securitization led to the creation of the so-called shadow banking system. The shadow banking system was made up of hedge funds, investment banks, finance companies, and other entities, all of which were largely unregulated and lacked transparency—that is, they were not required to disclose their assets. This system quickly rivaled commercial banks in lending power, providing $6 trillion in credit by 2007. Midway through the first decade of the 21st century, the shadow banking system accounted for 80 percent of all lending, compared with only 25 percent in the 1980s, according to some estimates. The success of this system prompted commercial banks to get involved in mortgage securities and other securitized loans by creating subsidiaries known as structured investment vehicles (SIVs). Because they were not backed by deposits, the SIVs had to be based offshore, mostly in the Cayman Islands. SIVs became part of the shadow banking system. They also borrowed aggressively and were leveraged as much as 30 to 40 times their actual assets. By 2007 SIVs held $1.4 trillion in CDOs and mortgage securities based on subprime mortgages.

Mortgage securities and CDOs soon became global investments. Nothing prevented banks and other financial institutions around the world from investing in them, and many did so. However, there was no way of determining how risky these investments were because they were pooled together. As a result ratings were given to them based on mathematical models that were supposed to determine risk level. Rating agencies used these mathematical models to determine risk. Many observers believed that there was an inherent conflict of interest in the system because the agencies earned high fees from providing these ratings and therefore tended to give the investments favorable ratings. In addition, many of the mathematical models were based on historical data regarding housing prices, and the data often failed to account for a downturn in those prices.

When housing prices began to decline in 2006 and 2007, many new homeowners found that they owed more on their homes than their homes were worth. By 2008 some 8.5 million homeowners had negative equity—that is, they owed more on their mortgage than the value of their house. Some of these homeowners were actually speculators, who did not live in the house but purchased it only to resell it immediately at what they anticipated would be a higher price, a practice known as flipping. In some cases these speculators ceased making payments when they experienced negative equity (also known as an “underwater” mortgage), sending the homes into foreclosure. When holders of subprime mortgages suffered financial difficulty through the loss of a job, a medical emergency, or because their adjustable rates had increased, they, too, faced foreclosure. The rise of foreclosures, reaching into the millions, left the holders of mortgage-backed securities with worthless or greatly devalued assets.

Further complicating matters was uncertainty over which mortgage-backed securities were risky or vulnerable, since no one actually knew how many bad mortgage loans were involved in these securities. The first warning sign came in 2007 when the investment bank Bear Stearns collapsed due to failed mortgage securities held by its hedge funds.

As the housing market crumbled, the nation’s sixth largest bank and its largest savings-and-loan institution, Washington Mutual, with $307 billion in assets, saw many depositors begin to withdraw their money in panic. The Federal Reserve seized the bank and arranged for it to be acquired by J.P. Morgan Chase & Co. It was the largest bank failure in the nation’s history. Soon after Washington Mutual failed, the Fed also had to rescue the banking operations of Wachovia Corporation. With this action, the U.S. banking industry was further consolidated into only three major banks—Bank of America Corporation, Citigroup, and J.P. Morgan Chase—which controlled about 30 percent of all bank deposits in the United States.

In October 2008 Congress passed and President George W. Bush signed the largest bailout plan in U.S. history. The banking rescue plan initially gave the Treasury Department the power to use $350 billion in taxpayer funds. It gave the secretary of the treasury, Henry Paulson, wide powers to determine how the funds should be used and gave him the authority to spend up to $700 billion. In addition, to reassure bank depositors, Congress temporarily increased deposit insurance guaranteed by the Federal Deposit Insurance Corporation from $100,000 per depositor to $250,000 for the period from October 2008 through December 2009.

The crisis promised to spark a sweeping reassessment of government regulation of the banking industry. Congressional inquiries began into the bank failures, and the Federal Bureau of Investigation (FBI) opened formal probes to determine if fraud was involved. Some economists argued that the unregulated shadow banking system was largely responsible for the disaster. They pointed to the role of nondepository institutions, such as the failed investment banks Bear Stearns and Lehman Brothers, which had assumed huge debts that were not backed by savings deposits and provided credit through the complex financial instruments known as derivatives. These derivatives also had escaped regulatory control and thus imperiled the entire financial system. See also Investment Banking.

The Treasury Department began to implement the bailout plan almost immediately. Among its first measures was to buy preferred shares, totaling $125 billion, in nine of the nation’s largest banks. Because the banks were compelled to participate in the bailout, some observers termed the move a “partial nationalization” of the nation’s banking industry. The measures fell short of total nationalization, in part because the Treasury Department acquired nonvoting shares, meaning that it had no control over banking operations.

To participate in the bailout program, which was titled the Troubled Asset Relief Program (TARP), the banks had to agree to restrictions on executive compensation and a ban on lucrative retirement packages for executives known as “golden parachutes.” In an attempt to recover some of the taxpayers’ money, TARP called for the preferred shares to pay a 5 percent dividend for the first few years and 9 percent thereafter. The government also obtained warrants that gave it the right to purchase additional bank shares if the share prices increased. Another $125 billion was allocated to purchase shares in thousands of midsized and smaller banks.

In an attempt to loosen credit and renew borrowing, the government also took a number of other unprecedented measures. Among these was a decision to guarantee new debt issued by banks for a three-year period, including loans made to other banks as well as bank customers. The FDIC also extended unlimited insurance on noninterest-bearing accounts, which are typically held by businesses.

The legislation passed by Congress, however, failed to give the Treasury Department any statutory authority to compel the banks to start lending again. Banking industry leaders revealed that they were unlikely to immediately start issuing loans on a wide scale, especially since their losses had virtually wiped out their profits from previous years. The nation’s nine leading banks reported that the value of their assets had declined by $323 billion. As a result, some banks indicated they would use the bailout fund as a cushion against their losses, to avoid cost-cutting measures such as layoffs and branch closings, or to acquire other banks. Some observers predicted that the bailout would lead to further consolidation in the banking industry as stronger banks used the TARP loans to acquire weaker competitors.

By the end of 2008 the Federal Reserve revealed that it had extended its lending and purchases of debt to $2.2 trillion, an increase of about $900 billion. Citigroup reported losses of $65 billion, and in response, the federal government increased Citigroup’s share of the $700-billion bailout package from $25 billion to $45 billion. In addition, the Treasury Department and the FDIC pledged to absorb Citigroup’s losses up to $306 billion in exchange for $7 billion in preferred shares and Citigroup’s agreement to participate in a mortgage loan modification program so that some homeowners facing foreclosure could remain in their homes.

The FDIC also seized three smaller banks and savings institutions that were on the verge of collapse and took the unprecedented step of easing loan repayments for their mortgage holders. The FDIC then sold the banks, two going to U.S. Bancorp, which agreed to absorb up to $1.6 billion of their losses in exchange for the acquisition. Altogether, banking regulators seized 22 banks in 2008.

As 2009 began, the incoming administration of President Barack Obama continued to adopt measures to rescue the banking industry, while also imposing restrictions on compensation for banking executives. In February 2009 Treasury Secretary Timothy Geithner announced a three-part plan totaling up to $2.5 trillion. About $350 billion of the plan was to come from the TARP fund, and the remainder was to be raised from private investors and from the Fed, which was to use its authority to print money to cover the costs. The centerpiece of the plan was the creation of a Public-Private Investment Fund to be jointly run by the Fed and the Treasury Department. Also known as “the bad bank,” the fund was to spend up to $1 trillion to buy the so-called toxic mortgage securities and other toxic assets held by banks and other financial institutions so that they could remove them from their books. The second part of the plan called for the Fed and Treasury to spend up to $1 trillion in financing student loans, automobile loans, and credit card debt. This program was to be known as the Term Asset-backed Secure Lending Facility (TALF). Finally, the plan called for new capital for banks so that they would begin lending again.

To qualify for the new capital, the banks would have to meet certain requirements. Among those requirements were cuts in executive pay and limits on shareholder dividends and corporate acquisitions. Banks were also to be required to make public more information about their lending practices, including a monthly report on new loans. The U.S. Congress also imposed restrictions on executive compensation, limiting bonuses to one-third of salaries paid to top banking executives who accepted TARP money.

In March Geithner released more details on how the Public-Private Investment Fund was intended to work. Under the program the government virtually guaranteed private investors that they would face only limited losses by participating. For example, for every dollar invested in the fund by a private investor the Treasury Department would match that dollar. In addition the FDIC would guarantee six dollars in loans for each dollar invested. If the newly acquired assets gained in value, both the government and the private investors would share in the gain. If the assets declined in value, however, private investors could walk away from the FDIC loans and not be required to repay them. Up to $1 trillion was to be potentially available for the fund to buy up toxic assets. Some critics of this proposal charged that it had the effect of largely privatizing the gains but socializing the losses since tax money would lie behind the government’s contributions. Investors could also use TALF funds to buy up toxic securities, in effect committing another $1 trillion potentially to help the banks remove the toxic assets from their ledgers.

The Obama administration anticipated tighter regulation of the banking industry as a result of the bailout. These new regulatory measures were also outlined in March 2009 but it was unclear if they would be enacted through legislation or simply adopted by existing regulatory agencies. Among the measures under consideration were requiring that derivatives, such as CDOs, be traded on exchanges so that they would have to meet existing regulatory requirements for transparency. The Federal Reserve was also expected to be given an expanded role in overseeing hedge funds and other financial institutions that formed part of the shadow banking system, such as the insurance firm A.I.G., which received substantial bailout money from the federal government.

In April 2009 the International Monetary Fund (IMF) reported that banks and other financial institutions around the world lost $4.1 trillion due to holding toxic assets. Of those losses, about $2.1 trillion could be traced to troubled securities that originated in the United States.