Financial Crisis Management

The increasing interconnectedness of financial institutions and markets has underscored the need for diverse federal, state, international, and private organizations to work together to contain and resolve financial disruptions. The federal government's ability to manage financial crises effectively is important to the stability of the U.S. financial system and economy as well as the worldwide financial system. This report examines federal actions that successfully contained four major financial crises during the 1980s--the Mexican debt crisis of 1982; the near failure of the Continental Illinois National Bank in 1984; the run on state-chartered, privately insured savings and loans in Ohio in 1985; and the stock market crash of 1987. The report focuses on the following three phases of financial crisis management: (1) preparedness, which includes activities undertaken before a crisis takes place; (2) containment, which involves measures undertaken immediately following a crisis to mitigate financial disruption and lessen any ill effects on the financial system; and (3) resolution, which includes steps taken to reduce the likelihood of a crisis reoccurring.

GAO noted that: (1) leadership was critical for effective management and containment of each of the four financial crises; (2) Treasury and the Federal Reserve led crisis containment efforts because of their financial resources, access, and expertise, although each agency had its own distinct and complementary leadership role; (3) as part of the executive branch, Treasury was better positioned than the Federal Reserve to provide the political leadership considered desirable in containing a financial crisis; (4) at the same time, the Federal Reserve had critical mechanisms and resources for providing temporary liquidity in a crisis--currency swaps, discount window lending, and open market operations; (5) Treasury also provided temporary liquidity during the Mexican crisis through the Exchange Stabilization Fund; (6) successful crisis response in each case depended greatly on swift and sometimes innovative action, which appeared to help reduce in scope and intensity the effect the crisis had on the financial system; (7) in addition, the more effective the communication of the federal response the more it appeared to help prevent a crisis from worsening, because it provided clear and credible information that played a part in calming financial markets; (8) several officials told GAO that contingency planning, including interagency planning, helped facilitate federal preparedness and response to a crisis; (9) they said that contingency planning helped federal financial regulators identify resources to contain the crisis as well as potentially vulnerable firms or markets; (10) GAO encountered mixed views on the part of financial crisis managers concerning whether or not contingency planning should be documented; (11) some officials were reluctant to document their planning efforts due to fears of triggering a panic or because circumstances of a crisis are never identical to those in the plan; (12) coordination of crisis containment efforts among key participants was important because rarely did one agency have the necessary authority, jurisdiction, and resources to contain the crisis; (13) reliable and timely information was important to federal efforts to provide early warning of potential crises and to help regulators decide whether and how to intervene; and (14) however, several officials told GAO that the federal government's ability to identify incipient financial crises or to monitor a crisis once it had occurred was sometimes limited by the dispersed nature of the government's crisis surveillance capability, along with limitations and gaps in the available information.