Incentive-Robust Financial Reform

By Calomiris, Charles W. | The Cato Journal, Fall 2011 | Go to article overview

Incentive-Robust Financial Reform


Calomiris, Charles W., The Cato Journal


"Will Rogers, commenting on the Depression, famously quipped: "If stupidity got us into this mess, why can't it get us out?" Rogers's rhetorical question has an obvious answer: persistent stupidity fails to recognize prior errors and, therefore, does not correct them. For three decades, many financial economists have been arguing that there are deep flaws in the financial policies of the U.S. government that account for the systemic fragility of our financial system, especially the government's subsidization of risk in housing finance and its ineffective approach to prudential banking regulation. To avoid continuing to make the same mistakes, it would be helpful to reflect on the history of crises and government policy over the past three decades.

The U.S. banking crises of the 1980s--which included the nationwide S&L crisis of 1979-91, the 1986-91 commercial real estate banking crisis (Boyd and Gertler 1993), the LDC debt crisis primarily afflicting money-center banks from 1979 to 1991, the farm credit crisis of the mid-1980s (Calomiris, Hubbard, and Stock 1986; Carey 1990), and the post-1982 Texas and Oklahoma banking crisis (Horvitz 1992)--were disruptive and pervasive. The resolution costs of the thrift failures alone amounted to about 3 percent of U.S. GDP. And, "large" troubled financial institutions (e.g., Continental Illinois Bank--actually a bank of moderate size and insignificant affairs--Citibank, and Fannie Mae) were either explicitly bailed out by the government or allowed to survive despite their apparent fundamental insolvency.

The underlying policy failures that had contributed to these crises were discussed and reasonably well understood by 1990. Clearly, the monetary policy changes of 1979-82, which caused interest rates to skyrocket and later decline, and which were associated with dramatic changes in inflation, term spreads, exchange rates, and energy prices, were the most important shocks driving events in the U.S. banking system during the 1980s. Changes in tax law in 1986 that eliminated accelerated depreciation were also important for promoting commercial real estate distress. But the U,S. banking crises of the 1980s were not primarily attributable to those shocks; three microeconomic policies substantially magnified the severity of the losses experienced by banks. (1)

First, at the heart of the real estate disaster was a raft of government subsidies for real estate finance that proved destabilizing, especially to real estate markets and to financial institutions operating in those markets. These distorting subsidies included special advantages of the thrift charter, subsidized lending from the Federal Home Loan Banks, "regulatory accounting" rules that purposely masked thrift losses, the absorption of interest rate risk in the mortgage market by the inadequately capitalized government-sponsored enterprises (GSEs), Fannie Mac and Freddie Mac, and the lending policies of the Farm Credit System that promoted the farm land bubble of the 1970s and early 1980s.

Second, the increased protection of banks removed deposit market discipline as a source of control over the risk-taking of banks and thrifts. Protection from deposit insurance increased dramatically in 1980 and has been further expanded subsequently, which substantially reduced the possibility that higher risk-taking by banks would lead depositors to withdraw their funds. (2)

Third, ineffective prudential regulation failed to substitute for the market discipline that deposit insurance and other government protection of banks removed. That was especially visible in the failure of supervisors to identify losses in failing banks and prevent those losses from growing larger as the result of increased risk-taking by "zombie" banks and thrifts.

In the wake of the banking crises of the 1980s, the U.S. promulgated an ambitious program of reform to prudential banking regulation and regulatory accounting practices, implemented through the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) in 1989 and the Federal Deposit Insurance Corporation Improvement Act (FDICIA) in 1991. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Incentive-Robust Financial Reform
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.