Academic journal article Contemporary Economic Policy

Politics and Length of Time to Bank Failure: 1986-1990

Academic journal article Contemporary Economic Policy

Politics and Length of Time to Bank Failure: 1986-1990

Article excerpt

I. INTRODUCTION

The 1980s and early 1990s mark a period of financial distress unparalleled in U.S. history since the Great Depression. From 1980-1992, 4,695 federally insured institutions with assets of $665 billion failed and were resolved at an estimated present-value cost of $165 billion (Barth and Jahera, 1994). Over the period, 1,142 savings and loans (S&Ls) failed. Resolving these savings and loans cost $127 billion. Additionally, resolving 1,503 failed banks cost $37 billion, and resolving 2,050 failed credit unions cost $452 million. S&Ls account for slightly over 76% of the $165 billion resolution costs. Banks account for approximately 22%. The S&L industry behavior during this time period understandably continues to generate great interest among economists.

Banking industry behavior has not received so much attention, perhaps because falling interest rates allowed banks to regain profitability before the industry experienced the magnitude of failures suffered by the S&Ls. The fact that banks can diversify their asset holdings in order to avoid some interest rate risk faced by S&Ls also may explain the lack of interest in banking industry behavior during this period. However, the banking industry is a much larger industry. If it ever reaches the crisis state the S&Ls faced in the 1980s, resolution costs would be significantly higher than they were for the S&L debacle. Therefore, it is very important to understand to what extent problems in the banking industry mimic those of the S&Ls.

This paper applies research on the S&L industry to the banking industry in order to determine whether political influence affects the length of time from initial undercapitalization until ultimate bank failure. Bennett and Loucks (1993) find evidence that insolvent S&Ls with political power, as measured by state representation on the Senate banking committee, were allowed to stay open longer than insolvent S&Ls without such political power This give rise to the question of whether failed banks in states with representation on congressional committees that oversee banking regulation were allowed to remain open longer than banks without such representation.

II. LITERATURE REVIEW

Analysts give several reasons for the S&L debacle and its severity: (i) During the late 1970s to early 1980s, rising interest rates exposed S&Ls to interest rate risk caused by a mismatch in duration and interest rate sensitivity of assets and liabilities. (ii) Regional economic conditions worsened. (iii) State and federal deregulation in the financial services industry allowed S&Ls to enter new loan markets at the same time capital requirements were lowered and the number of regulators decreased. (iv) Changes in federal tax laws that benefitted real estate investment in 1981 hindered it in 1986. (v) Existence of federal deposit insurance exacerbated the problems. (For further discussion of the S&L debacle, see Barth et al., 1985b; Kane, 1989; Barth, 1991; White, 1991; Barth and Brumbaugh, 1992b; and Cebula, 1993). Many of these factors affect the institutional structure within which banks, credit unions, and S&Ls operate. Congress controls these factors that affect the financial services industry's structure. Thus, the relationships among Congress, financial institutions, regulators responsible for protecting the safety and soundness of the financial system, and taxpayers are extremely important.

Becker (1983, p. 371) contends that pressure groups compete among one another for political favors and that "political equilibrium depends on the efficiency of each group in producing political pressure, the effect of additional pressure on their influence, the number of persons in different groups, and the deadweight costs of taxes and subsidies." Romer and Weingast (1991) and Bennett and Loucks (1993) apply this theory to the savings and loan industry to explain why delaying resolution of the failed S&Ls was advantageous to the stockholders, depositors, regulators, and politicians. …

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