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Real Interest Rates and the Savings and Loan Crisis: The Moral Hazard Premium

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  • John B. Shoven
  • Scott B. Smart
  • Joel Waldfogel

Abstract

Real interest rates shifted upwards by four or five percentage points in approximately 1980. The question is why. In this paper we review some of the more popular explanations and point out that they are somewhat inconsistent with the facts. We then present a new explanation which may partially account for the dramatic increase. We suggest that the upward shift in rates may be directly connected with the decade-long crisis in the savings and loan industry and the federal government's handling of that crisis. Owners and managers of troubled thrifts responded to the incentives provided by underpriced deposit insurance by offering higher and higher rates in an attempt to attract new funds. Depositors, anticipating that the government would protect their investments, actively sought out higher yields in local and national markets. The end result was that the rates offered by Treasury securities rose to compete with these quasi-risk-free substitutes sold by savings and loans. This added (and, indeed, continues to add) significantly to the federal government's borrowing costs. We calculate this increased cost under various assumptions about the effect of the S&L crisis on real interest rates.

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Bibliographic Info

Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 6 (1992)
Issue (Month): 1 (Winter)
Pages: 155-167

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Handle: RePEc:aea:jecper:v:6:y:1992:i:1:p:155-67

Note: DOI: 10.1257/jep.6.1.155
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  1. Mishkin, F.S., 1988. "Understanding Real Interest Rates," Papers fb-_88-40, Columbia - Graduate School of Business.
  2. Evans, Paul, 1987. "Do budget deficits raise nominal interest rates? : Evidence from six countries," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 281-300, September.
  3. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  4. Kane, Edward J, 1989. "The High Cost of Incompletely Funding the FSLIC Shortage of Explicit Capital," Journal of Economic Perspectives, American Economic Association, vol. 3(4), pages 31-47, Fall.
  5. B. Douglas Bernheim & Kyle Bagwell, 1989. "Is Everything Neutral?," NBER Working Papers 2086, National Bureau of Economic Research, Inc.
  6. Bernheim, B Douglas & Shleifer, Andrei & Summers, Lawrence H, 1985. "The Strategic Bequest Motive," Journal of Political Economy, University of Chicago Press, vol. 93(6), pages 1045-76, December.
  7. Evans, Paul, 1987. "Interest Rates and Expected Future Budget Deficits in the United States," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 34-58, February.
  8. Kane, Edward J, 1990. " Principal-Agent Problems in S&L Salvage," Journal of Finance, American Finance Association, vol. 45(3), pages 755-64, July.
  9. Poterba, James M. & Summers, Lawrence H., 1987. "Finite lifetimes and the effects of budget deficits on national saving," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 369-391, September.
  10. Plosser, Charles I., 1987. "Fiscal policy and the term structure," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 343-367, September.
  11. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
  12. Edward J. Kane, 1985. "The Gathering Crisis in Federal Deposit Insurance," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262611856, December.
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Cited by:
  1. Jorge A. Chan-Lau & Zhaohui Chen, 1998. "Financial Crisis and Credit Crunch as a Result of Inefficient Financial Intermediation—with Reference to the Asian Financial Crisis," International Finance 9804001, EconWPA, revised 24 Apr 1998.
  2. Ramon P. DeGennaro & James B. Thomson, 1992. "Capital forbearance and thrifts: an ex post examination of regulatory gambling," Working Paper 9209, Federal Reserve Bank of Cleveland.
  3. Hendrickson, Jill M., 2000. "The impact of bank failures on local bank pricing decisions," The Quarterly Review of Economics and Finance, Elsevier, vol. 40(3), pages 401-416.
  4. Kane, Edward J. & Yu, Min-Teh, 1996. "Opportunity cost of capital forbearance during the final years of the FSLIC mess," The Quarterly Review of Economics and Finance, Elsevier, vol. 36(3), pages 271-290.
  5. Bartholdy, Jan & Boyle, Glenn W. & Stover, Roger D., 2003. "Deposit insurance and the risk premium in bank deposit rates," Journal of Banking & Finance, Elsevier, vol. 27(4), pages 699-717, April.
  6. Tzavalis, Elias & Wickens, M. R., 1996. "Forecasting inflation from the term structure," Journal of Empirical Finance, Elsevier, vol. 3(1), pages 103-122, May.
  7. Hendricks, Torben W. & Kempa, Bernd, 2009. "The credit channel in U.S. economic history," Journal of Policy Modeling, Elsevier, vol. 31(1), pages 58-68.
  8. repec:fth:calaec:13-97 is not listed on IDEAS
  9. Harold M. Somers, 1992. "Deficits and Interest Rates," UCLA Economics Working Papers 645, UCLA Department of Economics.

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