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Bank Deregulation, Credit Markets and the Control of Capital

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  • G. B. Gorton
  • J. G. Haubrich

Abstract

A model with endogenously arising credit markets and banks is displayed. The model economy requires both types of institutions because they serve to control capital in different, yet complementary, ways. The value of credit market securities depends upon bank control of capital which markets cannot achieve. As regulations and technology change, the decision rules and contracts change, and the financial system creates new institutions, markets and assets. Since the model is at the level of underlying preferences and technology it can be used to consider the optimality of banking regulations when the underlying technology of controlling capital shifts. We show that, whatever the merits of the original arguments for bank regulation, with technological change bank regulation may become self-justifying. That is, we show that under plausible conditions the only reason bank regulation is needed is that it currently exists. Moreover, bank regulation can cause the very bank failures it purports to prevent. Bank regulators observing the world would erroneously argue for more bank regulations, including FDIC insurance, when this is, in fact, unnecessary.

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Bibliographic Info

Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 8-86.

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Handle: RePEc:fth:pennfi:8-86

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Cited by:
  1. Boyd, John H. & Chang, Chun & Smith, Bruce D., 2002. "Deposit insurance: a reconsideration," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1235-1260, September.
  2. Mark Gertler, 1988. "Financial structure and aggregate economic activity: an overview," Proceedings, Federal Reserve Bank of Cleveland, pages 559-596.
  3. Goodfriend, M. & King, R.G., 1988. "Financial Deregulation, Monetary Policy, And Central Banking," RCER Working Papers 121, University of Rochester - Center for Economic Research (RCER).
  4. João A.C. Santos, 1998. "Banking and commerce: how does the United States compare to other countries?," Economic Review, Federal Reserve Bank of Cleveland, issue Q IV, pages 14-26.
  5. Miarka, Tobias, 1999. "The recent economic role of bank-firm relationships in Japan," Discussion Papers, Research Unit: Market Dynamics FS IV 99-36, Social Science Research Center Berlin (WZB).
  6. Joseph G. Haubrich, 1995. "Imperfect state verification and financial contracting," Working Paper 9506, Federal Reserve Bank of Cleveland.
  7. Hongfei Sun, 2006. "Aggregate Uncertainty, Money and Banking," 2006 Meeting Papers 58, Society for Economic Dynamics.
  8. Randall J. Pozdena, 1991. "Why banks need commerce powers," Economic Review, Federal Reserve Bank of San Francisco, issue Sum, pages 18-31.
  9. João Santos, 1998. "Commercial Banks in the Securities Business: A Review," Journal of Financial Services Research, Springer, vol. 14(1), pages 35-60, July.
  10. Joseph G. Haubrich, 1992. "Sluggish deposit rates: endogenous institutions and aggregate fluctuations," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 23-35.
  11. Gary Gorton & George Pennacchi, 1990. "Banks and Loan Sales: Marketing Non-Marketable Assets," NBER Working Papers 3551, National Bureau of Economic Research, Inc.
  12. William P. Osterberg, 1992. "Intervention and the bid-ask spread in G-3 foreign exchange rates," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 2-13.

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