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How Much Did Capital Forbearance Add to the Cost of the S&L Insurance Mess

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  • Edward J. Kane
  • Min-Teh Yu

Abstract

Federal regulators characterize capital forbearance as an efficient way of nursing weak banks and thrifts back to health. An alternative hypothesis is that forbearance reflects inefficient costs of agency that fall on federal deposit-insurance funds. Divergences between regulatory measures of a troubled institution's net worth and GAAP and market-value measures relieved FSLIC from having to book de facto encumbrances that industry losses were imposing on the FSLIC fund. This omission protected the reputations and careers of top officials. Delays in insolvency resolution intensified FSLIC exposure to future losses by distorting management and risk-taking incentives and squeezing profit margins for surviving thrifts. Besides accumulating projects with negative net present value, delay hurt FSLIC indirectly by undermining the average profitability of the industry it insured. This paper seeks to measure the opportunity cost of FSLIC forbearance during 1985-1989. Although the opportunity cost of delay did not increase every year, it did increase on average. Had opportunity-cost standards of capital adequacy been routinely enforced, FSLIC guarantees would not have displaced private capital on a mammoth scale, surviving members of the industry would have proven more profitable, and investments in commercial real estate would have been restrained.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4701.

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Date of creation: Apr 1994
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Handle: RePEc:nbr:nberwo:4701

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  1. Buser, Stephen A & Chen, Andrew H & Kane, Edward J, 1981. "Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital," Journal of Finance, American Finance Association, vol. 36(1), pages 51-60, March.
  2. George G. Kaufman, 1987. "Bank Capital Forbearance And Public Policy," Contemporary Economic Policy, Western Economic Association International, vol. 5(1), pages 84-91, 01.
  3. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
  4. Elijah Brewer, 1987. "The current magnitude of the problem in the S&L industry," Proceedings, Federal Reserve Bank of Chicago, pages 272-284.
  5. Ramon P. DeGennaro & James B. Thomson & Robert A. Eisenbeis & ary, 1993. "Capital forbearance and thrifts: an ex post examination of regulatory gambling," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 406-420, 40.
  6. Lawrence J. White, 1990. "Problems Of The Fslic: A Former Policy Maker'S View," Contemporary Economic Policy, Western Economic Association International, vol. 8(2), pages 62-81, 04.
  7. Dennis E. Bennett & Roger D. Lundstrom & Donald G. Simonson, 1986. "Estimating portfolio net worth values and interest rate risk in savings institutions," Proceedings, Federal Reserve Bank of Chicago, pages 323-346.
  8. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-42, September.
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