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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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Publication status: published as Quarterly Review of Economics and Finance, 36 (Fall 1996), pp.189-199.
Handle: RePEc:nbr:nberwo:4701

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  1. Ramon P. DeGennaro & James B. Thomson & Robert A. Eisenbeis & ary, 1993. "Capital forbearance and thrifts: an ex post examination of regulatory gambling," Proceedings 421, Federal Reserve Bank of Chicago.
  2. Patric Hendershott & Edward J. Kane, 1992. "Office Market Values During the Past Decade: How Distorted Have Appraisals Been?," NBER Working Papers 4128, National Bureau of Economic Research, Inc.
  3. Kane, Edward J. & Min-Teh Yu, 1995. "Measuring the true profile of taxpayer losses in the S & L insurance mess," Journal of Banking & Finance, Elsevier, vol. 19(8), pages 1459-1477, November.
  4. 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.
  5. 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.
  6. Rebel A. Cole, 1993. "When are thrifts closed? An agency-theoretic model," Finance and Economics Discussion Series 93-37, Board of Governors of the Federal Reserve System (U.S.).
  7. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-42, September.
  8. George G. Kaufman, 1987. "Bank Capital Forbearance And Public Policy," Contemporary Economic Policy, Western Economic Association International, vol. 5(1), pages 84-91, 01.
  9. Edward J. Kane, 1987. "DANGERS OF CAPITAL FORBEARANCE: THE CASE OF THE FSLIC AND "ZOMBIE" S&Ls," Contemporary Economic Policy, Western Economic Association International, vol. 5(1), pages 77-83, 01.
  10. 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.
  11. Dennis E. Bennett & Roger D. Lundstrom & Donald G. Simonson, 1986. "Estimating portfolio net worth values and interest rate risk in savings institutions," Proceedings 116, Federal Reserve Bank of Chicago.
  12. Elijah Brewer, 1987. "The current magnitude of the problem in the S&L industry," Proceedings 160, Federal Reserve Bank of Chicago.
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